By Ishac Diwan and Dani Rodrik
Bridging the Climate-Development Gap
Thématique générale: Green Finance
8 reasons to support a new International Green Bank
In a new policy Note, Hafez Ghanem, FDL distinguished fellow, makes the case for establishing a new "Green bank", which would have the legitimacy, the size and the financial instruments to meet those challenges.
The world has reached a climate crossroads and revolution in climate finance is long overdue. The latest Intergovernmental Panel on Climate Change (IPCC) report made it crystal clear: “The choices and actions implemented in this decade [ie by 2030] will have impacts now and for thousands of years”.
Countries of the Global South (outside of China) will need to spend more than one trillion dollars a year by 2025, and more than two trillion dollars a year by 2030 on adaptation and mitigation., according to the Songwe-Stern report.
How can the Green Bank go beyond "business as usual"?
This notes provides eight reasons to support the green the proposed Green Bank.
Urgency
- There needs to be a true revolution in climate finance. A new institution would send a strong signal that the international community is ready to tackle the huge and urgent needs for climate action.
Institution and politics
- Bretton Woods Institutions simply to not have the mandate, nor the credibility to undertake such a drastic effort.
- The Green Bank would provide a platform for governments, private sector and civil society to dialogue and work together, hence it would mobilize strong political support across the North and South to advance the climate agenda;
- Commitments by international organizations on climate change matters may be prone to shift to reflect political changes in their host country, the Green Bank’s governance structure would protect it from such changes;
- By providing a strong voice for countries of the South in its governance, and by separating funding for climate--and thus protecting general development funding by MDBs--it will ensure the South’s buy-in and full implementation of needed reforms, programs and projects.
The financial case for a green bank
- The essential challenge which faces recent proposals, including for instance the proposed “Mitigation Trust”, is the ability to mobilize the private capital needed to reach sufficient scale. Private sector participation in Green Bank’s capital means that less will be required from governments, and the presence of private sector representatives in governance structure should help inform decisions to attract private investments in countries of the Global South;
- The Green Bank could be the instrument for the international community to respond to the Bridgetown Initiative and the promise made at COP27 by making use of innovative financing like green bonds, interest rate buy-downs, carbon credits, and green taxes;
- Unlike most MDBs, Green Bank lending would not require a sovereign guarantee and thus would not add to sovereign debt.
The geopolitical rationale:
In the present geopolitical climate of superpower competition, an institution focused on a single issue that is important for all humanity could be a useful platform for international cooperation. Climate change is a challenge for all of humanity East and West, North and South. It is a possible area where all countries can put their rivalries aside and focus on cooperating to save human civilization. Green Bank could be a platform for cooperation between rival powers, and thus make a small contribution to better understanding and a reduction of tensions.
Questions and objections:
There are many natural objections and questions to this proposal:
- "There are too many climate funds": the Green Bank would be a drastically different institution than all existing climate funds, sometime subsuming their function (and thus recommending to close some of them).
- "It would take too long to set up a new institution": this is not necessarily true: starting with a coalition of the willing and not waiting for global consensus could be feasible rapidly.
- "It separates development from climate": no, as the idea behind Green Bank is to protect development finance while mobilizing additional resources for climate. It is not to separate climate and development work.
- "The World Bank should take this role." the Green Bank would work closely with Bretton Woods Institutions and regional MDBs, but its functions would remain different, with a primary, and indeed single focus on mobilising finance for climate. The World Bank would continue taking the lead on development work and coordinating the work of other institutions— including Green Bank—through its support to country platforms. There is a possible option to create the Green Bank within the World Bank, which would allow to rely on its staff and expertise. In this case, the Green Bank would still need to be institutionally protected from poltiical meddling, and to have the private sector and CSOs in its board.
Hafez Ghanem is a distinguished fellow at the Finance for Development Lab.
He is a development expert with more than forty years’ experience (including 31 years at the World Bank) in policy analysis, project formulation and supervision, and management of multinational institutions. He has worked in over 40 countries in Africa, Europe and Central Asia, Middle East and North Africa, and South East Asia. He is currently a senior fellow at the Policy Center for the New South in Morocco, and a non-Resident Senior Fellow at the Brookings Institution in Washington DC.
How to move from trillions to people ?
This blogpost was written in collaboration with participating think tanks from the Amplifying African Voices Initiative and jointly published
Climate finance has emerged as a major concern not just for African countries, but for the developing world at large.
A recent meeting of African think-tanks, under the Amplifying African Voices Initiative co-convened by the African Center for Economic Transformation (ACET) and the Finance for Development Lab (FDL), discussed existing knowledge on the pressing topic of climate finance and highlighted the need for further work to advance the cause of an effective and fair green transition on the African continent.
