Kicking away the green ladder: the asymmetric sovereign risk from nature degradation

This paper investigates the uneven consequences of nature and biodiversity loss for the cost of sovereign government borrowing. A growing literature documents the adverse economic consequences of climate change. However, little attention has been devoted to the influence of nature degradation on sovereign bond yield spreads, which determine government’s funding costs and fiscal policy space. Employing panel interactive fixed effects and quantile regressions with latent factors, we extend the literature to the nature context with three proxies for countries’ nature-related financial vulnerability. Across 28 advanced and 25 emerging economies over the 2000-2020 period and 2, 5, and 10-year bond maturities, our results indicate substantial average impacts from within-country degradation for sovereign borrowing costs whilst controlling for conventional economic and institutional determinants, and common global financial factors. Our second-stage heterogeneity analysis reveals significant variation in impacts. We find that countries with elevated sovereign risk are disproportionally impacted by nature vulnerability, up to three times the average marginal effect of forty-to-fifty basis points for countries in the 90th percentile of borrowing costs. Our novel empirical results underline the asymmetric macro-criticality of nature for sovereign borrowing costs with disproportional effects that exacerbate existing macro-financial fragilities. Yet the financial effects are unlikely to be confined to debt-distressed, high-risk and nature-dependent countries, considering the integrated nature of global supply chains and sovereign debt markets.