By Nina Chestney
LONDON (Reuters) - Countries' natural resources should be considered when assessing sovereign credit risk as their worth can affect the underlying value of sovereign bonds, the United Nations' Environment Programme (UNEP) said on Monday.
Pressures on nations from the overuse and scarcity of water, food, forests and minerals, coupled with the effects of climate change, are currently mostly left out of models used to set sovereign credit ratings.
"Commodity markets, food prices and food and resource security are becoming increasingly volatile, exacerbated by climate change-caused weather extremes and uncertainty," UNEP said in a study.
"Raters, investors and governments alike will therefore need to not only become more aware of the repercussions of these trends on a country's economy but also better able to assess the impact of these risks within sovereign credit risk assessment."
Demand for natural resources exceeds the world's ability to provide them by one and a half times. Many countries find they cannot provide resources from within their own borders, import bills rise and there is fierce competition for resources.
"Bonds are not shielded from the impact of resource constraints and environmental degradation," UNEP said.
"Together with increasing volatility in commodity prices and human consumption of natural resources, these issues are gradually being recognized as having the potential to affect the risk profile of bonds."
Sovereign bonds - securities issued by governments to raise money on capital markets - account for more than 40 percent of the global bond market. At the end of 2010, outstanding sovereign debt equaled $41 trillion.
Traditionally, they have been considered a reliable and risk-free investment by fund managers but in the past two years that view has been challenged as Europe's sovereign debt crisis took hold and helped deepen the global economic downturn.
As a result, some investors see a need to understand wider emerging risks in bond markets, such as environmental factors.
The report analyzed the risks associated with five countries - Brazil, France, India, Japan and Turkey. Continued...