The Earth’s average temperature has warmed about one degree (10) Celsius above pre-industrial levels, according to the most recent data from NASA. This change, though seemingly insignificant, has resulted in a rapid global torrent of weather anomalies, followed by increasingly frequent and catastrophic natural disasters. At the macro level, climate change risks can be characterized as: (i) “physical risks”, resulting from economic losses and deaths caused by extreme and unforeseen weather events, and (ii) “transition risks” , uncertainty and policy-induced transition to a carbon-neutral economy. How would these two risks impact economic growth and trade, particularly in the many developing and climate-vulnerable countries of South Asia? This article aims to examine this issue, as well as its policy implications, with a focus on the BoP.

PHYSICAL RISKS: Rising temperatures, intensification of cyclones, floods and salt water intrusion, among others, threaten agricultural production in terms of land and labor productivity. This paints a stark picture of Bangladesh, a low-lying country with an economically important agricultural sector – ranked in Germanwatch’s Global (Long-Term) Climate Risk Index 2021 as the seventh most vulnerable country to physical hazards. An International Monetary Fund Country Report on Climate Change Mitigation and Adaptation in Bangladesh: Policy Options (dated September 2019) states that in 2017, extreme flooding alone affected more than 8 million people and resulted in severe crop destruction in Bangladesh. This, in turn, led to a drastic increase in food imports which largely contributed to the deterioration of its current account deficit in fiscal year 2016-2017: from $1,331 million to $9,780 million; moving the overall BoP from a surplus of $3,169 million to a deficit of $885 million (for the first time since fiscal 2001).

In addition, weather disasters would also weigh on the tourism industry. The destruction of natural heritage and tourist infrastructure lowers tourism demand and risks triggering increases in insurance premiums – thus hampering the survival of small and medium-sized businesses in the sector. Accordingly, the potential balance of payments complications brought about by climate change can be exemplified by the COVID-19 pandemic shock which has severely affected many tourism-dependent developing economies. Taking Vietnam as an example, the International Monetary Fund’s country report on the “2020 Article IV consultation” with Vietnam points out that a decline in the country’s tourism receipts (and remittances) has led to a decline in the current account surplus through FY2020 – in stark contrast to the decline from 1.9 to 3.8% of GDP in the prior FY.

Overall, the collapse of agricultural and tourism exports may coincide with reduced investment in local infrastructure (resulting in lower future production) and weaker foreign exchange inflows – in turn, sowing BoP deficits potentially persistent through the current (trade) account. As a Swiss Re Institute publication titled “The Economics of Climate Change: No Action, No Option” states: developing countries, due to heavy economic dependence on these sectors and with low mitigating capacity, are often the ones who bear the brunt of these physical risks. This, by implication, dims growth prospects while reinforcing vicious cycles of poverty.

TRANSITION RISKS: In much of the current literature, the term ‘transition risks’, usually considered at the firm level, describes the situation in which fossil fuels are treated as ‘stranded assets’ in commodity markets. capital during the global transition to cleaner renewable energy sources. – fueled by concerns about structural and policy changes aimed at mitigating climate change. This would therefore erode the value of the companies and industries that produce or exploit these fossil fuel-based products. Thus, shedding light on the potentially serious macroeconomic issues that transition risks can introduce economy-wide.

The latest statistics from the World Bank describe the proliferation of carbon pricing instruments as policymakers around the world recognize the need to deter (internalize the cost) of greenhouse gas emissions – namely, in 46 countries in September 2022. This includes carbon taxes and caps. and commercial systems, each of which translates directly into higher production costs and tight fossil fuel supplies, respectively. Simultaneously, they would reduce business and export competitiveness in carbon-intensive industries, with knock-on effects to the rest of the economy (i.e. through lower input costs and utility bills higher). In addition, a group of researchers from Boston University, in the policy brief entitled “Climate Change and IMF Surveillance: The Need for Ambition”, coined the concept of “transition risk spillover” to illustrate how transition risks can be further amplified by border trade policies. A prime example is the European Union’s proposal for a ‘Carbon Border Adjustment Mechanism (CBAM)’ which aims to adjust the prices of imports according to their carbon footprint as early as 2023. This has however been highly controversial, citing strong accusations of protectionism and likely trade diversion from the developing world to the developed world – where such carbon pricing mechanisms are already well established domestically.

Another likely implication is that as the global economy embarks on a phase-out of fossil fuel consumption, coupled with uncertainty and weak market sentiment towards the industry, transition risks would weigh negatively on commodity currencies. Commodity currencies refer to currencies that tend to be closely linked to world prices of commodities, including fossil fuels – due to the importance of natural resources in generating global income, such as in Malaysia (Ringgit Malaysian). This can be explained using the classic “Dutch disease model”, devised by Max Corden and Peter Neary in 1982, which points out that in the event of an expected permanent decline in commodity prices and production, a reduction natural resource revenues leads to a decline in aggregate domestic demand. This fall in demand is partly absorbed by a fall in demand in the non-tradable sectors at the international level (services), leading to a displacement of labor and capital towards the tradable sectors at the international level (agriculture and industry), facilitated by a depreciation of the exchange rate. With this in mind, a more recent research paper from the BI Norwegian Business School titled “Climate Risk and Commodity Currencies” presents empirical results consistent with the argument that “when transition risk is high, commodity-linked currencies are likely to experience an episode of persistent depreciation”. as well as a weakened relationship with commodity prices”. From the perspective of a fossil fuel exporting developing country, a weaker currency may indicate cheaper but obsolete fossil fuel exports, while imports (usually associated with high knowledge and technology content/life-savings for economic development) become more expensive. Therefore, with a decrease in the value of exports and an increase in import costs, such a depreciation is unlikely to translate into an improvement – ​​but rather a deterioration in the current account and the balance of payments as a whole.

Given the 2015 Paris Agreement to pursue the goal of limiting global warming to 1.5 degrees Celsius (and no more than 2 degrees Celsius) above pre-industrial levels, it has been estimated that around 80 % of fossil fuel reserves are needed to remain unextracted. to curb climate change – as reported in a Financial Times article entitled “Lex in depth: The $900 billion cost of ‘stranded energy assets’. Thus, a move in this direction – giving rise to a shrinking global market for oil, coal and natural gas – is likely to create long-term pressure on the balance of payments of “fossil fuel-powered” economies. especially in less developed countries. generally associated with the “resource curse” (low export diversification).

CLIMATE INACTION IS NOT A SOLUTION: The looming climate crisis underscores the urgency of designing prudent and well-targeted policies to protect the economy against such damaging and possibly irrevocable consequences. On the one hand, the adaptation approach, including the development of more climate-resilient agricultural strategies (i.e. crop and livestock diversification) and infrastructure, is essential to support vulnerable industries and promote food security. In terms of mitigation measures, carbon tax systems should be commensurate with the provision of public funding and subsidies (or development aid) for the adoption of cleaner production methods and technologies. Namely, climate policies should incentivize environmentally friendly companies to improve their profitability and competitiveness (for example through the sale of carbon allowances which could, in turn, be invested in greater production capacity). In both cases, developed countries play a central role in helping the less developed to adapt and rapidly mitigate the risks induced by climate change. Therefore, these climate policies would help ensure balance of payments stability – driving export growth, as well as overall development and innovation, in the “right” sustainable direction.

Chenlin Li and Chua Shu Yi graduated from the School of Economics at the University of Nottingham in Malaysia. [email protected], [email protected]