As climate risks are increasingly embedded into sovereign credit ratings, developing countries face higher borrowing costs that undermine access to climate finance and entrench global climate injustice
COP30, widely billed as the “Implementation COP”, concluded without concrete progress on several core workstreams. Most notably, it failed to outline a credible pathway for mobilising the promised US$1.3 trillion per year in climate finance for developing countries, more than five times the current US$300 billion pledge from developed nations. This shortfall highlights a deeper structural tension in the global climate finance architecture.
While a strong moral and economic case exists for North–South climate finance transfers in the form of grants, reflecting historical responsibility and asymmetric climate exposure, grant-based finance remains strikingly inadequate relative to need. Estimates from Climate Policy Initiative show that grants account for only about 3 percent of global climate finance tracked, with the overwhelming majority delivered through debt and other market-based instruments. As a result, developing countries are compelled to rely disproportionately on debt-financed climate action, even for investments that generate global public good.
Estimates from Climate Policy Initiative show that grants account for only about 3 percent of global climate finance tracked, with the overwhelming majority delivered through debt and other market-based instruments.
The Independent High-Level Expert Group on Climate Finance estimates that emerging market and developing economies, excluding China, will require US$3.2 trillion annually by 2035 to meet climate and sustainable development goals, with US$1.3 trillion to be sourced from external sources. Mobilising this external capital may prove challenging in the current volatile political landscape and within existing financial mechanisms. Moreover, sovereign credit ratings are increasingly becoming a barrier rather than a bridge.
Credit rating is a barometer of credit risk that can either restrict or unlock a massive volume of capital. Sovereign ratings, which are credit ratings assigned to countries, traditionally focus on downside risks, assessing the likelihood that a country may fail to meet its debt obligations, drawing on metrics such as fiscal strength, external balances, growth stability, and institutional capacity. Since these frameworks are designed to flag vulnerabilities rather than reward potential, they incorporate emerging climate risks but seldom account for climate opportunities or resilience gains that can support upgrading the rating.
While ratings guide prudent capital allocation and maintain healthy credit markets, their growing incorporation of climate risk into sovereign assessments risks undermining climate finance mobilisation for developing countries. Rating agencies now treat both physical and transition vulnerabilities as material to repayment capacity. The old logic favouring resource-rich, fossil-fuel-heavy economies is reversing — countries reliant on coal, oil, or energy-intensive manufacturing are increasingly flagged for long-term transition risk — a risk ignored during industrialisation in developed countries.
The new climate-conscious credit regime risks penalising them by treating current emissions as inherent financial risk, while overlooking development context, intent, and the transitions needed for decarbonisation and adaptation.
This integration, in theory, is welcome. Climate risk is real. Yet, for sovereign borrowers in the Global South — like India, Indonesia, Kenya, and Bangladesh — this revaluation is about climate justice, not just risk transparency. Nations least responsible for historical emissions now face higher borrowing costs driven not by weak macroeconomic fundamentals, but by structural climate exposure. The new climate-conscious credit regime risks penalising them by treating current emissions as inherent financial risk, while overlooking development context, intent, and the transitions needed for decarbonisation and adaptation.
Climate vulnerability is empirically linked to sovereign borrowing costs. A study by the International Monetary Fund (IMF) found that countries more exposed to climate shocks pay significantly higher interest rates on their debt — up to 1.5 percentage points more than their less-exposed peers. The Vulnerable Twenty (V20), a group of climate-vulnerable nations, estimated in 2018 that they had paid more than US$60 billion in additional interest over the past decade because of this “climate premium” and that if nothing changes, the total cost could exceed US$160 billion by 2030. Every dollar spent servicing this premium is a dollar diverted from food security, health systems, adaptation investments, and clean energy infrastructure, a financial loss embedded in climate injustice.
Every dollar spent servicing this premium is a dollar diverted from food security, health systems, adaptation investments, and clean energy infrastructure, a financial loss embedded in climate injustice.
