For developing countries, the challenge of raising finance to meet the costs of climate change looks impossibly daunting.
Rich countries have commonly failed to deliver the amounts they promised — which, in any case, are far short of what is needed. Borrowing holds little appeal for low-income countries, more than half of which are in debt distress or at high risk of it. And blended finance, in which multilateral institutions, such as development banks, attract commercial capital — once seen as having great potential — has proved a damp squib.
That has left development economists to conclude that, rather than tinkering with solutions to a fraction of the problem, what is needed is an overhaul of those multilateral institutions to increase their firepower.
“One of the key problems is that multilateral financial institutions are fundamentally ill-suited to the challenges,” says Daniel Munevar of the debt and development finance department at the UN Conference on Trade and Development. “The one thing that should be done is to further leverage their balance sheets, but there is not the political commitment to do it.”
Putting a figure on the amount of finance that must be mobilised is a challenge in itself. US Treasury secretary Janet Yellen spoke last month of the “trillions and trillions of dollars” needed to tackle climate change in developing countries. A widely cited report by the consultancy McKinsey identified a global need for additional capital spending on energy and land-use systems alone of $3.5tn a year for the next 30 years.
A recent UN report says spending on adaptation — dams to hold back rising sea levels or irrigation to deal with droughts — will require as much as $300bn a year by 2030 and $500bn a year by 2050 for developing countries. That is without counting investments in mitigation — such as renewable energy and electric vehicles — where most finance is directed today.
But the finance so far delivered is a fraction of those amounts. In 2009, developed countries promised $100bn a year by 2020 to reduce greenhouse gas emissions and finance adaptation in developing countries. This promise has not been met. Between 2020 and 2025, according to Oxfam, poor countries face a combined shortfall of $75bn.
Blended finance has disappointed, too. The amount mobilised for development rose from $15bn in 2012 to more than $50bn in 2018, according to the OECD. But that growth then went into reverse and the money delivered, while welcome, will not make much impact.
“Blended finance is likely to remain niche,” says Simon Cooke, emerging markets portfolio manager at Insight Investment, who sees greater opportunity in green bonds.
In emerging markets, he argues, bondholders can make a particularly big difference, as more than 60 per cent of corporate issuers of green bonds in these territories have no publicly listed equity. Green bond issuance, indeed, has taken off. From a few hundred million dollars in 2012, annual issuance rose to almost $500bn worldwide last year, according to data compiled by Dealogic. About $200bn was issued by companies, including almost $80bn in emerging markets.
However, only about $10bn was raised last year by governments and government-backed issuers in developing countries.
Ugo Panizza, professor at the Graduate Institute of International and Development Studies in Geneva, says that while green bonds will play a role, “they are not going to be the silver bullet that solves the climate financing needs of poor countries”.
One problem is that, while a lot of corporate green bond issuance is for mitigation projects, the costs for governments lie mostly in adaptation. Sovereign issuance is hard to monitor. Corporate green bond issuance is often deposited in a special account for green purposes, but most governments do not allow this. Indeed, the contracts of green sovereign bonds issued by developing countries often contain language that protects the issuer from any action if they fail to meet their green commitments.
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“A big problem with green sovereign bonds is that they are not enforceable,” Panizza says. “There is too much hype.”
Others question the wisdom of encouraging poor countries to issue more debt, green or otherwise, when they are struggling with the debts they have taken on in the pandemic.
“The IMF is telling us that 60 per cent of the world, where a good part of emissions is coming from, doesn’t even have the fiscal space to deal with the Covid crisis,” points out Kevin Gallagher, director of the Boston University Global Development Policy Center. “How are they going to mobilise trillions by 2030, when our pledge of $100bn a year is still a drop in the bucket?”
A big part of the answer, he and others argue, is for multilateral development banks such as the World Bank to take a less conservative approach.
Studies suggest that two steps — expanding their collateral by including callable capital and accepting a single-notch downgrade from credit rating agencies — would allow them to quadruple the amount of grants and concessional loans they provide to poor countries. This could free up additional annual finance by many trillions of dollars.
But the World Bank argues that its own triple A rating is the cornerstone of its financial model and that lower ratings would reduce rather than increase its firepower.
Nevertheless, as Yellen and others urge the multilateral lenders to do more, change may come soon. An independent review of these banks’ capital structures commissioned by the G20 group of large economies is due to present its finding by the middle of this year.
For EM climate finance, that might just be a game-changer.