El Niño is unlikely on its own to trigger widespread sovereign credit rating downgrades unless the weather phenomenon proves significantly more severe than expected or governments respond with costly support measures, according to S&P Global.
Joydeep Mukherji, S&P Global’s lead ratings analyst for Latin America, said the impact on sovereign ratings would depend not only on the economic disruption caused by severe droughts or flooding linked to a potential “super” El Niño, but also on how policymakers respond to the fallout.
Mukherji said temporary disruptions to economic activity caused by flooding or drought would not necessarily lead to rating pressures if economies are expected to recover within six to 12 months.
“If it’s a flooding or a drought that causes disruption in economic activity, you assume it’s going to pick up in six months, 12 months’ time,” Mukherji said in an interview.
“Ratings should be able to withstand that kind of stress, if that’s all that happens.”
However, he said the fiscal response from governments in countries severely affected by the weather phenomenon could become a more important factor.
Mukherji explained that limited fiscal assistance to affected households and businesses would have a different impact from broader government interventions such as electricity or fuel price controls.
Such measures, he warned, could create additional pressure on public finances and turn a temporary climate shock into a broader fiscal problem.
Governments therefore face a choice between allowing households and businesses to absorb part of the economic losses or taking on a larger share of the costs through increased public spending, wider fiscal deficits and additional borrowing.
“Policy response is key here,” Mukherji said, adding that governments must decide whether to share the costs of the shock or absorb a larger portion through higher deficits and debt.
Sovereign ratings could come under greater pressure if governments significantly increase borrowing to shield consumers and businesses from the economic impact of El Niño.
Mukherji also said countries with flexible exchange rates could be better positioned to absorb weather-related economic shocks.
He cited Colombia and Peru as examples of economies where the impact could be substantial but flexible currencies could provide policymakers with an additional tool to manage the disruption and maintain competitiveness.
By contrast, countries without their own currencies may have fewer policy options available.
Mukherji pointed to dollarised Ecuador, where the absence of an independent currency could limit the government’s ability to use exchange-rate adjustments to support competitiveness following an economic shock.
Despite the potential risks, S&P Global is not currently expecting El Niño to trigger a broad wave of negative sovereign rating actions.
Mukherji cautioned, however, that uncertainty remains high over the eventual scale and severity of the weather phenomenon.
The potential for a stronger-than-expected El Niño, combined with the fiscal choices governments make in response, will therefore remain important factors for sovereign creditworthiness as the climate event develops.
