Fitch: Sovereigns face rising risk from natural disasters

A market comment provided by Fitch Ratings asserts that Latin America and the Caribbean's sovereign credit ratings are facing growing risk from natural disasters.

"While credit ratings already incorporate a significant degree of catastrophe risk, sovereigns remain exposed to large tail-risk events," said the ratings agency. "As these are expected to become more frequent and more devastating going forward, we believe that catastrophe risk management strategies could become more widespread."

The string of hurricanes Harvey, Irma and Maria coupled with Mexico's earthquakes in September is already having a significant effect on global risk management, expected to produce a jump in reinsurance rates in 2017 and generating a call for a more effective, internationally supported framework for handling hurricane impacts across the Caribbean.

Despite the historic destruction in 3Q17, sovereigns likely face even worse times ahead, according to Fitch, who noted, "Economic losses from natural catastrophes in the region have gradually increased over the last 50 years due to climate changes and greater economic development and urbanization, which have increased the value of property at risk. As climate change and economic development continue, these events are likely to become more powerful and frequent."

The agency added that economies exposed to severe storms and quakes are "especially vulnerable, as are those that rely on drought-prone agribusinesses, including Argentina, Brazil, Paraguay and Uruguay, or that have high economic risk concentrations, such as the Panama Canal Zone, tourism facilities in the Caribbean, etc."

Fitch acknowledged that the incidence of disaster-driven ratings actions is low, as most sovereigns are partially insulated from natural disasters, where the period of impact is typically shorter than the ratings' forecast horizon and ratings levels already incorporate a degree of catastrophe risk "via variables that capture fiscal resilience to shocks generally, as well as through the legacy costs of past events."

"Nevertheless, the fiscal costs of catastrophes can be substantial and more difficult to manage for lower rated credits," added Fitch.

The agency said that for large and diversified economies, the increase in general government spending attributable to recovery and reconstruction has ranged from 0.1% to 0.6%, though smaller economies were not as lucky.

"The hurricanes that hit Jamaica and several Central American countries in recent years led to disaster-related increases of 5%-20% of general governmental expenditures," said Fitch.

To finance repair-and reconstruction-related expenditures, governments have tended to rely on contingency reserves, credit lines and bond issuance, even raising taxes has been necessary in some cases, Fitch said.

"If natural catastrophes become more common and costly, other loss mitigation techniques may be prudent, including sovereign catastrophe insurance, contingency reserves and fostering private sector insurance," the agency said. "While these create recurring budget expenditures for premiums, capital contributions to funds, and premium subsidies for private-sector insurance, the costs of such programs are often only a small share of current spending and a fraction of disaster-related recovery costs."