Global temperatures have reached their highest level since the 1850s in the last decade, and the frequency and severity of extreme temperatures are expected to rise in the future due to climate change.
This forecast has heightened concerns about the possible effects of extreme weather, particularly in low- and middle-income economies (LMIEs), where equipment to deal with environmental shocks is rare and resources to invest in adaptive technologies are limited. Recent economic research indicates that extreme weather occurrences raise company costs and lower local demand. There is evidence that these events impair agricultural yields, reduce worker productivity, increase absenteeism, reduce local expenditure, and boost operational costs when they encourage adaptation.
These effects on costs and demand may result in liquidity difficulties for corporations, which may lead to solvency issues, particularly for small and medium-sized businesses (SMEs). SMEs have less access to finance than large enterprises, making it more difficult for them to deal with liquidity shortages. Furthermore, loan availability is more restricted in LMIEs, where credit markets are shallow and institutions are less prepared to deal with informational asymmetries. Overall, this shows that SMEs in LMIEs may be unable to secure the finance they require to deal with the negative effects of extreme weather, and this difficulty may cause them to default on their loans.
In a new working paper, we look at how extreme weather events affect loan default and credit utilization among SMEs in Mexico, a middle-income country. In developing nations, where SMEs are the key source of employment and job development, finance is critical for SME growth. To the best of our knowledge, this is the first study to look at the influence of severe temperatures on credit performance in enterprises of any size, and hence the first to look at credit delinquency in SMEs in a middle-income economy.
The exposure to extremes variable is defined as the number of days in a quarter where the minimum and maximum temperatures are below 3°C and over 36°C, respectively, corresponding to the bottom and top 5 percent of the country’s daily minimum and maximum temperature distributions.
These are related to the number of anomalous days of excessive temperature that occurred in a certain municipality and quarter, based on quarterly credit default rates at the municipal level. The identification strategy was based on the assumption that these extreme temperature shocks (i.e., the number of anomalous days of extreme temperature) are exogenous after controlling for seasonality and time trends specific to each municipality, as well as changes in credit delinquency rates at the national level over time.
Extremely hot days, according to World Bank data, enhance the delinquency rates of SMEs but not of large enterprises. Every 10 days of very high heat in a quarter increases the delinquency rate of SMEs by 0.16 percentage point (8% of the sample mean). In the case of large enterprises, however, none of the parameters produce a statistically significant outcome. This data supports the notion that extreme weather events have a detrimental influence on SMEs’ loan defaults because these enterprises are less suited to deal with harsh temperatures and find it more difficult to get additional loans in times of financial crisis in LMIEs.
Concerns have also been raised about the potential diverse impacts of severe temperatures across industries and geographies. Temperature shocks have a variety of effects on economic outcomes, some of which are larger in particular industries than others and have varied implications for extreme heat and cold. For starters, weather is a direct input in the process of plant growth, hence high heat has a particularly large impact on agriculture. Second, severe heat affects task efficiency and working hours by causing weariness and cognitive impairment. However, the evidence for extreme cold is less conclusive. Finally, heat stress is unpleasant and reduces demand. These impacts are more pronounced for leisure and outdoor activities like shopping, dining, travelling, and personal services.
According to these mechanisms, it is argued that the harmful effects of excessive heat are more severe in agriculture. Surprisingly, in places with a high concentration of agricultural workers, excessive heat has a significant impact on non-agricultural industries. These effects are concentrated in non-tradable industries that rely largely on local demand, such as services and retail. The findings imply that spillover effects originated in agriculture and spread to non-agricultural industries via reduced local expenditure. As a result, the findings indicate that excessive heat is harmful not just to agriculture but also to non-tradable sectors. In non-tradable businesses, excessive cold has a relatively minimal influence on delinquency rates, which is consistent with the hypothesis that consumer discomfort diminishes demand for leisure activities on cold days. It also supports previous research that outdoor leisure activities are more responsive to extreme cold than extreme heat.
Finally, it should be emphasised the need of providing loans to SMEs in order to assist them in dealing with the detrimental effects of extreme weather caused by climate change. Policymakers in LMIEs could put measures in place to attain this goal. These policies could supplement efforts that more directly target bank balance-sheet exposure to climate hazards.
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