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Here’s how natural disasters can hit a country’s ratings: S&P

How much do natural disasters like earthquakes or floods cost a country? Well, from a credit worthiness perspective, as much as a downgrade of two-and-a-half notches, according to Standard & Poor's (S&P).

As floods spread across Japan on Friday, leaving at least 25 people missing and 100,000 displaced, the credit rating agency reported that major natural disasters could lower sovereign ratings.


Yoshikazu Tsuno | AFP | Getty Images

In its first-ever simulation, S&P found that Japan was one of four countries that risked a two-notch or greater downgrade—making it more expensive to tap credit—in the event of a "1-in-250-year natural disaster."

"We see particularly large potential direct economic damage and related pressure on creditworthiness for sovereigns on or close to the edges of Earth's geological plates, for example, around the Pacific Rim (for example Chile, Costa Rica, Ecuador, Japan, Panama, Peru, Philippines, Taiwan), in the Caribbean (Costa Rica, Dominican Republic, Panama), and on the North Anatolian fault (Turkey)," S&P said in a report on Friday.

The Japanese sovereign is currently rated AA-minus by S&P, three notches below the top AAA rating.

Despite the current flooding, S&P said that Japan was at great risk from a severe earthquake from a ratings perspective. Mainland Japan last suffered a major earthquake in 2012, which triggered a small tsunami.

The rating agency said that an earthquake of a severity seen at least once every 250 years in Japan could cause "a significant economic downturn and a decline in the sovereign rating by at least two notches, with potentially severe economic and financial repercussions for the rest of the world.

"We believe that in the immediate aftermath, the earthquake would result in a disruption of trade flows, block supply channels, with a simultaneous sell-off of foreign assets held by the Japanese residents and partial repatriation of Japanese financial assets held abroad, possibly causing an economic slowdown in the rest of the world and turmoil in global financial markets."

Floodwaters flow from the burst Kinugawa river into a residential area in Joso, Ibaraki Prefecture, on September 10, 2015. The Japanese city 50 km north east of Tokyo was flooded when the river burst its banks.
Jiji Press | AFP | Getty Images
Floodwaters flow from the burst Kinugawa river into a residential area in Joso, Ibaraki Prefecture, on September 10, 2015. The Japanese city 50 km north east of Tokyo was flooded when the river burst its banks.

The agency added that its findings were particularly relevant for emerging and developing countries.

"They are typically the most vulnerable to natural disasters in terms of direct and indirect economic losses and, as a result, creditworthiness. It is also in those economies where insurance coverage is typically low," it said.

S&P found that Chile and Bangladesh both risked even greater credit downgrades from natural disasters, with the Dominican Republic the most susceptible of all.

The agency said that if the Dominican Republic suffered a 1-in-250 year tropical storm and subsequent surge in sea levels, it risked a downgrade of a full 2.5 notches.

The top 10 most vulnerable countries:

  1. Dominican Republic – tropical storm – 2.5 notch downgrade
  2. Chile – earthquake – 2.4 notch downgrade
  3. Bangladesh – tropical storm – 2.2 notch downgrade
  4. Japan – earthquake – 2.1 notch downgrade
  5. Costa Rica – earthquake – 1.8 notch downgrade
  6. Vietnam – tropical storm – 1.8 notch downgrade
  7. Peru – earthquake – 1.8 notch downgrade
  8. Thailand – flood – 1.6 notch downgrade
  9. Taiwan – earthquake – 1.3 notch downgrade
  10. Turkey – earthquake – 1.3 notch downgrade
Mohamed Nureldin Abdallah, Reuters

Other vulnerable countries included Ecuador, Panama, Columbia and Mexico in the Americas, Indonesia in Asia Pacific and New Zealand, Israel and surprisingly, Italy, among advanced economies.

"Looking ahead, climatic perils could intensify in line with past trends as climate change gathers pace. Specifically we view it as possible that storms and floods will become more frequent and more severe as the average global temperature rises and weather patterns shift," Moritz Kraemer, S&P chief sovereign ratings officer, said in the report.

The ratings agency recommended that one way to mitigate the threat from natural disasters was greater investment by governments in catastrophe insurance.

"In the case of the five biggest earthquakes covered in the study, the rating impact would be a downgrade of about one notch if 50 percent of the damage were reinsured, compared with almost two notches for no insurance coverage at all," said S&P in the report.

—By CNBC's Katy Barnato. Follower her on Twitter @KatyBarnato.