By Amit Garg, Akhilesh Tilotia, & Sanjay K Jain
One of the significant outcomes of the New Delhi Leaders’ Declaration at the recent G20 summit was the Green Development Pact for a Sustainable Future. It helps build crucial momentum in the world’s race to fulfill the temperature targets in the Paris Agreement. As part of this Green Development Pact, the Declaration highlighted the importance of mobilising timely and adequate low-cost climate financing through blended finance and risk-sharing facilities.
However, this path is not without its challenges. Among the major impediments for private investment in climate change projects, especially in Emerging markets and Developing Economies (EMDEs), are prevailing information asymmetries and adverse risk perceptions. Achieving success hinges on the calibration of three factors: innovatively augmenting the resources of Multilateral Development Banks (MDBs); alignment with national goals; and effective delivery of climate technology, finance, and resilience.
Central to financing low-carbon and climate-resilient initiatives in EMDEs are MDBs, which provided $51 billion (62% of overall MDB financing) in climate finance as of 2021 to low- and middle-income economies (2021 Joint Report on MDBs’ Climate Finance), highlighting their pivotal role in steering sustainable development within these regions.
Augmenting MDB resources and avenues…
In light of the annual $100 billion pledge by developed countries to the developing world, there’s potential for a significant increase in the present paid-in capital of MDBs. By increasing capital contribution, MDBs can expand their borrowing programmes without impacting leverage ratios and credit ratings. This becomes especially pertinent given MDBs’ enviable credit ratings, which enable them to borrow at almost risk-free rates.
ODI, a global affairs think tank, pegged the cumulative paid-in capital across MDBs at $79 billion, with accumulated reserves of $127 billion. In addition to this $206 billion of net worth, MDBs hold commitments from their key shareholders, known as callable capital, amounting to $890 billion (as of 2021)—over four times their net worth.
While MDBs are justifiably cautious about safeguarding their sterling credit ratings, there’s a pressing need for engagement with credit rating agencies on the leverage possible on such callable capital without impacting ratings. Moreover, designing financial instruments are imperative for de-risking projects. MDBs have worked with a variety of instruments, from low-carbon investment trusts, securitisation, credit default, and currency swaps to equity-based funds, collective investment vehicles (structured funds), convertible bonds, and outcome-based sustainability-linked loans or bonds. These instruments serve to recalibrate the risk profile of projects and lower capital costs.
In the context of financial instruments, exchange rate protection can help EMDEs in mobilising climate finance. This mechanism can involve long-term currency swaps between central banks of various countries. MDBs have the potential to become the nodal or aggregating agencies for pooling together climate finance flows between countries and offer exchange protection to private investors. While their primary focus has traditionally been sovereign and sub-sovereign funding, there’s an emerging case for deeper engagement with non-sovereign borrowers spearheading green and climate action projects. Collaborative learnings and the sharing of best practices among MDBs can further hone these instruments and strategies, ensuring they evolve in tandem with the dynamic climate landscape.
Aligning with national goals
To amplify the impact of their funding, MDBs must synchronise the projects they fund with each country’s Nationally Determined Contributions (NDCs) and Long-Term Strategy (LTS) to meet the targets of the Paris Agreement. This alignment not only solidifies the path to meeting the Paris targets, but also bolsters energy security, curtails the risk of stranded assets, and fortifies economic resilience. Since many EMDEs are still in the process of defining their green and sustainable benchmarks, such projects can serve as a robust foundation, accelerating the pace of low-carbon and climate resilient development.
However, that even as these nations focus on green initiatives, traditional energy sources are still required for energy security and development. While the phasing out of coal remains a contentious issue for many EMDEs due to economic dependencies, modern technology and manufacturing processes can help reduce coal consumption per unit of output. MDBs should consider supporting these transition projects, facilitating a more sustainable trajectory for EMDEs.
Effective delivery of climate tech, finance, and resilience
Given their deep expertise and experience of project funding, MDBs are uniquely positioned to bridge the prevailing information asymmetry in EMDEs, offering invaluable reassurances to private investors.
Technological and manufacturing innovations are critical in low-carbon and climate-resilient development. Pioneering technologies such as Carbon Capture, Utilisation, and Storage (CCUS), bioenergy, and green hydrogen can drastically reduce greenhouse gas emissions.
However, their widespread adoption in EMDEs is often hamstrung by economic viability and Intellectual Property Rights (IPRs) challenges. IPRs for certain low-carbon technologies could, for instance, be held by private firms, making green technology costly or unavailable to EMDEs. One way for MDBs to address these challenges is by pooling together to create a special fund to reduce the cost of technology transfers for EMDEs. Programmes akin to the Clean Technology Fund can be replicated across and/or amongst MDBs.
In an era defined by shifting climate patterns, resilience is paramount for any infrastructure development. MDBs have a pivotal role in collaborating with governments at all levels to design resilient infrastructure that can weather the challenges posed by climate change. By partnering with insurers, they can further ensure these structures have a financial safety net in case of a climate disaster.
The recent G20 declaration has cast the spotlight on the critical role of MDBs in climate financing. It has highlighted a golden opportunity to facilitate action-oriented outcomes for MDBs and speed up the transition to a low-carbon world. Acting with urgency can mitigate future global costs associated with delayed transitions, lock-ins, asset stranding, loss and damage. The time is ripe for action and MDBs stand at the forefront of this shift towards a greener future.
Amit Garg, Akhilesh Tilotia, & Sanjay K Jain. Garg is NIIF ESG Chair Professor at IIM-A, Tilotia is with NIIFL, Jain is a civil servant and a PhD scholar at IIM-A. Views are personal.