Blended finance vs policy barriers

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??This week: A responsible commercial investor might be keen to allocate money towards renewable energy projects. But what if those projects sit in a market with slow government approvals and coal policies that keep the cost of the fossil fuel low? Would the enthusiasm wane?

Those conditions currently exist in Indonesia, says blended finance think tank Convergence . They’re significant reasons why commercial capital participation is so low in the country’s blended finance transactions – so called because they’re structured to enable concessional capital investing alongside commercial funding.

For developing economies like Indonesia, removing policy barriers is just as – if not more – important for achieving climate change commitments as attracting investments.

Convergence’s newly minted climate edition of its State of Blended Finance 2024 report showed that the value of climate blended finance deals more than doubled to US$18.3 billion in 2023 from US$8 billion the year before. Of the 78 climate blended deals in 2023, six were “whales” – deals worth at least US$1 billion.

Among the most active countries were Vietnam, which saw 13 deals in 2023, and Indonesia, which saw nine deals.

Despite the buzz in emerging and developing South-east Asia, private commercial participation can be low, which makes it difficult to scale up blended finance in the region and to finance the achievement of countries’ international decarbonisation commitments.

For instance, the public sector funded 73 per cent of blended investments in Indonesia in 2023. About 48 per cent came from development agencies and multilateral donor funds.

Having that sweet public-sector money and donations is awesome, but there really isn’t a lot going around on account of these being concessional funding. So if you’re trying to close that trillion-dollar investment gap to meet your climate goals, you need to get the private sector involved.

Mobilising private capital is ultimately what blended finance is about. Concessional capital takes part at below-market terms to nudge the risk-reward balance for the rest of the deal to a point where private capital is comfortable getting involved. For example, a multilateral development bank like the Asian Development Bank might provide a first-loss guarantee for a project, reducing the risk enough for commercial banks to provide the bulk of financing. The goal is to leverage each concessional dollar to catalyse as much private money as possible.

But simply providing concessional capital and a blended structure isn’t enough. Private investors are also concerned about the policy landscape, since this also greatly affects success and impact.

In the Indonesian example, Convergence highlighted that the tendering process for renewable projects can take years before approvals are granted, which erodes investor confidence.

Legislated coal supply from domestic coal mines at capped prices also keeps the high-emitting fuel unnaturally cheap, making it challenging for renewable projects to be economically viable.

“The economics of renewable energy in Indonesia demonstrate less of a need for blended finance to subsidise renewables, and more so a reduction in subsidies for coal-fired power,” Convergence wrote.

Building technical capacity could help. For example, Convergence noted the need to create transition roadmaps and asset-by-asset suitability assessments for the early retirement of coal power plants in Indonesia.

Developing countries can also better mobilise domestic capital, especially in South-east Asia’s largest economies. Only 3 per cent of investments by Indonesia’s domestic financial institutions are climate-aligned, Convergence said, which suggests that significantly more domestic financing could be pointed towards climate objectives. Domestic financing represents lower cost of capital, since local lenders are less concerned about currency risk.

In fact, if Indonesia properly addresses the policy hurdles to its energy transition, blended finance might not even be necessary, Convergence stated. That’s because private capital appears to have the appetite for renewable electricity investments in Indonesia.

It’s a situation where private investors would really, really like some of the renewable energy projects that Indonesia’s warung is serving in the streets of Jakarta, but they’re not comfortable taking a bite until Indonesia sorts out some hygiene issues. Merely lowering the price won’t make them budge.

??Top ESG reads:

1. While green finance aims to channel resources away from polluters, there’s now a need for transition finance to allocate money back to heavy emitters, but for the purpose of decarbonisation, says China environmentalist Ma Jun .
2. CapitaLand Investment may have slipped in the Global Real Estate Sustainability Benchmark, but it will still receive interest rate savings on its sustainability-linked loans.
3. Temasek Trust’s digital impact marketplace Co-Axis has partnered digital wealth platform Arta Finance to raise US$30 million over two years for sustainable development projects.
4. Negotiators at the COP16 biodiversity summit in Colombia are discussing funding for key nature protection goals.
5. For the Asean power grid to take off, there must be win-win for all countries in the region, says Singapore Institute of International Affairs chairman Simon Tay.

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