The Environmental Risk in Sovereign Credit methodology (ERISC) focuses on the development of metrics and methods for quantifying natural resource and environmental risks so they can be incorporated into country risk assessments used by insurance companies, investors and credit rating agencies. It is a partnership between UNEP FI and Global Footprint Network.
Phase I (2010 – 2012)
ERISC Phase I demonstrated for the first time that natural resource-related environmental issues can affect the economic and sovereign credit risk situation of countries in ways that can be identified and quantified. The research demonstrated how importers and exporters of natural resources such as fossil fuel, timber, fish and crops are exposed to the increasing volatility that accompanies rising global resource scarcity. Meanwhile, the economic consequences of environmental degradation can be severe.
Phase II (2013 – 2016)
The goal of ERISC II was to refine the sophistication and robustness of the ERISC methodology and test its results in existing sovereign credit risk models in order to make it a market-ready tool.
Food is the focus of this round of research. Because food is an essential good (people cannot easily reduce their food intake), the impact of sharp short-term movements in commodity prices is particularly acute. Furthermore, food biomass represents 32 percent of humanity’s Ecological Footprint.
The research considers the factors shaping food supply and demand. They include drivers of food consumption on the demand side (such as the shift of emerging markets toward higher protein-based diets, which are more resource intensive) as well as the supply side (with the flattening of yield growth and the increase in extreme weather events and drought due to climate change).
Given the increasing mismatch between humanity’s demand and nature’s capacity to supply natural resources, as tracked by Ecological Footprint accounting data, it is likely that supply shocks will soon become increasingly relevant to country risk analysis. Newly developed standardized stress testing will allow us to explore how exposed countries are to supply shocks, particularly if they become more frequent and severe.
In the future, the world will likely suffer from higher and more volatile food prices as a result of a growing imbalance between the supply and demand of food, the report notes. Rising populations and incomes will intensify the demand for food while climate change and resource scarcity will disrupt food production. The report, which was published in collaboration with Cambridge Econometrics and several leading financial institutions, models the impact of a global food price shock on 110 countries to assess which countries face the greatest economic risk from this growing imbalance.
In terms of the highest percentage loss to GDP, the five countries that will be worst hit if food commodity prices double are all in Africa – Benin, Nigeria, Cote d’Ivoire, Senegal and Ghana. But China will see the most amount of money wiped from its GDP of any country – $161 billion, equivalent to the total GDP of New Zealand. India will see the second highest loss to GDP – $49 billion, equivalent to the total GDP of Croatia.
Among the report’s other key findings are:
- Overall, Egypt, Morocco and Philippines could suffer the most from a doubling of food prices in terms of the combined impact on GDP, current account balance and inflation.
- 17 out of the 20 countries most at risk from a food price shock are in Africa.
- Paraguay, Uruguay, Brazil, Australia, Canada and the US would benefit the most from a sharp increase in food commodity prices.
- Globally, negative effects of a food price shock massively outweigh positive effects in absolute terms. While China could see an absolute reduction in GDP of $161 billion, the highest absolute positive effect on GDP, seen in the United States, is only $3 billion -50 times smaller than the impact on China.
- In 23 countries, a doubling in food prices leads to a 10 per cent (or more) rise in the consumer price index.
- Countries with higher sovereign credit ratings tend to be less exposed to risks resulting from a food price spike.
- Countries whose populations have the highest consumption of natural resources and services, and are therefore most responsible for the environmental constraints that make future food prices higher and more volatile, tend to face the lowest risk exposure.
UNEP Executive Director Achim Steiner said, “Fluctuations in food prices are felt directly by consumers and reverberate throughout national economies. As environmental pressures mount, it is important to anticipate the economic impact of these stresses so that countries and investors can work on mitigating and minimizing risk. And as the global population continues to rise, food prices can be a bellwether for how environmental risk translates to economic risk and vulnerability.”
The ERISC Phase II report was published in collaboration with Cambridge Econometrics and several financial institutions: Caisse des Dépôts, First State Investments, HSBC, Kempen Capital Management, KfW, and S&P Global Ratings.
This second phase of ERISC is one step in a larger process that aims to identify and quantify the environmental risks linked to the overuse of nature’s assets, and to help financial institutions to integrate these considerations into their decision-making processes. Ultimately, we aim to cover a wide range of such risks. The food-focused analysis of ERISC II is to be part of a larger framework that considers other natural resources, longer-term degradation issues as well as energy, carbon dioxide and climate change risks.