Digging into deforestation
The latest data on deforestation in the Amazon makes for sobering reading. Preliminary figures from Brazil’s space agency, Inpe, show that more of the Brazilian Amazon was cut down in the 12 months to July 2020 than in any year since 2008. Rising deforestation in the country, part of an upward trend since 2012, has been accelerated by the policies of right-wing populist Jair Bolsonaro’s government, which has encouraged agricultural and mining interests and de-funded government bodies responsible for policing compliance with Brazil’s environmental code.
Globally, the rate of deforestation is lower than in previous decades. Between 2015 and 2020, an estimated 10 million hectares — almost twice the size of the United Kingdom — was deforested each year. This is down from 16 million hectares in the 1990s, according to the UN Food & Agricultural Organization (FAO). However, global forest cover continues to decline, and much of this deforestation is occurring in biodiversity hotspots in the tropics, contributing both to the climate emergency and the crisis in nature loss.
According to data from the World Bank and FAO, forest area as a percentage of land area has declined on a global basis since the early 1990s.
Country differences
However, the global numbers mask wide variation at the country level. In the following chart, we picked some countries of interest. Brazil and especially Indonesia lost a substantial area of forests over the past three decades while countries like Finland — which is covered by forests to a very large extent — and Russia have been fairly stable.
The countries with the largest loss of forest areas are shown in the chart below. The worst performer based on the World Bank data is Honduras, losing more than 30 percentage points of forest area (as a share of land area) since 1990. Demand for agricultural land — think about your Honduran coffee beans — has been one of the major causes of deforestation besides illegal logging activities.
On the other end of the spectrum, Puerto Rico and Vietnam are success stories for reforestation. For Vietnam, reforestation is not only an environmental goal but also an economic one; it aims to generate export revenues of $12 billion from wood and wood furniture.
Linkages to institutional quality
The management — or mismanagement — of a country’s forests is an important indicator of sovereign risk, both in environmental and economic terms. Forest cover is part of a country’s natural capital and is increasingly viewed as an asset on a country’s balance sheet. In addition, a country’s ability to prevent illegal deforestation is also a proxy for the quality of its governance.
The following chart plots the relationship between change of forest area and the “Rule of Law” governance indicator. From a statistical point of view, there is only a very weak relationship between these two factors. However, one can find a cluster of countries with very weak rule of law and large loss of forests in the past decades. Once again, Honduras stands out here and is in line with this relationship.
Similar conclusions can be drawn when we contrast forest area change and climate change vulnerability. We use the index from the Notre Dame university (see here for details). A higher score indicates higher vulnerability towards climate change. Honduras, Zimbabwe, Timor-Leste, Uganda and Guinea-Bissau are all at high risk from climate change and have lost a substantial area of forest in the past. Such countries would benefit from investments in sustainable forestry and could learn from the positive examples mentioned above.
Alternative data to track forests
Data on deforestation on a global and timeliness basis has been an issue for analysts attempting to integrate such factors into ESG country and sovereign risk models. However, improvements in satellite monitoring means that deforestation is no longer as much of a lagging indicator for sovereign risk analysts as in the past. Analysts can access more up-to-date information — such as that provided by the satellites used by Inpe or other organisations like NASA — to get a more dynamic picture of the success or failure of government policies to control deforestation. (See here for an informative blog from NASA on the topic.) The chart below shows how to track the activities through satellite images.
I can also recommend the World Bank Atlas of Sustainable Development Goals 2020, which has a very well-produced section on deforestation as part of Goal 15: Life on Land.
The proximate cause of much tropical deforestation is the unwillingness or the inability of local authorities to enforce legislation. However, governments are often at the mercy of external forces. First, demand from consumers in the West and, increasingly, in China creates the incentive for illegal logging and deforestation in order to produce agricultural commodities. Any global effort to control tropical deforestation will need to address these demand drivers.
Consequences of climate change
But even in wealthier countries where these factors are less relevant, the management of their forests is complicated by the changing climate.
Forests around the world risk falling victim to a climate change feedback loop. Rising temperatures and changing patterns of precipitation make forests vulnerable to wildfires, as has been vividly seen in the western United States in recent years. In Germany, too, recurring droughts are threatening the health of the forests that cover around one third of its land area.
This increases the onus on governments to develop strategies to protect their forests in the face of climate change. Whether through better managing fire risk, or proactively encouraging species that are more drought resistant, governments’ sustainable forests strategies represent a new, qualitative factor that will bear on their sovereign ESG ratings.
As we emerge from the Covid-19 pandemic, climate change will reassert itself as the most pressing sustainability challenge facing governments around the world. Their success or failure in protecting their forests will be a key determinant of their success or failure in addressing the climate emergency. Global investors should incorporate a country’s performance in terms of sustainable forestry into their risk assessment and country due diligence and add it to their list of engagement topics with governments around the world.