Climate finance has emerged as a major concern not just for African countries, but for the developing world at large. Global warming is estimated to generate a median loss of 1.5 percent of annual GDP in developing countries and in SSA (IPCC, 2022). At the same time, there is a rising occurrence of catastrophic events – droughts, floods, pandemics – that lead to the loss of years of development at once. It is poor people, women, and children that are the least able to protect themselves and bear the brunt of these shocks.
A recent meeting of African think-tanks, under the Amplifying Africa Voices Initiative co-convened by the African Center for Economic Transformation (ACET) and the Finance for Development Lab (FDL), discussed existing knowledge on the pressing topic of climate finance and highlighted the need for further work to advance the cause of an effective and fair green transition on the African continent.
The key tensions between development and climate needs were not resolved at COP27. We are still very far from a credible agenda for a fair transition to a de-carbonated world. From a fairness perspective, Africa needs to be compensated for the emission gap (AfDB 2022). The continent generates 3% of global emissions, and yet it suffers most from climate change. North Americans emit 14 tons of CO2 per person annually; Chinese and Europeans 7 tons, and Africans emit just 1.1 tons. The African Development Bank estimates that climate debt requires a transfer from the rich world to Africa of more than $150b/year until 2050. But, as the world aims to net zero by 2050, Africa’s aspiration is not just to be compensated for damages but also use green development pathways to its comparative advantages, including renewable energy, green hydrogen production and credible carbon offsets.
Think-tanks need to be much closer to the ground to start bringing this vision closer to reality.
Where is climate finance for Africa?
Climate funds mobilized for African countries still fall far short of the amount needed to avoid the worst impacts of climate change, support adaptation and the building up of resilience on the continent. Worse, some of what is raised crowds out traditional ODA, and much of what is spent is tilted towards mitigation. A recent report by ACET showed that for the period 2020-2030, the average annual climate funding needs for Africa are estimated at over $140bn per year - around $30bn for adaptation, $70bn for mitigation, and $40bn for loss and damage. This compares to current flows of only $20 bn per year.
It is not going to be easy to raise these large amounts in a world of tight budget constraints. Several initiatives on this front need to be supported – such as MDBs reform and SDR rechanneling. Moreover, different aspects of the problems require different types of financing:
- Adaptation finance should be largely financed by MDBs, since it covers projects with public goods characteristics. Allocation criteria should be related to climatic vulnerability, not just to poverty.
- Funding for climate mitigation should come largely from the private sector, and supported with instruments to mitigate country risk through FDI, PPPs, guarantees and other enhancements from MDBs.
- Loss and damage funds should be grants-based and may require a new global tax instrument to be put in place – for example in the domain of transport, carbon, or capital flows.
To move from trillions to people, there is mostly a need to move from “back of the envelop” estimates to closer to the ground and to the identification of people’s needs. There are indications that rates of return on adaptation projects can be in the triple digits (see e.g. IMF 2022). But pipelines of actual projects ready to be financed remain hard to come by, especially for adaptation, but also for mitigation. To flow, climate finance needs to be irrigated by a pipeline of proposals. To get there requires work at the field-level to determine how to reduce vulnerability. It also requires large amounts of technical assistance funding to build up financeable proposals for desirable projects. AUDA-NEPAD has been a provider of such capacity building and project preparation.
Listening to people's voices
How can think-tanks and civil society be more involved? There are already models in the continent that can be emulated. Through a series of webinars called "What is the voice of Africa?", the Egyptian Center for Economic Studies (ECES) has explored solutions proposed by African countries’ speakers to address their concerns about climate change.
Africa’s youth need to play a fundamental role since they will be the primary bearers of climate change consequences: as the continent will be on the frontline of the consequences of climate change, and the current young generation will experience increasing impact.
The South African Institute of International Affairs (SAIIA) has been working on capacity-building programs with young scholars on climate. The Kenyan Institute from Public Policy Research and Analysis (KIPPRA) organized a Youth in Climate Change Action Symposium which informed policy briefs in preparation of COP27. But in Sharm-El-Sheikh, a big gap remained between closed-door negotiations and debates among civil society actors.
More pressure is needed to open up formal negotiations to demands emanating from citizens. At the national and global levels, we need mechanisms to hold leaders accountable, and for their pledges to be translated to concrete actions.
Defining climate change vulnerability
The newly approved Loss and Damage Fund was one of the successes of the COP27, as this has been an African priority in global climate negotiations for more than a decade (SAIIA, 2022). But central questions on the mechanism, its funding, and conditions of access remain wide open. Conversations took place during COP27 on the urgency of defining economic and non-economic impacts of climate change, including depending on social characteristics, such as gender or age. It was clear that a much better understanding is needed about the connection between efforts to improve adaptation to global warming and loss & damage. Adaptation includes projects to build defenses against sea-level rising, reduce the salinity intrusion and floods, make resilient road and bridge infrastructure, and increase water conservation. An important side-benefit is that adaptation will improve food security in a world with greater variability in food prices.
