The International Monetary Fund (IMF) Climate Staff Notes has noted recent increases in energy prices have exposed many Emerging Market and Developing Economies (EMDEs) to high fossil fuel prices and, in some cases, to energy rationing.

According to the report, several minerals critical for the transition have seen further sharp price increases since the start of the war in Ukraine.

“In the context of hurdle rates in project finance to very high levels, jeopardizing projects with high upfront capital costs, such as sparked energy security concerns, delaying efforts to spur the low-carbon transition in some countries, and monetary policy tightening in advanced economies (AEs), high sovereign bond yields in some EMDEs can raise solar and wind projects,” the report said.

In its July publication, the International Monetary Fund Staff Climate Notes says the global macroeconomic context plays a determining role in climate finance.

“It is also important to monitor balance of payments vulnerabilities that could arise from large capital inflows associated with climate finance. If the de-risking of climate-friendly infrastructure assets is not accompanied by increased domestic capabilities in low-carbon manufacturing (for example, renewable energy technology) or large critical minerals endowments, capital inflows could drive current account deterioration, and could lead to financial imbalances if future returns are overestimated, generating macroeconomic vulnerabilities.”

Despite recent rapid increases in private sector investment, the report noted that climate finance needs to remain significant, despite considerable uncertainty about the size of mitigation and adaptation needs.

It said that, global investments required to meet the Paris Agreement’s temperature and adaptation goals are estimated to be between $3 and $6 trillion per year until 2050. Global climate finance currently amounts to approximately US$630 billion per year with debt serving as the primary source of funding for these investments. And also Green bonds account for less than 3% of global bond markets, with the majority issued in developed markets and China.

Part of the report indicated that estimates of financing needs vary due to large data gaps in climate finance data tracking, particularly in sectors other than renewable energy, energy efficiency, and transportation. Furthermore, data on climate finance are incomplete because data collection and disclosure are not currently mandated in several countries.

The notes discussed strategies and policies for attracting domestic and international private sector capital in climate-related products by overcoming existing constraints.

Beginning with first principles, it highlighted existing constraints and risks, such as the lack of carbon pricing and business models for infrastructure projects.

Multiple constraints, including supply and demand factors, macro-financial and microeconomic impediments, unattractive risk-return profiles in unproven markets, high fossil fuel investments, and data-related constraints, prevent attracting and scaling up private sector climate finance.

High upfront costs and risk associated with mitigation and adaptation investments have also been identified as significant deterrents in Emerging Market and Developing Economies (EMDEs).

Several others include significant macro-financial constraints to mobilizing private capital, as well as the absence of adequate carbon pricing in EMDEs in particular.

According to the IMF Notes series, which aims to quickly disseminate concise IMF analysis on critical economic issues to member countries and the broader policy community, such pricing would help generate incentives for private investment in low-carbon projects and promote a more transparent market to make informed investment decisions in various markets and economies.

Another macroeconomic constraint is country risk, which can be difficult to price for some EMDEs, particularly those related to climate change.

Ananthakrishnan Prasad, Elena Loukoianova, Alan Xiaochen Feng, and William Oman, authors of the notes series, stated that discussions with large development finance institutions revealed that the cost of equity for climate investment for impact investors and development finance institutions (DFIs) was 12-15 percent in small frontier EMDEs as of June 2022, suggesting that it could be even higher for commercial investors.

High fossil fuel investments have also been identified as a barrier to improving climate finance that must be addressed.

“Phasing out fossil fuel assets to replace them with low-carbon energy sources requires managing the macro-financial consequences of asset stranding, including the reallocation of capital an labor.”

Aside from climate-related externalities, there are taxonomy information asymmetries and large data gaps.

Among the data gaps, developing weather monitoring and forecasting systems is critical, particularly for smaller low-income countries (LICs) that rely heavily on agriculture. Externalities of this magnitude create significant barriers to private sector climate investment and effective capital reallocation.

A few large-scale private-public partnerships have been established to leverage public financial resources to facilitate private climate investment.

According to the authors, some partnerships, such as the Green Climate Fund, face challenges such as low accreditation rates and slow disbursements as a result of lengthy and complex processes.
This emphasizes the significance of capacity building for EMDEs that lack the capacity to leverage such partnerships.

Climate Investment Funds (CIF), established by global leaders in 2008, is a $8.5 billion multi-donor trust fund that supports climate investment in developing and middle-income countries.

Working with the private sector, governments, and six multilateral development banks (MDBs), the fund provides a platform for partners to pool and leverage financial resources while de-risking investments through concessional financing and other financing products.

By the end of 2020, the fund had channeled over US$60 billion in co-financing green projects from its global partners.

Climate technology and sustainable forests, as well as climatesmart cities and renewable energy integration, are among the projects funded by the CIF.

The G7 committed additional resources of up to $2 billion in 2021 to strengthen its role in financing climate investment in low- and middle-income countries.

At COP15 in Copenhagen in 2010, the UNFCCC framework established the Green Climate Fund (GCF), with a goal of mobilizing $100 billion per year by 2020.

The fund quickly raised $8.3 billion during its initial resource mobilization period in 2014. As of September 2021, it had raised more than US$10 billion from 34 contributors in the fund’s first replenishment (2020-23) period.

Through its Private Sector Facility, the GCF encourages private sector investment by providing concessional loans, lines of credit to banks, equity investments, guarantees, and first-loss protection, among other financing instruments.

During 2015-20, the fund co-financed or directly financed climate investments totaling $23.4 billion in 117 developing countries, covering both climate adaptation and mitigation projects.

The Green Growth Equity Fund (GGEF) is a new initiative that aims to transfer and replicate technologies.

The GGEF, which is supported by concessional funds in the form of subordinated equity from the GCF and is anchored by India’s National Investment and Infrastructure Fund (NIIF) and the UK Foreign, Commonwealth, and Development Office (FCDO), is a fund-of-funds structure that aims to raise US$900 million from a mix of institutional investors and development financial institutions (DFIs) (via Dutch development bank FMO).

GGEF intends to invest equity capital in climate technology growth firms in renewable energy, e-mobility, energy services, and resource efficiency projects with high innovation potential through sectoral platforms.

The IFC Managed Co-Lending Portfolio Program (MCPP) provides infrastructure funding while facilitating the flow of private capital to emerging market infrastructure projects.

The program offers an innovative model for mobilizing development financing that combines insurance company financing, IFC project origination and credit enhancement, and public sector donor support.

A portfolio syndication process in each MCPP Infrastructure facility provides investors with a diversified portfolio of loans that mirrors the IFC’s portfolio, as well as an IFC investment in the first-loss tranche that provides private investors with an investment-grade profile.

The logic behind creating a portfolio that mirrors the IFC’s portfolio is to allow MCPP investors to co-lend in every new loan that IFC originates that meets the investor’s criteria (allowing investors to benefit from the IFC’s country and sectoral diversification), as well as to allow IFC and MCPP investors to invest in equal amounts.

The Multilateral Investment Guarantee Agency (MIGA), a World Bank Group member, leverages the use of its guarantees to support private-sector green investment.

In the fiscal year 2021, for example, the agency issued US$1.35 billion in guarantees, or 26 percent of its total new business volume, to support climate adaptation and mitigation projects in 22 countries. These green investments include, among other things, renewable energy, infrastructure, and agricultural projects.

MIGA guarantees facilitate cross-border green investment by providing investors and lenders with political risk insurance and credit enhancement. MIGA insures cross-border investments against sovereign risk but not against project risk.

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