By Janak Raj & Priti Dubey,
Emerging market and developing economies (EMDEs) need large financing for climate action. The Independent High-Level Expert Group (IHLEG) on Climate Finance, which submitted its report in November 2022, estimated external fund requirement for EMDEs (excluding China) at $1 trillion per year up to 2030. To meet such large external requirement of funds, multilateral development banks (MDBs) are expected to play a major role, for which several high-level committees have made useful recommendations to augment their lending capacity. The major suggestions that have emerged in this regard are: (i) optimisation of balance sheets of MDBs, (ii) increase in their capital base, and (iii) re-channelling of special drawing rights (SDRs, an international reserve asset created by the International Monetary Fund) through MDBs. The role of MDBs in financing climate action is indeed critical, especially for countries which are heavily indebted. Least developed countries (LDCs), in particular, face enormous challenges, with their external public debt climbing from 20% in 2010 to 26% in 2022, and their interest payment burden soaring from 2.7% of their public revenue in 2010 to 7.8% in 2023. Many of them are, therefore, not able to access international capital markets, and for those which can, the cost of borrowing is prohibitive.
MDBs had set for themselves the target of $65 billion for climate finance for 2025 at the UN secretary general’s Climate Action Summit in 2019. Climate finance extended by MDBs in 2022 was $100 billion — the second year when climate finance exceeded the target of $65 billion. The share of climate finance in incremental loans extended by MDBs rose consistently from 32% in 2018 to 47% in 2022. Climate finance activity in 2022 was led by the European Investment Bank, with its share of 37% in total climate finance by all MDBs, followed by the World Bank Group (33%).
Though efforts made by MDBs to scale up their climate finance in recent years are laudable, the present scale of their operations is too small, considering the external requirements of climate finance by low- and middle-income countries (LMICs). Overall climate finance extended by MDBs to LMICs was $61 billion in 2022, which constituted 6.1% of the total requirement. The quality of climate finance by MDBs also raises concerns. Of total climate finance extended by MDBs to LMICs, only 23% was for adaptation action and a very small share of 6% was by way of grants.
A lot of emphasis has been placed on the optimisation of balance sheets of MDBs to augment their lending capacity so that a “dollar in” managed by them results in many times a “dollar out” for financing development and climate action. However, the situation on the ground has not changed much. Capital and reserves of MDBs grew by 2.3% during 2018-22 (compared with 6.0% during 2013-2017) and their overall balance sheets expanded by 2.7% during the same period. However, the multiplier (the ratio of total assets/liabilities to capital and reserves) increased only marginally from 3.7 in 2017 to 3.8 in 2022. On an average basis, however, the multiplier at 3.8 during 2018-2022 was significantly lower than 4.3 during 2013-2017.
In any case, optimisation of balance sheets cannot be expected to make a large difference to the overall lending capacity of MDBs. Since MDBs are keen to retain their highest credit rating, the only other way to augment their lending capacity is to expand their capital base. Despite the recommendation by the G20 Independent Expert Group (IEG) in November 2023 to expand the capital base of MDBs by $100 billion in the next 10 years ($10 billion every year), there has hardly been any progress to this effect. It seems that the stressed fiscal situation in major advanced economies and the current geopolitical situation have become the main stumbling blocks.
In the absence of any capital increase and assuming the same compound annual growth rate (CAGR) as in the last five years for the entire climate finance portfolio (15%), MDBs’ climate finance to LMICs is estimated to rise from $61 billion in 2022 to $180 billion in 2030. In all, this aggregates $940 billion during 2023-2030, which will meet only about 12% of external climate finance requirements of LMICs (based on $1 trillion requirement every year).
Re-channelling of SDRs through MDBs has a huge potential to strengthen the lending capacity of MDBs by generating a much-needed multiplier effect. Many advanced economies are sitting on large idle SDR balances of their total allocations (59% of total SDRs allocations of SDR 660.7 billion). The IMF in May approved that SDRs recycled to MDBs can be considered as reserves, though it initially capped the amount of SDRs that can be utilised by such facilities at SDRs 15 billion. Re-channelling of SDRs through Europe-based MDBs seems unlikely as the European Central Bank (ECB) has indicated that recycling of SDRs to MDBs is not permitted under current ECB rules and regulations. However, it is reported that some headway has been made by the African Development Bank and the Inter-American Development Bank for re-channelling SDRs.
To conclude, MDBs are severely constrained in their lending capacity in the business-as-usual scenario. Their reserves have grown at a meagre CAGR of 2.5% in last five years and there are no signs of expansion in their capital base as recommended by the G20 IEG. Approval by the IMF to re-channel SDRs through MDBs is a welcome development, but it remains to be seen how far this gets materialised. In the absence of any further change in capital and/or re-channelling of SDRs, even the most optimistic estimates suggest that MDBs can finance only a small part of climate-related requirements of LMICs. Furthermore, in the absence of any significant improvement in the lending capacity of MDBs, financing of climate action by them can come only at the expense of financing of development activity.
Janak Raj & Priti Dubey, Respectively senior fellow and research associate, Centre for Social and Economic Progress (CSEP).
Disclaimer: Views expressed are personal and do not reflect the official position or policy of Financial Express Online. Reproducing this content without permission is prohibited.