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International Monetary Fund. Monetary and Capital Markets Department

Abstract

The April 2020 Global Financial Stability Report (GFSR) assesses the financial stability challenges posed by the coronavirus (COVID-19) pandemic. Chapter 1 describes how financial conditions tightened abrubtly with the onset of the pandemic, with risk asset prices dropping sharply as investors rushed to safety and liquidity. It finds that a further tightening of financial conditions may expose vulnerabilities, including among nonbank financial institutions, and that bank resilience may be tested if economic and financial market stresses rise. Vulnerabilities in global risky corporate credit markets, including weakened credit quality of borrowers, looser underwriting standards, liquidity risks at investment funds, and increased interconnectedness, could generate losses at nonbank financial institutions in a severe adverse scenario, as discussed in Chapter 2. The pandemic led to an unprecedented and sharp reversal of portfolio flows, highlighting the challenges of managing flows in emerging and frontier markets. Chapter 3 shows that global financial conditions tend to influence portfolio flows more during surges than in normal times, that stronger domestic fundamentals can help mitigate outflows, and that greater foreign participation in local currency bond markets may increase price volatility where domestic markets lack depth. Beyond the immediate challenges of COVID-19, Chapter 4 explores the profitability pressures that banks are likely to face over the medium term in an environment where low interest rates are expected to persist. Chapter 5 takes a broader perspective on physical risks associated with climate change. It finds that these risks do not appear to be reflected in global equity valuations and that stress testing and better disclosure of exposures to climatic hazards are essential to better assess physical risk.

Mr. Paul S. Mills

Commodity Boom: How Long Will It Last?" asks how economies will fare after the record-high prices of key raw materials posted in recent months, which build on dramatic increases from their lows of 2000. The lead article warns that the impact on headline inflation levels might persist throughout 2008, even without further commodity price hikes. It urges policymakers to ensure efficient functioning of market forces at the global level, and to move swiftly to protect the poorest. Another article addresses the effects of climate change on agriculture, warning that farm production will fall dramatically-especially in developing countries-if steps are not taken to curb carbon emissions. Other articles on this theme argue that policies to reduce greenhouse gas emissions need not hobble economies, and that financial markets can help address climate change. "People in Economics" profiles John Taylor; "Picture This" says the global energy system is on an increasingly unsustainable path; "Country Focus" spotlights South Africa; and "Straight Talk" examines early warnings provided by credit derivatives. Also in this issue, articles examine China's increasing economic engagement with Africa, and the outsourcing of service jobs to other countries.

Ms. Catherine A Pattillo and Mr. Hugh Bredenkamp
This note outlines a scheme for mobilizing financing to help developing countries confront the challenges posed by climate change. The idea is to create a “Green Fund” with the capacity to raise resources on a scale commensurate with the Copenhagen Accord ($100 billion a year by 2020). By providing a unified resource mobilization framework, with up-front agreement on burdensharing and the capacity to meet the financing needs identified at Copenhagen, the Green Fund could facilitate progress toward a binding global agreement on reducing greenhouse gas emissions and allow developing countries to begin scaling up their climate change responses without delay. To achieve the necessary scale, the Green Fund would use an initial capital injection by developed countries in the form of reserve assets, which could include SDRs, to leverage resources from private and official investors by issuing low-cost “green bonds” in global capital markets. Contributors could agree to scale their equity stakes in proportion to their IMF quota shares, making these the “key” for burden sharing among the contributing countries. Since much of the financing would need to be provided ultimately as grants or highly concessional loans, the fund would also need to mobilize subsidy resources from contributors. Governments would likely require new sources of fiscal revenue for this purpose, including from carbon taxes and expanded carbon-trading schemes, which may take time to put in place. In the interim, the Green Fund could cover its subsidy needs from bond proceeds, interest income on its reserve asset capital base, and/or revenues from other innovative international tax schemes. Resources mobilized by the Green Fund could be channeled through existing climate funds, or via newly created special-purpose disbursement facilities. We are not proposing that the IMF itself would create, finance, or manage the Green Fund. The ideas set out in this note are being offered purely for consideration by the international community, and as a contribution to the broader public debate.
Stefan Mittnik, Willi Semmler, and Alexander Haider
Recent research in financial economics has shown that rare large disasters have the potential to disrupt financial sectors via the destruction of capital stocks and jumps in risk premia. These disruptions often entail negative feedback e?ects on the macroecon-omy. Research on disaster risks has also actively been pursued in the macroeconomic models of climate change. Our paper uses insights from the former work to study disaster risks in the macroeconomics of climate change and to spell out policy needs. Empirically the link between carbon dioxide emission and the frequency of climate re-lated disaster is investigated using cross-sectional and panel data. The modeling part then uses a multi-phase dynamic macro model to explore this causal nexus and the e?ects of rare large disasters resulting in capital losses and rising risk premia. Our proposed multi-phase dynamic model, incorporating climate-related disaster shocks and their aftermath as one phase, is suitable for studying mitigation and adaptation policies.
Mr. Serhan Cevik and João Tovar Jalles
Climate change is already a systemic risk to the global economy. While there is a large body of literature documenting potential economic consequences, there is scarce research on the link between climate change and sovereign risk. This paper therefore investigates the impact of climate change vulnerability and resilience on sovereign bond yields and spreads in 98 advanced and developing countries over the period 1995–2017. We find that the vulnerability and resilience to climate change have a significant impact on the cost government borrowing, after controlling for conventional determinants of sovereign risk. That is, countries that are more resilient to climate change have lower bond yields and spreads relative to countries with greater vulnerability to risks associated with climate change. Furthermore, partitioning the sample into country groups reveals that the magnitude and statistical significance of these effects are much greater in developing countries with weaker capacity to adapt to and mitigate the consequences of climate change.
Afsaneh Beschloss and Mina Mashayekhi

GREEN BONDS, LAUNCHED by the World Bank and the European Investment Bank more than a decade ago, blazed a trail for investments that could eventually reach into trillions of dollars in climate-related projects, including renewable energy, energy efficiency, and ecosystem protection and restoration.