At the regional and local levels, work is needed to understand how efforts on adaptation can be better integrated to reduce the costs of natural disasters. In East Africa or the Sahel, the nexus between humanitarian or food insecurity needs is linked to efforts in adapting to climate change. Estimating needs and returns on certain investments could be a step forward in making the case for much more financing from the international community.
What is green growth?
In the future, African economic growth will have to be green.
What constitutes green growth – sustainable, inclusive - remains to be imagined. Some elements are becoming clearer but need to be brought together into a coherent whole.
Solar and hydro can become a source of comparative advantage. With adapted technology transfers, economies could leapfrog to higher levels of productivity in many fields.
Progress in these areas requires large investment, technological transfers, and proper planning. In some cases, global reforms are needed. African initiatives to transform and strengthen carbon offsets markets could unlock large sources of financing: at $50/ton, $15b of annual revenue and 50 million jobs can be generated (Climate Action 2022). Those flows would compensate for global environmental services.
A tight connection between growth and Nationally Determined Contributions (NDC) needs to be achieved, which would help define the needs, chart green development pathways and link projects to funding sources. For instance, the Kenya Institute for Public Policy Research and Analysis (KIPPRA) has recently introduced a task force with the Kenyan government and World Bank representatives, as well as other think-tanks, which will look at the green initiatives in Kenya, their incentives, and outcomes. A national framework has been drafted and is awaiting approval for implementation. A further research and evaluation project will look at the integration of green economy in Kenya and determine the outcomes to be evaluated.
Amidst a growing number of initiatives, this meeting clarified important questions that remain to achieve green development pathways:
- charting green growth with economic transformation and infrastructure investment,
- connecting them to financing sources,
- protecting vulnerable people and economic systems through adaptation,
- compensating losses and rewarding global public goods contributions.
Ultimately, it also implies reforming institutions to provide more voice and accountability from decision makers.
Amplifying Africa Voice is an initiative of the African Center for Economic Transformation (ACET) and Finance for Development Lab (FDL) to improve knowledge sharing and joint analysis among African economic policy institutes on the global financial architecture agenda.
The first technical session on African perspectives on climate finance was hold on January 10, 2023. It included the participation of nine African think tanks – African Center for Economic Transformation (ACET); African Economic Research Consortium (AERC); BIDPA (Botswana); AUDA-NEPAD Policy Bridge Tank; ECES (Egypt); KIPPRA (Kenya); Policy Center for the New South (PCNS); REPOA (Tanzania); and the South African Institute for International Affairs (SAIIA) – as well as several independent experts – Hafez Ghanem (FDL), Jean-Louis Sarbib (ACET Distinguished Fellow), and Lemma Senbet (University of Maryland).
The financial costs of the green transition in developing countries
How interest rates impact the access to affordable and renewable energy
As climate talks continue to progress this week at UN’s COP27 summit in Egypt, it is clear that everyone, developed and developing countries alike, has considerable interest in making sure that energy demand is oriented towards renewable sources. The good news is that according to the International Energy Agency (IEA), investments in renewable energies have reached record levels, accounting for almost three-quarters of the growth in overall energy investment.
For developing countries to be able to follow, this means that renewable electricity production should be cheaper than the fossil fuel alternatives. When one looks at the costs of energy investments, financing (i.e., total expenses due to borrowing) represents the largest source of expenditure. It is higher than capital purchases or marginal costs (operations and maintenance): it could represent between 25 and 50% of the long-term average costs of producing clean energy in emerging markets (ex-China), according to the IEA. The level of interest rate has a direct impact on these investments. As they increase, so does the cost of debt, thus raising even more overall investment costs, and disproportionately so in countries with higher risk spreads.
This leads us to two key questions:
1. What would it take to direct the sector’s massive investments over the next 8 years predominantly towards wind and solar?
2. Is the current rise in interest rates, especially in developing countries, a threat to today’s much-needed green transition?
This short note looks at the relative cost-advantage of renewable sources of energy compared to a gas-combined cycle and analyses whether the current rise in interest rates could threaten their cost competitiveness. It is based on average cost estimates formulae for medium size plans determined by Lazard (2022). Solar costs will be lower in sunny places, and wind plants less expensive in windy places, but using averages provide us with useful orders of magnitude that can lead to important policy advice.
1. At medium-levels of interest rate, renewable sources of energy are cost-effective
Start by considering the impact of fuel prices on the choice of technology. Obviously, producing electricity using gas becomes more competitive at low gas prices. Chart 1 shows that, with interest rates at 10%, solar and wind have very close average costs, which are independent of gas price - at around 4.8-5 cent/kwh. The gas-based technology is cheaper when fuel costs are below $6-7.5/mwh. This means that the recent period of high fossil fuel prices (about $10/mwh during 2018-19 and $15 in 2022) was favourable to green energy.
