Policy Circle, August 25, 2023

By Sankalan Dey

Climate change and climate finance have become the buzzwords of contemporary discourse. A recent appraisal by a group of distinguished economists on climate finance has estimated that the world will need $2.4 trillion by 2030 for the recalibration of climate change dynamics in emerging markets and developing nations. The crucial question is how to effectively mobilise and utilise these funds to make a compelling business case that attracts private sector investment.

Despite the frequent use of the terms climate change and climate finance in environmental discussions, there exists a noticeable gap in comprehending meaningful and sustainable financial solutions to effectively tackle the ongoing challenge of climate change. Previous goals aimed at addressing climate change were formulated before this latest estimation. Regrettably, as various authorities indicate, these goals did not materialise as initially intended. For instance, there has been a failure in achieving the developed countries’ commitment of $100 billion annually by 2020.

According to the Organisation for Economic Cooperation and Development, collective efforts resulted in mobilising $83.3 billion in funds in 2020. A positive trend suggests that this milestone might be reached by 2023.

The inability to meet specific financial benchmarks to tackle climate-related challenges emphasises its urgency. A new framework proposed by the upcoming 28th round of the Conference of Parties (COP28), scheduled for October this year in Abu Dhabi, aims to address new focus areas such as debt distress in vulnerable countries. It may also explore the role of increased private sector financing to achieve the estimated target.

In this context, it is important to note that despite a significant increase in private and public sector investments to mitigate the effects of climate change, which nearly doubled from $940 billion in 2011 to $940 billion in 2021, it still falls short of the estimated target. This underscores the need for more innovative financing methods to escalate climate-related investments.

Innovative approaches to finance climate change mitigation and adaptation can help eliminate existing barriers that hinder potential funding sources, thus opening new avenues for financing that can help attain the estimated investment levels. Particularly, the issue of debt, which affects various countries, especially the poor and vulnerable ones, impedes their access to other investment sources. A strategy that combines debt management with climate finance is necessary to address these challenges, potentially leading to an expansion and enhancement of both international and domestic private and public investments.

Hence, it is crucial to address the primary barriers obstructing climate finance. Advancing such financing requires a meticulous diagnostic approach to comprehend underlying issues. Enhancing investment effectiveness demands the use of financial instruments to mitigate risks. This is where innovative financing approaches can play a pivotal role.

Exploring innovative uses of Special Drawing Rights (SDRs) to support climate finance holds the potential for transformative changes. However, it is equally important to preserve the intrinsic benefits of SDRs, characterised by conditional exemption and debt-free liquidity. This might involve adjusting SDR allocations in favor of multilateral development banks.

Addressing allocation disparities could ensure that SDRs are allocated to essential areas and projects. Alternatively, embracing novel concepts like blended finance could be considered to generate fresh SDR assets, especially for climate resilience initiatives. Such a comprehensive strategy balances caution and creativity, advancing the use of SDRs as a cutting-edge method to finance the battle against climate change while preserving their unique attributes.

Another potential funding source could be government-backed development banks, which provide a direct route to expand climate-related development financing. Their long-term focus counters the cyclical nature of private finance, and their localised expertise covers various regions. Climate funds from these banks could potentially assist in transition challenges beyond technical aspects. To facilitate this, multilateral development banks and their regional counterparts should devise new instruments for capital infusion.

In this context, blended finance emerges as a pertinent tool, evident in significant climate projects like Africa 50 and Amundi Planet Emerging Green One. Additional funding sources encompass Green, Social, and Sustainability Bonds, Sustainability Linked Loans, the Global Market for Ecosystem Services, Resilience and Sustainability Trust, and Debt-for-Nature Swaps.

With a total estimated market capitalisation of $3.8 trillion as of 2022, Green, Social, and Sustainability Bonds lead the pack, trailed by Sustainability Linked Loans at $600 billion. By judiciously complementing and utilising such instruments, multilateral development banks should facilitate private sector investment in climate-related endeavors by convincing them of the sound business case it presents.

(Sankalan Dey is a Research Associate working for CUTS International, a global public policy research and advocacy group.)

This news can also be viewed at: https://www.policycircle.org/