This climate premium is already embedded in market pricing, and bond yields and credit default swap spreads reflect climate vulnerability daily. Rating agencies, though slower to adjust, carry far greater institutional weight. When they formalise climate risk into downgrades, they don’t just follow the market; they amplify and lock in higher borrowing costs across a country’s entire debt portfolio, making the climate penalty permanent rather than transactional.
Compounding this challenge is geography. Many countries in the Global South sit on the frontline of acute physical climate risks—floods, droughts, cyclones, and extreme heat—alongside chronic hazards such as sea-level rise and shifting rainfall patterns. Their economies remain rooted in climate-sensitive sectors like agriculture, even as they expand as global manufacturing hubs for wealthier nations, making their emissions appear high not due to negligence but because of their structural role in global supply chains. Climate finance flows, however, remain overwhelmingly skewed toward mitigation and revenue-generating investments, with adaptation receiving only a small share and attracting limited private capital due to diffuse benefits, long time horizons, and weak revenue visibility. As a result, adaptation continues to rely heavily on sovereign balance sheets. When lower credit ratings constrain access to external finance, and rating agencies penalise countries for physical climate vulnerability without adequately recognising adaptation investment or resilience-building efforts, they raise the cost of financing the very actions needed to reduce future climate risk, reinforcing vulnerability rather than alleviating it.
When lower credit ratings constrain access to external finance, and rating agencies penalise countries for physical climate vulnerability without adequately recognising adaptation investment or resilience-building efforts, they raise the cost of financing the very actions needed to reduce future climate risk, reinforcing vulnerability rather than alleviating it.
Credit rating agencies are not acting maliciously — they are doing what they’ve always done: flagging downside risks. Traditionally, this focus on vulnerabilities over opportunities has served credit markets well. However, climate is different. Unlike conventional risks, climate impacts are not static — they respond to policy action, investment, and systemic transformation. Yet, rating frameworks treat climate exposure as fixed, rarely crediting countries that build resilient infrastructure, diversify energy systems, or strengthen adaptation capacity. A nation actively reducing its future climate risk sees little benefit in its creditworthiness, even as these investments fundamentally alter its risk profile. In a domain defined by transition and change, static metrics fail.
Moreover, transition risks are not natural; they are designed. The pace and structure of global decarbonisation are largely determined by policy and market shifts in the Global North. When rich countries subsidise clean technologies, impose carbon border taxes, or enforce sustainable investment mandates, they create ripple effects that raise compliance and technology costs for poorer nations. In this context, assigning transition risk to countries without offering concessional support or time to adapt amounts to climate conditionality by another name.
Assigning transition risk to countries without offering concessional support or time to adapt amounts to climate conditionality by another name.
Climate risk is real, and so is the risk of deepening inequality through financial structures that fail to consider the development context. We urgently need climate-adjusted credit frameworks that include equity as a core principle. Multilateral development banks should deploy ‘climate-resilient debt clauses’; developing countries should receive credit enhancement guarantees to lower their borrowing costs; and new capital instruments, such as the IMF’s Resilience and Sustainability Trust or the climate-linked Special Drawing Rights, must be scaled up and made more accessible.
The world is waking up to the climate crisis, but unless we align climate finance with climate justice, we risk reproducing neo-colonial dynamics under the banner of sustainability.
Subham Shrivastava is a Climate Finance Analyst at the Institute for Energy Economics and Financial Analysis (IEEFA).
Labanya Prakash Jena is the Director at Climate and Sustainability Initiative (CSI) and a Visiting Senior Fellow at LSE.
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Subham Shrivastava is a Climate Finance Analyst at the Institute for Energy Economics and Financial Analysis (IEEFA). ...
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Labanya Prakash Jena is Director at the Climate and Sustainability Initiative (CSI) and a visiting senior fellow at the London School of Economics and Political ...
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