One of the key issues in the crucial climate negotiations in Glasgow is the extent of financing support that developed countries should provide the developing ones, to undertake climate mitigation and adaptation activities.
The existing finance flows highlighted in the COP26 Presidency’s recently released Climate Finance Delivery Plan are inadequate in both scale and purpose. First, they are expected to rise to the $100 billion level only by 2023, a full three years behind the date originally promised by developed countries in 2009.
Second, the share of concessional finance continues to be low. According to the Organisation for Economic Cooperation and Development (OECD), outright grants stood at a mere 27 per cent of public climate finance flows, as per the latest figures available from 2019. Non-grant concessional loans constituted another small but undefined fraction of flows.
International climate finance flows need to be scaled up from current levels to plug gaps in the financial system of developing countries in mobilising climate finance. For context, consider India’s energy transition, which has been largely debt-financed by domestic banks and non-banking financial companies (NBFCs).
The CEEW Centre for Energy Finance (CEEW-CEF) estimates that India’s 450 GW by 2030 renewables target requires $200 billion in new investments in power generation alone, whereas the overall exposure of domestic banks and NBFCs to the entire power sector currently totals to $168 billion.
The International Finance Corporation (IFC) estimates that India’s Nationally Determined Contribution (NDC) and domestic policies could represent an investment opportunity of $3.1 trillion by 2030, which dwarfs overall domestic banking and NBFC assets totalling $1.9 trillion. Both sectoral and overall finance requirements would be even higher for more ambitious decarbonisation trajectories.
If India, a country with bank and NBFC assets totalling 70 per cent of GDP, faces a mismatch in domestic capital availability versus requirements, the same will be true of developing countries at large, most of which have smaller financial systems. To be sure, international capital is alleviating some of these constraints, but more needs to flow.
For example, CEEW-CEF estimates that 10 per cent of India’s domestic debt for solar and wind capacity has been refinanced through the international bond markets. However, these represent flows to investments that offer attractive commercial returns. But what about climate-aligned investments where a compelling business case does not yet exist?
A much larger scale of concessional finance in the form of grants or soft loans is necessary to unlock investment opportunities where money is not flowing. These include nascent technologies where technology performance track records or business models are not well established, such as off-grid renewables, storage, or the vast majority of adaptation activities.
These also include investments in underdeveloped countries where investment risks are high, or are perceived to be so. Such capital may be used to underwrite risks in order to crowd in many multiples in private sector capital flows. Such catalytic finance is the most efficient use of scarce concessional capital.
In general, catalytic finance support from developed countries should be delivered through mechanisms that maximise impact. This is particularly relevant in the wake of Covid-19, which has diminished the fiscal capacity in developed countries to extend such financial support.
In this context, mechanisms that pool together risks across developing countries and facilitate their mitigation through a common fund could be key enablers. The International Solar Alliance (ISA) has commissioned a feasibility study on a market instrument that pools together and mitigates non-project specific risks (offtake, political, and currency) for renewable energy investments across developing markets. Capitalising such solutions could be a means to maximise the impact of climate finance.
While developed countries must enhance climate finance support, developing countries must equally provide a conducive ecosystem for its delivery.
For example, green taxonomies and climate risk reporting and disclosure requirements could simplify due diligence for investors at the asset and corporate level respectively.
Collaboration between financial regulators through multilateral forums such as the Network for Greening the Financial System (NGFS) can ensure international harmonisation of these standards which would facilitate due diligence.
The writer is a Programme Lead at the Centre for Energy Finance at the Council on Energy, Environment and Water