Climate and sovereign risk: the Latin American experience with ENSO events

Using monthly panel data over the 2007-2019 period for seven Latin American countries, we empirically test the impact of climate oscillations – here ENSO (El Niño Southern Oscillations) on sovereign risk. Local Projections are computed to assess the dynamic response of sovereign spreads to ENSO events. Results show that strong El Nino and La Nina shocks lead to a significant increase in sovereign spreads, but with a different timing. Strong El Nino shock are associated with a significant short-term increase in sovereign spreads, while strong La Nina events are associated with a delayed but significant increase in sovereign spreads after a short-term decrease. Thus, our results suggest a potential asymmetry in the effect of these ENSO events on sovereign risk. We also highlight a high volatility in the dynamics of sovereign spreads, which may reflect an overreaction of investors in the face of the high degree of uncertainty generated by the economic and financial consequences associated with ENSO events. Complementary time-series estimates suggest that Costa Rica and Peru are especially representative of those effects. Overall, our results warn about the fact that, in the case of Latin American countries, weather shocks associated with strong ENSO events have adverse macroeconomic and financial consequences that can lead to an increase in sovereign risk.