Source of data: Lazard 2022. These curves are calculated at a 10% interest rate.
Interest rates matter differentially in terms of total cost because the 3 technologies have a different mix of fixed capital investment. Solar and wind are dominated by fixed costs – solar panels and wind turbines are expensive, but the wind and the sun are free, meaning that maintaining those assets is relatively cheap. In contrast, gas-produced electricity uses much cheaper plants at a fixed cost, but this comes at the expense of higher marginal cost from burning fuel all the time. The lower the interest rate, the more attractive clean technologies become relative to fossil fuels. Chart 2 shows a threshold of interest rates below 14%, at which solar-based energy is more competitive than gas.
Source of data: Lazard. Calculated at the 2018-2019 mean gas prices of $10/MWh.
2. A key policy objective: make investing in renewables a safe bet
Energy projects are long-term investments and the above comparisons only work over time. Indeed, current prices are not very informative for the 20 years ahead in terms of cost-forecasts for each technology.
A finance minister of a developing country looking at Chart 2 would be concerned that even at a 14% interest rate, when solar appears to break even with a gas-based plant, the chance that gas prices will decline, compared to their 2010-2018 average levels, still remains strong.
Chart 3: At any level of gas price, solar power is more competitive with sufficiently low IR
For any given level of gas price, solar is competitive with sufficiently low IR
How can international lenders make this bet safer, considering that we are moving into an era of high interest rates and low access to capital?
This short blogpost may not answer the question entirely but it points to the fact that it would not require much: first-loss guarantees, some level of interest rate subsidy, and refinancing facilities to ensure stable borrowing costs would help make renewables a safe bet.
The real challenge is that it must be done at scale: the IEA forecasts more than $1 trillion private sector investment in the energy sector per year for developing countries and just as much by the public sector. It estimates that lowering costs of capital by 200 basis points would reduce the cumulative financing costs of getting to net zero by $15 trillion through to 2050.
Green Finance | The Road from Billions to Trillions
This paper is coauthored with Homi Kharas (Brookings Institution). It is a longer version of a chapter in a collective book edited by Lili Yan Ing and Dani Rodrik for the Indonesian G20 Presidency.
Costs of green finance
The numbers associated with green finance are often strikingly large, but the incremental costs, net of associated co-benefits, are far smaller and could even be negative. Green finance is not costly, in the traditional sense, but shifts costs from the future to the present. In this report, we propose ways for the G20 to make this cost both more certain and supportable for developing countries.
options for the G20
The G20 should enhance green finance along two parallel tracks: a short-term track that underlines the urgency of the situation and the need to accelerate now, and a medium-term track that recognises that green finance must be sustained over decades and therefore requires reform in the international financial architecture.
There are many promising evolving innovations in green finance, some of which are highlighted in this note. At this stage, we recommend that the G20 develop a process for advancing green finance that is credible and consistent with the scale and urgency of the challenge.
On the short-term track, the G20 could:
- Establish a digital database of all cross-border activities, supported by its members, initially with a focus on public finance but with the potential to expand to capture private finance later.
- Monitor progress towards the $100 billion climate finance pledge in the G20 Sustainable Finance Working Group annual report and bring to leaders’ attention any gaps, including in disaggregated areas such as adaptation.
- Encourage dialogue amongst advanced economy (AE) members on a sub-target for additional concessional finance for climate by 2025.
- Motivate expanded multilateral finance to permit more ambitious implementation of the nationally determined contributions (NDCs) by low- and middle-income countries.
- Reallocate, on a voluntary basis, surplus special drawing rights (SDRs) in a way that permits countries to expand fiscal space for NDC implementation in a leveraged way.
- Encourage a review of climate-related official development assistance allocations, in their own agencies and in multilateral agencies, to take into account the needs established in NDCs and the ability to prepare and execute quality green public activities.
On the medium-term track of reforming the international financial architecture, the G20 could:
- Encourage multilateral development banks (MDBs) to scale up their contribution to NDCs, including by helping to scale up country-owned, country-led green country platforms.
- Establish a long-term, forward-looking strategy of MDB capital adequacy, and encourage innovations to free up capital, such as backstop credit facilities, guarantees to reduce single borrower risks, and asset sales, along with a process for considering paid-in capital increments.
- Review principles for debt restructurings such that official and mobilised private green finance are not bound by the same comparable treatment rules as other forms of debt.
- Assess ways of de-risking privately mobilised green finance, including through the use of guarantees.
- Review regular issuance of SDRs to expand the fiscal space for NDC implementation.
- Review the potential for expanding and integrating carbon offset markets.