How to fund climate-smart cities

According to UN-Habitat’s estimates, over 64 per cent of the world population is expected to reside in cities by 2050. Cities consume enormous resources. The Intergovernmental Panel on Climate Change estimates that urban infrastructure accounts for two-third of the global energy use and 70 per cent of energy related Green House Gas (GHG) emissions. By 2025 megacities of 10 million or more people will house more than half the world’s population and contribute more than half of global GDP.

As India’s urban population grows from 410 million in 2014 to 814 million in 2050, with about 7 cities having more than 10 million people, so will there be rise in energy consumption, degradation of forest areas and agricultural land and disturbed ecosystems, problems of water supply and solid waste management.

This will be accentuated by growing risks of climate vulnerability (frequent floods, cyclones, extreme temperature and heat waves) disrupting city lives and affecting the poor who typically lack adequate resources and safeguards to fight such stresses.

The scale of such damages are enormous; the 2011 Bangkok flood caused damages of $45 billion to the global supply chain of which only 10 billion was insured. Swiss Re, a reinsurer estimated that of the $50 billion or so losses to floods, cyclones and other disasters in Asia in 2014, only 8 per cent were covered ( The Economist ). This holds out an unprecedented opportunity for cities to lead the world towards a sustainable future by becoming resilient and climate-smart and, ‘leap-frogging’ the inefficient and resource-intensive systems of the past.

Fundamentally, climate-smart transformation needs set of city-specific strategies to systematically reduce city’s carbon footprint and enhance resilience to climate change through smart, affordable and, resilient infrastructure, and mixed form of adaptable land-use. Cities can use ‘predictive models’ to assess the potential risks of climate vulnerabilities (erratic rainfalls, flood, high temperature) and, monetise those risks to account for additional financial and social costs for building safeguards.

On the other hand, each city should have a clearly defined ‘low carbon pathway’, a series of interventions under certain plausible scenarios around integrated solid waste management (ISWM), energy efficient energy/ water supply, harnessing rooftop solar and battery storage, green urban mobility (including electric mobility, public and, non-motorised transport), green and affordable building infrastructure, smart grids, that decouple city’s economic growth from the growth of GHG emissions.

Financing climate-smart cities is always a challenge that needs innovative solutions. The ability of cities to finance urban infrastructure largely depends on their budgets, revenue sources and creditworthiness. The perceived lack of creditworthiness (among 500 largest emerging market cities, only 4 per cent are creditworthy) for most cities in India becomes a critical barrier to secure affordable financing on international market or issue bonds to fund climate projects. Credit enhancement facilities such as, Guarantee Fund can help cities to overcome such barrier and raise funds by issuing bonds, etc.

An effective way to catalyse private investment in urban projects is to mobilise credits through local financial institutions (LFIs) who are perhaps better positioned to assess and manage the risks inherent to the local authorities and, mobilise medium and, long-term financing in local currencies, thus eliminating the forex risk.

They typically offer longer tenor lengths that suit climate projects with longer payback period. Projects such as micro-grids, bundled energy efficiency in water pumping, or waste-to-energy, having smaller deal sizes make them a better fit for local financial institutions having smaller investment appetite. However, to maximise the development impact, the LFIs while disbursing credits should ensure appropriate Environment-Social Governance (ESG) safeguards.

To attract investments, cities should develop a pipeline of ‘bankable’ projects that meet broad feasibility parameters. Project preparation is expensive, typically accounts for 5-10 per cent of the project cost, and, most cities lack capacity for conducting feasibility, design and, financial structuring of the projects.

This is where development partners and multilateral banks, equipped with global best-practices, can step in to support cities in setting project selection criteria to favour climate-smart infrastructure, laying right indicators for monitoring sustainability, and building technical and financial capacity of city officials to mainstream climate goals in planning, designing, operations and maintenance of the city. City-focused ‘fund’ becomes useful, on one-side to support project development and, on the other side to mobilise lending for actual project implementation.

Research shows that nearly 70 per cent of climate finance moves towards mitigation projects that largely focus on energy and transport. The higher proportion of finance flowing to mitigation projects may reflect the fact that mitigation projects have more proven and healthier cash flow dynamics.

This calls for innovative instruments and mechanisms to help improve the risk/ return profiles of the climate-resilience projects that often lack financing beyond government’s budgetary endowment. One such instrument is ‘pricing climate externalities’ — by creating a marketplace and trading scheme where some participants find it cheaper to deal with an externality than others. For example, developers building improved storm-water drainage in dense areas would be more willing to pay for ‘credits’ to meet regulatory requirement than developers in less dense areas.

Such a mechanism can ultimately make climate resilient investments, which might not otherwise meet investors’ risk adjusted return, financially more attractive. At a certain level, cities should also consider reforming the principles of municipal budgeting to accurately value and internalise positive and negative climate externalities of every project and allocate and harmonise budgets and savings accordingly so as to mainstream climate considerations in infrastructure planning and operations.

Transformative change is needed in how we build our cities, transport people and goods, and manage our landscapes. The need is urgent; the time-frame for making the choice is critical due to lock-in effect of capital and technology. The challenge is not simply to increase the volume of funding in the pipeline, but also to create an enabling environment to catalyse new finance flow from a broad spectrum of investors — public or private.

Tapping into diverse, well-administered local sources of revenue can decrease reliance of cities on the Centre’s transfers. It is important to prioritise among various options of revenue augmentation that are within the remit of the authority to adjust, while also considering the administration and compliance cost, to ensure that they are both feasible and desirable.

The writer is a partner of KPMG, India. The views are personal

COMMENT NOW