Authors are members of the Economics faculty at IIM Calcutta. They are also co-editors of an Open Access volume ‘The Role of Coal in a Sustainable Energy Mix for India: A Wide-Angle View’, published by Routledge earlier this year.
A signal achievement of COP 27 at Sharm-al-Sheikh was the in-principle agreement to set up a Loss-and-Damage (L&D) facility to deal with the physical ravages of unrelenting climate change. It was the first indication that as a global community we are taking steps towards recognising that we need to adapt to climate change at the same time as mitigating its impact.
Equally heartening is a recognition that even to finance mitigation and adaptation strategies, the Global South needs access to low cost finance, and Multilateral Development Banks (MDBs) have a critical role to play. Reflecting that understanding was the “simple but urgent appeal” of G20 leaders at their September summit held in Delhi under India’s ongoing Presidency.
The G20 Delhi declaration notes that around USD 10 trillion is required in the pre-2030 period by developing countries to meet their needs to implement their nationally determined contributions as committed in the Paris Agreement and for investments in clean energy technologies by 2050. As the Energy Transitions Report prepared under the Indian Presidency states “The provision of concessional funds by applying blended financing approach in collaboration with the private sector, as well as other risk mitigation measures related to off-taker or exchange rate risk are important levers.”
As Avinash Persaud has argued in a recent paper (Unblocking the green transformation in developing countries with a partial foreign exchange guarantee), risk is priced differentially between developed and emerging markets, and “macro-risk premia … account entirely for the higher cost of capital in emerging economies”. Calling this a “planet-sized” market failure, he argues that MDB intervention would be a sustainable way of reducing macro-risk premia. The Delhi G20 statement resonates with this understanding.
MDBs are coming under pressure to leverage their substantial balance sheets towards financing climate change. According to Reuters (US Treasury pushing development banks for progress on next phase of reforms by April, Andrea Shalal, October 8, 2023) the US Treasury has been urging MDBs to finish, by April 2024, work on new rules that will allow them to additionally leverage shareholder capital. The idea is to give “more value to callable capital”—commitments by shareholders to supply additional resources in the event of severe financial problems—and unlock “significantly more financing” for developing countries.
Can we, therefore, argue that climate financing has turned a corner? Unfortunately, not.
First, the L&D Fund: As the Global Policy Forum’s Briefing Note of May 2023 notes, the UN’s Financing for Development Forum 2023 in its meeting earlier this year could not agree on a L&D mechanism. So much for the global community being on the same page on an effective L&D Fund!
Second, the G20 Delhi declaration falls short in terms of the scale of requirements. Where would an annual flow of climate finance of the order of a trillion USD come from? Despite balance sheet innovation, the contribution of the MDBs would be of the order of billions, the proverbial drop in the ocean. At what rate of interest will such financing be available? This is important as developing economies are already overburdened with debt. Having gingerly recognised the enormity of the problem, the G20, it appears, did not have an appetite to deal with the nub of the issue at hand – from where and at what price will climate finance be available for emerging economies.
Finally, climate finance needs to address both mitigation and adaptation. Mitigation projects, while inherently risky, offer reasonable risk adjusted returns. Therefore, with some risk assurances, private sector financing can be leveraged to fund such projects. Little wonder that most climate finance thus far has been for mitigation projects. Equally important however, is the need for adaptation and L&D funding. The public good nature of adaptation renders private returns from these projects unprofitable, unless the finance is offered at a discounted rate. Where will finance at discounted rates come from? What will be the appropriate discount rate(s) to use? These issues are not yet on the table.
Unless there is new money, climate investments run the risk of crowding out government spending on other public goods like infrastructure, health and education, and will amount to robbing Peter to pay Paul.
The work needed to be done at the COP 28 in Dubai remains cut out. An effective L&D mechanism, sources and mechanisms of low-cost financing for mitigation and adaptation, and sources of new money have to be agreed upon. It might be worthwhile revisiting Barbadian PM Mia Mottley’s Bridgetown Initiative which proposes using SDR allocations as a mechanism for climate finance, and setting up a new multilateral instrument to allocate USD 650 billion. That would require IMF reform but could break the financing logjam. Any takers? Piecemeal financing reform will simply not cut it. And time is running out, if it hasn’t already.
Authors are members of the Economics faculty at IIM Calcutta. They are also co-editors of an Open Access volume ‘The Role of Coal in a Sustainable Energy Mix for India: A Wide-Angle View’, published by Routledge earlier this year