The wildfires sweeping through California could set off a chain of events that can spark a financial crisis in America and its ripple effect can take countries like India in its grasp.

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According to a US government agency, The Commodity Futures Trading Commission (CFTC), the increasing wildfires are among the sparks from climate change that could ignite a financial crisis by destabilising the US financial system and its ability to sustain the American economy.

The report presented by CFTC, the agency that regulates the US derivatives, on 'Managing Climate Risk In The US Financial System' said, "Climate change is already impacting or is anticipated to impact nearly every facet of the economy, including infrastructure, agriculture, residential and commercial property, as well as human health and labour productivity."

These effects could set off a cascade of events that could impair the productive capacity of the economy and undermine its ability to generate employment, income, and opportunity, thus sparking a crisis.

How can it spark a financial crisis?

Home Values

3 million homes from the states 12 million homes are at risk from wildfires, according to CalFire, California's fire-fighting agency.

And early-stage research has demonstrated that the price of homes drops when they are designated to be in a wildfire risk zone. That means 3m homes set to be in wildfire risk zone have seen a drop in their value.

Financial Institutions

Since most residential real estate in the United States is purchased with a mortgage, the physical risk could also affect the underlying mortgages. Early-stage research suggests that wildfires and flooding cause increased residential mortgage default rates, the report suggested. These declines in mortgage values could affect financial market participants, including banks that hold these mortgages on their balance sheets.

Local government bond defaults

The real estate sector is not only dependent on infrastructure; it also generates local property tax revenue that supports most domestic infrastructure investment in the first place. Since the value of the real estate is closely linked to the value of the land it is built on, physical risks, such as wildfires and rising sea levels, can directly affect real estate prices, the report said. This imperative reduction in home values affect the cities' real estate tax revenue and diminish their ability to repay tax, potentially leading to bond defaults. Further, the drop in tourists because of business disruptions lead to decreasing municipal finances.

Markets

Investors likely will increase their efforts to identify which assets are unduly exposed to a collapse in asset values that could threaten the economic viability of entire asset classes. These efforts can trigger a disorderly repricing of assets which could have cascading effects in portfolios and balance sheets, and therefore, systemic implications for financial stability, the report added.

Insurers back off from coverage

Emerging evidence suggests that lenders are passing along riskier mortgages to the Government-Sponsored Enterprise (GSE), in part, to remove risk from their books, the report said. Expensive insurance further depresses home prices.

Other impacts on the economy

Brain Drain - The declining quality of life will lead to the emigration of qualified human assets to other countries.

Developmental problems: Increasing air pollution due to wildfire is putting the future generation at risk of developmental issues.

Productivity: Numerous studies have found that high pollution leads to an unproductive workforce. Rising air pollution that would impact millions, therefore affecting the GDP.

Impact on Indian economy

The US meltdown of 2009 shook the entire world, but it had little impact in the first half of FY09 in India. However, the second-half saw the impacts of glaringly. Globalisation, with itself, brings both prosperity and distress. India saw a drop in its growth rate year-on-year as the impact of the US financial crisis in 2009 cascaded down on the developing countries as well.India's growth rate in 2009 was 7 percent, as compared to 9 percent in the previous year.

Some other effects observed were -

Stock Market: On October 10, 2008, Rs. 250,000 crores were wiped out on a single day bourses of India's share market. The Sensex lost 1000 points on that day before regaining 200 points, an intraday loss of 200 points.

Exports: Exports fell by 9.9 percent to $1.5 billion in November 2008 from $12.7 billion y-o-y. In contrast, imports grew by $6.1 billion to $21.5 billion.

Exchange rate depreciation: Rupee depreciated by 20 percent against USD and stood at Rs 49.

FII and FDI: FII withdrew $5.5b whereas the inflow of FDI doubled from $7.5b in 07-08 to $19.3b in 2008.

The economy has changed tremendously over the last decade. With the current state of the Indian economy, India wouldn't have time to balance itself once the contagion effect sets off.

First Published:Sept 17, 2020 3:42 PM IST