NGFS scenarios foresee climate hit to global growth before 2030

Climate disasters could dent global economic growth by up to 3% within the next five years, but the damage could be limited if governments keep up efforts to promote a green transition, according to new analysis from the Network for Greening the Financial System (NGFS).

The projected hit to economic growth is part of new short-term climate scenarios published by the NGFS to help regulators and financial institutions to assess the possible impacts of climate policies and climate change on financial stability.

“Climate change is not a distant threat – it is a current reality reshaping our economies and financial systems. Understanding the immediate impact of climate-related risks has thus become an urgent necessity for central banks and other financial actors,” wrote NGFS chair Sabine Mauderer and Livio Stracca, who heads the NGFS workstream on scenario design, in the paper’s introduction.

The NGFS, a global group of 143 central banks set up in 2017 in Paris, has vowed to keep working together to help the financial sector mitigate the risks of climate change and to support the transition to a greener economy, even after the departure of the US Federal Reserve.

The new analysis provides four scenarios: two that focus on transition risks from either an orderly or sudden introduction of green policies; one that focuses on the physical risks of extreme weather events combined with policy stagnation; and a fourth – the most severe – that combines physical and transition risks.

“The physical scenarios lead to bigger losses,” Stracca, who is also a deputy director general at the European Central Bank, told Green Central Banking. He added that severe droughts in Africa could hit the continent’s growth by as much as 13%. “Inflation is more important in the transition scenario as an abrupt transition leads to higher carbon prices.”

The most severe scenario foresees frequent weather shocks, alongside supply chain disruptions in raw materials needed for the transition to renewable energy. Under that scenario, global growth takes a hit of up to 2.8% in 2028 which persists into the future, alongside a lasting increase in the unemployment rate of up to 1.7%.

The short-term scenarios are meant to complement NGFS long-term climate scenarios, released last year, which paint a grim picture of potential global GDP losses reaching 30% by 2100 under current policies, with tail risks of up to 50%.

Under the most optimistic short-term scenario, there is only a minor impact on growth and employment as governments around the world meet pledges to reduce emissions by gradually increasing carbon taxes and reinvesting the proceeds in green technologies.
Do NGFS scenarios understate the risks?

Mark Cliffe, an economic consultant specialising in sustainability, said the NGFS scenarios understate climate risks, by ignoring innate economic and financial volatility and by treating physical and transition risks as separable.

“This approach completely ignores other sources of transition risk. Recessions, market crashes, wars, policy battles and surprising tech breakthroughs could all trigger transition risks and tipping points over the next five years. As it has in the past, the NGFS is structurally understating the range of climate-related financial risks,” he says.

“Booms and busts in the economy and markets have dramatic effects on the profitability and prices of the climate-related assets that are the ultimate focus of climate financial risk scenarios. This source of transition risks continues to be a blind spot for the NGFS.”

The short-term scenarios includes a disclaimer that the NGFS is constantly working to improve the scenarios, including taking polycrises into consideration. It also notes that nature-related risks and uncertainty about climate tipping points are not necessarily captured by the scenarios.

“It cannot be excluded that the economic effects of climate change might turn out to be even more severe than visualised under the NGFS scenarios,” the disclaimer states. “While the NGFS climate scenarios are a helpful tool, they do not alleviate the responsibility of banks and other (financial) organisations to design and implement their own risk management frameworks.”

Stracca said the NGFS workstream was working to address feedback.

“We are not climate policymakers nor climate activists. The NGFS receives a lot of feedback from climate activists but we try to be neutral,” he said.ECB deputy director general and NGFS scenario workstream head Livio Stracca. Photo: ECB

Stracca noted that the scenarios are based on government climate policies decided up to 2023. Since then, assumptions for US policy might be less ambitious under president Donald Trump while China might be considered more ambitious.

“The situation is rapidly evolving and the baseline is changing all the time … ideally we would like to have something that is updating in real time but that unfortunately is impossible so there is a certain amount of lag,” he said.
No reason for complacency

The NGFS’s sudden transition scenario has the biggest inflationary impact due to a sharp rise in the shadow carbon price. The scenarios predict that floods increase financial risks more for transport, power supply and consumer sectors than droughts, which hit agriculture.

Meanwhile, the transition scenarios also include the financial risk posed by the coal sector becoming a stranded asset.

James Talbot, an executive director at the Bank of England who is chair of the NGFS workstream on monetary policy, said climate change is becoming a bigger issue for central bankers, who need to take account of shocks which could happen in the next two to three years, especially those which push inflation and output in different directions.

“If climate change – or the policies enacted to mitigate it – affect economic outcomes, it is a relevant consideration for monetary policy makers just like any other economic shock,” Talbot said.

Stracca said the NGFS cannot speak to the robustness of the financial sector on the basis of the scenarios as they are not a stress test, but his sense is that the EU banking sector is not immediately at risk.

“I wouldn’t think that the financial sector in Europe is super at risk in the next few years but that doesn’t mean that we should be completely complacent,” he said. “The banks are still not perfectly good in understanding these risks and measuring them, and parties also lack data.”