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.
"We tried to find a direct link between the net resource- rich (countries) and sovereign credit risk," Ivo Mulder, programme officer at UNEP Finance Initiative, told Reuters.
"In terms of resource balance and trade-related risk, Japan comes out as more vulnerable than the other four countries. In terms of degradation of natural capital, India and Turkey are the most prone to those risks."
UNEP found that in the short-term - a period of up to five years - a 10 percent change in commodity prices could alter a country's trade balance by between 0.2 to 0.5 percent of gross domestic product.
Over five to 10 years, a 10 percent cut in the productive capacity of renewables and natural resources could lead to a reduction in the trade balance of between 1 and over 4 percent of a nation's GDP.
Sovereign wealth and pension funds can help drive the move to more comprehensive risk frameworks by requesting rating agencies to account for environmental risks, UNEP said.
This could prompt changes to accounting standards in both countries and companies.
(Editing by Catherine Evans)