How maximizing green finance flows to developing countries could tackle global warming 

Climate finance is high on the global agenda with the 29^th United Nations Framework Convention on Climate Change (UNFCCC) Conference of Parties (COP) in Baku, dubbed the 'Finance COP,' just four months away. Negotiators will work towards setting a new climate finance mobilization target for developing countries known as the new collective quantified goal (NCQG). These negotiations will take place even as the discourse around the reform of multilateral development banks (MDBs) to better equip them to finance global challenges, including climate, in developing countries gathers momentum. The quest for a breakthrough in climate finance assumes urgency against the backdrop of increasing socioeconomic disruptions caused by extreme weather events, particularly in developing countries.

Decarbonizing and building climate resilience in developing countries is critical to the success of global climate action since these countries will drive the incremental consumption of energy and materials in the coming decades. Emerging markets, for example, are expected to account for 88% of the growth in global electricity demand between 2019 and 2040. These countries, however, are ill-equipped to finance transformations to low-carbon and resilient economies by themselves. As illustrated by the figure below, the lower the income level, the greater the disadvantage when it comes to mobilizing credit for investment by the private sector. This is particularly relevant as public capital alone is insufficient for climate action.

Both perceived and real risks associated with investing in developing countries limit climate finance flows to them. Further, developed countries underdelivered on their commitment under the UNFCCC to mobilize $100 billion per year for developing countries by 2020. This goal was reportedly achieved two years after the target date and there remain question marks over the accuracy and methodological robustness of the reported figures.

Developing countries (excluding China) need to invest an estimated $2.4 trillion per year by 2030 for climate action, of which around $1 trillion or ~40% per year need to be sourced from external flows. Actual developing country climate finance flows are a fraction of this amount. Only 15% of the estimated $1.27 trillion global annual climate finance (~$190 billion) flows to or within emerging markets and developing economies (excluding China). Given the steep increase required in developing country climate flows, progress on the NCQG and MDB reform would be welcome measures that increase the capacity of existing channels to deliver finance. At the same time, complementary action on three fronts could help maximize actual climate finance delivery.

The latest OECD climate finance figures for the year 2022 report that $91.6 billion in international public finance mobilized only $21.9 billion in private flows. This indicates that international public capital is primarily deployed as direct loans, instead of through de-risking instruments, in which public capital underwrites risk to crowd in private capital. If public capital is instead deployed primarily through de-risking instruments, it can achieve much greater private capital mobilization.

The India Deep Dive leg of the World Economic Forum’s Mobilizing Investment for Clean Energy in EMDEs (MICEE) initiative, which was co-led by the Council on Energy, Environment and Water and consulted public and private sector stakeholders in the field of energy and finance in India, offers two examples of such de-risking instruments. The first addresses financing constraints associated with utility-scale renewable energy deployment. India’s banking system already offers debt capital for utility-scale renewable energy on competitive terms. However, capital from domestic lenders by themselves would likely be insufficient to finance the achievement of India’s 2030 renewable energy targets.

The solution lies in unlocking new sources of finance to complement existing ones. The MICEE proposed a subsidized credit enhancement facility for unlocking the domestic debt capital markets for renewable energy. If capitalized with $20 million, such a facility could mobilize gigawatt-scale bond issuances and free up bank debt for fresh lending.

The second solution addresses challenges associated with funding battery energy storage systems in power sector applications. Currently, the absence of an extensive track record of technology performance and business models translates into heightened risk perceptions by domestic lenders and elevated cost of capital for these systems. The MICEE proposed a technology de-risking fund that provides guarantees to lenders against losses stemming from the underperformance of nascent technologies. This can potentially lower the cost of capital for storage projects.

Developing countries can better equip themselves to receive international climate finance by creating an enabling environment for investments. This can happen through policy action at two levels – sectoral and cross-cutting. Policy action in specific green sectors (e.g., renewables and sustainable transport) can help address investment risks. Further, cross-cutting regulations, such as sustainable finance taxonomies and corporate sustainability disclosures, can facilitate the linking of capital with credible investment opportunities. Such cross-cutting frameworks should be interoperable with international frameworks to facilitate international capital flows.

Emerging sustainable finance hubs in large emerging economies, such as GIFT IFSC in India, can be developed as regional platforms to serve markets beyond their immediate jurisdictions. These can play an important role in linking international capital with investment opportunities in the Global South. Such initiatives can help bridge the gaps in the financial systems of smaller developing countries in the region.

Climate action requires significant investment. In the case of developing countries, much of it is projected to be sourced from within. However, a significant chunk (~40% in 2030) required by them will still need to be sourced from developed countries. At the same time, developing countries can play a role by paving the way for these flows from overseas. Acting on the aforementioned three-pronged approach can be an effective way to do so.

Finally, it is essential to appreciate why one set of countries, namely developed, needs to step up flows and what the second set of countries, namely developing, can do to accelerate those flows. Only then will developed and developing countries be able to act in concert to deliver climate finance that staves off the worst impacts of global warming.