Spillover effects of foreign climate-related phyiscal risks via trade channels: Evidence from Korea [BOK Issue Note 2023-26]

BOK Issue Note
기후변화 무역채널 산업생산 글로벌 공급망 금융기관
Financial Stability Department(02-750-6858)

1. Global warming has intensified in recent years, so the average global temperature in 2023 has reached the highest on record (WMO, 2023). Climate change around the world has detrimental influences on the global economy and subsequently for the Korean economy through trade channels. Regarding import channels, the supply shocks from global agricultural, livestock, and fisheries products can push up import prices, thereby affecting the domestic economy. Regarding export channels, decline in global demand due to climate change could lead to a decrease in demand for Korean products. This paper explores the spillover effects of foreign climate risks on the Korean economy.

2. This study finds that an increase in global average temeperature (i.e., chornic risks) negatively affects domestic industrial productions and the value-added through a decrease in global agricultural, livestock, and fisheries supply and global demand. In particular, temperature rise around the world decreases the value-added of domestic industries relying on imported agricultural products, such as manufacture of food products(-6.1~-18.2%, 2023-2100 accumulated losses in the value-added, the same below)

and food services(-10.2~-17.9%). Moreover, global temperature rise decreases the value-added of export-oriented sectors, such as maufacture of motor vehicles(-6.6~-13.6%), manufacture of refined petroleum proudcts(-5.8~-11.6%), and manufacture of chemicals(-5.0~-10.2%). This study further finds that firms with high dependence on trades face deterioration in financial health with increase in default probabilities and decrease in market values. Deterioration in financial health of those firms can translate into risks for financial institutions. To the extent that the findings in this study cover only chronic risks and do not cover acute risks from natural hazards, the negative impact of foreign physical risks can be further exacerbated when acute risks are realized.

3. Given that the Korean economy is highly reliant on trades, the negative impacts of foreign climate risks on domestic industrial productions are inevitable. Therefore, both non-financial and financial firms should preemptively ready themselves against foreign

climate risks. Non-financial Firms should monitor their counterparty’s climate risks and diversify global supply chains to reduce the negative influences from foreign climate risks. Financial institutions should incorporate foreign as well as domestic climate risks in their climate risk management.

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