Modelling the impact of physical climate risk and adaptation on sovereign credit ratings

Climate-related extreme weather events create significant fiscal pressures for governments, yet their impacts on sovereign creditworthiness and the risk reduction benefits of adaptation remain poorly quantified. We develop an integrated modelling framework linking acute climate risk, macroeconomic, and sovereign credit rating models to probabilistically assess how climate extremes and adaptation investments impact sovereign creditworthiness. Applying this framework to river flooding in Thailand, we show that flood-induced losses in an extreme year could trigger multi-notch sovereign rating downgrades, substantially increasing borrowing costs. Under future emissions scenarios, these rating impacts increase significantly. However, large-scale government-funded adaptation investments in flood protection can substantially reduce these risks across all climate scenarios. Built using open data and existing macroeconomic tools, our framework provides governments and international institutions with practical methodologies for integrating acute climate risks and adaptation benefits into sovereign debt sustainability analyses, offering climate vulnerable, indebted countries an evidence-based pathway to break the ‘climate investment trap’.