How credit ratings can undermine climate finance for the global south

COP30, widely billed as the ‘implementation COP’, concluded without any concrete action. Several core workstreams remain unfinished, most importantly, the commitment to outline a credible pathway for mobilising USD1.3 trillion per year in climate finance for developing countries — more than five times the current USD300 billion pledge from developed nations. 

The Independent High-Level Expert Group on Climate Finance estimates that emerging market and developing economies, excluding China, will require USD3.2 trillion annually by 2035 to meet climate and sustainable development goals, with USD1.3 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 can restrict the flow of climate capital to developing countries

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. 

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.

The global south pays more to borrow because of climate risk

Climate vulnerability is empirically linked to sovereign borrowing costs. A study by the International Monetary Fund 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 USD60 billion in additional interest over the past decade because of this “climate premium” and that if nothing changes, the total cost could exceed USD160 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.

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.

Geography amplifies structural climate vulnerability

Compounding this challenge is geography. Many countries in the global south sit on the frontline of acute physical climate risks, including floods, droughts, cyclones, and extreme heat, as well as chronic hazards such as sea-level rise and shifting rainfall patterns. Their economies are still rooted in climate-sensitive sectors, such as agriculture, while also expanding as global manufacturing hubs for wealthier nations. As a result, their emissions appear high, not due to negligence, but because of their structural roles in global supply chains. Yet, limited external funding due to a lower credit rating constrains their ability to adapt to heightened exposure to climate hazards.

Static risk metrics tend to ignore dynamic climate progress

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. But 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.

Global decarbonisation policies amplify risk for developing countries

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.

Aligning climate finance with climate justice 

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.

This article was first published in ORF.