An Independent High-Level Expert Group on Climate Finance in its report in November 2022 estimated external finance requirement for emerging markets and developing economies, other than China, at $1 trillion per year up to 2030.

However, three major sources of external finance, which have often hogged the limelight, have so far proved to be grossly inadequate to meet the huge requirement of climate finance of developing and emerging economies.

At COP14 at Copenhagen in 2009, developed countries committed to mobilise $100 billion per year by 2020 (later extended up to 2025) for climate action in developing economies. However, the target of $100 billion has not been achieved, with the largest contribution of $89.6 billion occurring in 2021; the target of $100 billion might have been achieved at end-2023, according to OECD.

Pattern of finance

Quality of such climate finance also leaves much to be desired as most of the funding was by way of loans (about 70 per cent) and the share of adaptation was only 27 per cent as against the call of a balance between mitigation and adaptation by the Paris Agreement.

However, even these reported figures need to be taken cautiously as Oxfam has estimated that the true value of climate finance provided in 2020 was just $21-24 billion as against a reported figure of $68.3 billion. The discrepancy was for several reasons, including reporting of loans at face value, ignoring repayments.

The second major source of climate finance has been multilateral development banks (MDBs), which in 2022 extended climate finance of $100 billion (of which $61 billion was for low-and middle-income countries — LMICs).

This was the second consecutive year when climate finance exceeded the target of $65 billion that MDBs set for themselves for 2025 at the UN Secretary General’s Climate Action Summit in 2019.

Resilience and Sustainability Trust (RST) of the International Monetary Fund (IMF) is yet another source to address longer-term challenges facing LMICs, including climate change. As on March 1, 2024, total pledges received by the IMF under RST were of $42.3 billion.

Thus, in all, the above-mentioned sources of climate finance aggregate less than $300 billion per year. MDBs have a critical role to play in providing climate finance and they have done well to meet their own targets well ahead of the schedule.

However, MDBs cannot provide climate finance on a scale expected of them unless their capital base is expanded enormously and/or special drawing rights are rechannelled through them. Capital base is central to the MDBs’ ability to augment their lending capacity multiple times by leveraging it.

However, there has hardly been any progress regarding an increase in capital of MDBs, despite the recommendation by the Independent Expert Group in September 2023, possibly due to the stressed government finances in most major economies and the current geo-political situation. The rechannelling of SDRs, which can also allow MDBs to multiply their lending, has hit a technical roadblock.

Fossil fuel subsidies

It is, therefore, time for developing economies to wake up to the reality that bulk of climate finance will have to be mobilised by themselves. It is intriguing that many countries continue to provide explicit fossil fuel subsidies (undercharging for the costs of fossil fuels), estimated by the IMF at $1.3 trillion in 2022 or 1.3 per cent of global GDP.

Fossil fuel subsidies act like a negative emission price and discourage investment in clean energy. It is heartening that India has sharply reduced fuel subsidies in recent years, constituting now just 0.04 per cent of GDP.

Many countries tax fossil fuel. However, there are wide gaps between efficient prices based on their carbon content and retail fuel prices. The IMF has estimated implicit fuel subsidies (charging below efficient fuel prices) globally at $5.7 trillion or nearly 5.7 per cent of global GDP. Implicit subsidies in the case of India have been estimated at 9.6 per cent of GDP.

Thus, apart from eliminating subsidies, it is also important to tax fossil fuels based on their carbon content through a well-designed carbon pricing system. Emission trading system (ETS) and carbon taxes are two well-known carbon pricing instruments based on the ‘polluter pay’ principle.

Carbon taxes and ETS now cover about 23 per cent of global carbon emissions, contributed mainly by Europe.

Many countries tax fossil fuel. However, there are wide gaps between efficient prices based on their carbon content and retail fuel prices. The difference is much more pronounced in the case of coal consumption, 80 per cent of which, according to the IMF, was globally priced at below half of its efficient level in 2022. This is also the case with India, which taxes petrol and diesel heavily, but coal very little.

India does not have a system of carbon pricing. However, if we convert fuel taxes into carbon taxes, they work out to around ₹18,000 per tonne of CO2 in the case of petrol, ₹12,000 per tonne of Co2 in the case of diesel, and ₹200 per tonne of CO2 in the case of coal (in 2016 before coal cess was merged with GST compensation cess). India taxes petrol and diesel close to the level of taxes imposed by many countries in Europe, which have per capita income many times than that of India.

Countries can raise large resources, should they decide to tax fossil fuels based on their carbon content. The IMF has estimated implicit fuel subsidies (charging below efficient fuel prices) globally at $5.7 trillion or nearly 5.7 per cent of global GDP. Revenues raised through carbon pricing can be used for (i) investment in low/zero carbon energy; (ii) adaptation action; and (iii) raising private finance (estimated by the IMF over USD 200 trillion globally) by de-risking it as green projects generally involve higher risks.

Revenue from carbon pricing will gradually shrink as the use of fossil fuels declines. However, carbon pricing can certainly help tide over financing constraints over the medium-term. Carbon pricing has also assumed added significance in view of cross border adjustment mechanism (CBAM) by the European Union, which will become effective January 1, 2026.

The writer is Senior Fellow at the Centre for Social and Economic Progress (CSEP). Views expressed are personal