Introduction

The report examines how nature and biodiversity degradation influence sovereign borrowing costs. While climate-related financial risks are widely studied, the effects of nature loss on sovereign bond markets remain less explored. The study analyses whether environmental degradation increases sovereign bond yield spreads, thereby raising governments’ financing costs and constraining fiscal space.

Using a dataset covering 53 countries (28 advanced and 25 emerging economies) between 2000 and 2020, the research assesses sovereign bond spreads across 2-, 5- and 10-year maturities. The authors test whether biodiversity degradation and broader environmental vulnerability affect sovereign risk pricing. The central hypothesis is that worsening ecosystem conditions increase perceived macroeconomic and fiscal risk, which financial markets incorporate into sovereign bond pricing.

The study also investigates whether the financial impacts of nature loss are asymmetric, disproportionately affecting countries with already higher borrowing costs, which tend to include lower-income economies.

Related literature

Previous research has demonstrated that climate change can influence sovereign risk through impacts on economic growth, fiscal balances and debt sustainability. Studies have also identified relationships between environmental vulnerability and sovereign credit ratings or borrowing costs.

However, much of the literature focuses primarily on climate risks rather than biodiversity loss or ecosystem degradation. Existing work on nature-related financial risk often concentrates on firm-level exposures or macroeconomic consequences rather than sovereign debt markets.

The report contributes to this literature by empirically testing the link between nature degradation and sovereign bond spreads. It also builds on earlier work examining differences in environmental risk pricing across countries with varying credit ratings or income levels. By applying quantile regression methods, the study evaluates whether environmental risks have stronger effects for countries located at the higher end of the sovereign borrowing cost distribution.

Data

The analysis uses sovereign bond yield spreads calculated as the difference between each country’s local currency sovereign bond yield and the equivalent US Treasury benchmark. This standardisation allows for comparison of borrowing costs across countries and maturities.

Environmental vulnerability is measured using three proxies related to biodiversity and ecosystem degradation:

• Biodiversity Intactness Index (BII)
• Biodiversity Habitat Index (BHI)
• Environmental Performance Index (EPI) biodiversity and habitat sub-index

The Environmental Performance Index, developed by Yale and Columbia universities, provides a composite measure of ecosystem health and biodiversity performance. The authors construct a consistent annual time series from the 2024 EPI dataset to ensure coverage from 2000 onwards.

Additional macroeconomic controls include variables commonly used in sovereign risk analysis, such as economic indicators and measures of climate vulnerability.

Descriptive statistics

Descriptive analysis shows variation in biodiversity degradation and environmental vulnerability across countries and over time. Emerging and developing economies generally display higher exposure to environmental degradation risks.

Sovereign bond spreads also vary substantially between countries, reflecting differences in credit risk and macroeconomic conditions. Countries with higher environmental vulnerability tend to coincide with those experiencing higher borrowing costs, suggesting a possible link between ecological degradation and sovereign financial risk.

The data indicate that biodiversity loss and environmental deterioration are not evenly distributed globally, reinforcing the need to examine how these risks translate into sovereign financial outcomes.

Estimation strategy

The empirical analysis uses interactive fixed effects (IFE) panel models to estimate the relationship between environmental vulnerability and sovereign bond spreads. This approach accounts for unobserved global factors that may influence multiple countries simultaneously.

To examine potential asymmetries in financial risk pricing, the study also employs quantile regression with interactive fixed effects. Unlike traditional regression models that estimate average effects, quantile regression evaluates how relationships differ across the distribution of sovereign borrowing costs.

This allows the authors to test whether countries with higher bond spreads experience stronger financial impacts from biodiversity degradation.

Results

The results indicate that nature degradation increases sovereign borrowing costs, particularly for countries already facing higher bond spreads.

Across the models, biodiversity degradation and environmental vulnerability measures show statistically significant positive relationships with sovereign bond spreads. This implies that worsening environmental conditions are associated with higher perceived credit risk and increased financing costs.

The quantile regression analysis demonstrates strong asymmetric effects. For countries in the 90th percentile of borrowing costs, the estimated impact of biodiversity degradation on bond spreads can be up to three times larger than the average effect. These countries are often lower-income economies located in Africa and Asia.

In some cases, the estimated effects of nature-related risks exceed those associated with climate vulnerability, indicating that biodiversity loss represents a substantial but under-recognised macro-financial risk.

The findings remain robust across different model specifications, alternative lag structures and varying numbers of global factors.

Discussion, concluding remarks and policy implications

The study provides empirical evidence that nature degradation constitutes a material sovereign financial risk. By increasing borrowing costs, biodiversity loss can constrain governments’ fiscal capacity and hinder economic development.

The asymmetric results suggest that countries already facing higher borrowing costs are most vulnerable. This raises concerns about environmental risk reinforcing existing global financial inequalities, particularly for developing economies with high ecological exposure.

The findings highlight the importance of integrating nature-related risks into sovereign risk assessment, financial regulation and policy frameworks. Improved environmental management and biodiversity protection could reduce long-term macroeconomic and fiscal risks while supporting financial stability.