There is now a 95% probability that we will see an El Niño event during the 2023-2024 winter in the northern hemisphere, with forecasters anticipating it to be “strong.”[1] Typical El Niño effects include suppressed rainfall across Southeast Asia from December to February and dry/warm weather across large swaths of South America from June to August.
El Niño’s negative impact on key crop yields
Agriculture is one of the main sectors of the economy that could be severely affected by El Niño. Maize in China, East and West Africa, Mexico and Indonesia; rice in southern China, Myanmar and Tanzania; and wheat in parts of China have all been negatively affected by recent El Niño episodes, while global average yields for rice (-1.3%), corn (-0.3%) and wheat (-4.0%) tend to be below normal during El Niño years.[2] Indeed, benchmark rice prices in Asia already rose to a near-15-year record in mid-August 2023 due to concerns that El Niño-related dryness could reduce production in Thailand (the world’s second-largest exporter).[3]
Public-debt ratios may start to deteriorate in 2024
Higher food prices, already elevated from the COVID-19 supply-chain shock and the Russia-Ukraine war, could be the start of a cascading trend for the global economy. Governments may increase relief spending to provide a safety net for citizens. Depending on the magnitude of impact, countries may need to ratchet up capital expenditure to repair damaged infrastructure.[4] Productivity could also worsen, reducing economic output.[5] Some areas, such as Peru and Southeast Asia, have already begun to prepare for El Niño.[6]
The combination of lower economic growth and higher fiscal expenditure could result in higher public-debt-to-GDP ratios for impacted sovereign issuers. MSCI determined that the median debt-to-GDP increase for the years following an El Niño event was 0.6% of GDP globally and 2.1% for emerging markets (based on data between 1994 and 2021). Although there seems to be a statistically significant relationship between El Niño and a country’s debt-to-GDP ratio[7] — even when controlling for variables such as the primary budget balance, GDP growth and exchange-rate fluctuations — we acknowledge that two of these periods took place during other major financial events: the Asian financial crisis and COVID-19.[8] Given the limitations of the historical analysis, we are curious to see whether developments during this period support our hypothesis that debt-to-GDP ratios rise in the year after an El Niño event.
Debt-to-GDP ratios tend to increase the year after El Niño
Governments’ financial position and physical-risk vulnerability could signal the most at-risk sovereign issuers
Sovereign-debt investors may wish to bear El Niño in mind when making country-allocation decisions. El Niño tends to negatively affect issuers in South America, Southeast Asia and parts of Sub-Saharan Africa more than regions in the northern hemisphere. However, the magnitude and nature of the impact can vary substantially between countries[9] and even within countries.[10]
The current baseline of a sovereign issuer’s credit fundamentals and physical-risk exposure and management is also important. Within MSCI ESG Government Ratings, investors may wish to compare the country’s financial-governance and physical-risk scores to assess existing vulnerabilities. For both scores, a low number means that a country possesses high risk exposure and poor management of those risks.
Comparing these two scores illustrates that if a country is already in a strained financial position and generally possesses high levels of physical risk, an extreme El Niño event could exacerbate its ability to service debt.
Countries with low financial-governance and physical-risk scores may be more susceptible to El Niño
Our research highlights that the governments of certain countries that score poorly on both factors may not be able to fully provide financial relief to the economy, resulting in “loss and damage.” Impact investors, bilateral lenders and multinational development banks may need to mobilize financing during this El Niño event to avoid loss-and-damage outcomes.