Unlocking Green Growth: How Emerging Markets Can Bridge the Climate Finance Gap

Written by Theresa Holbein

Amidst the urgent global call to combat climate change, emerging markets stand at the forefront of both the challenge and the opportunity, where innovative finance instruments hold the key to unlocking sustainable growth and resilience for generations to come.??

?

Navigating Economic Growth and Climate Vulnerability??

Emerging market economies are classified as experiencing substantial economic growth. In comparison, developing economies have a less developed industrial base and a lower human development index. Emerging economies are in the process of shifting from a "developing" stage to a "developed" one, embodying certain, albeit not all, characteristics of a developed economy [1]. They constitute 80% of the global population, account for nearly 70% of the world’s GDP growth and include countries like Bangladesh, Indonesia, and Pakistan [2]. Emerging market and developing economies (EMDEs) together account for two-thirds of global greenhouse gas emissions, and given future population and GDP growth projections, this is set to rise. Many of these nations are, however, also extremely vulnerable to the hazardous impacts of climate change [3]. In August 2022 for instance, Pakistan faced significant flooding, resulting in a third of the country being submerged. This event caused approximately 15,000 casualties and is estimated to have displaced 8 million people. Given their susceptibility to adverse climate impacts, discussions concerning these countries often revolve around adaptation and resilience. However, to limit warming in line with the Paris Agreement, it is critical that sufficient capital is mobilised to drive decarbonisation efforts and to fund transition, mitigation, and adaptation measures in emerging markets. By positioning these economies on a low-carbon development path for green growth, the world can limit warming while providing them with novel economic opportunities [4].?

?

Challenges in Mobilising Climate Finance??

The Climate Policy Initiative (CPI) determined in its “Global Landscape of Climate Finance 2023” Report, that developed economies continue to mobilise the most climate finance. International climate finance flows, however, remain insufficient in meeting demands, especially in emerging economies which received only 15% of the global total [5]. Consequently, emerging markets find themselves trapped in a detrimental cycle: they are among the countries most vulnerable to the climate change crisis yet possess the fewest resources to adapt. So, what are the obstacles hindering the mobilisation of climate finance in emerging markets, and how can we effectively bridge the climate financing gap within these regions??

?

Many of the emerging market economies are burdened with significant debt and limited budgets, especially following the Covid-19 pandemic. They also encounter elevated government borrowing costs as central banks worldwide tighten policy to tackle inflation, causing global interest rates to rise and further complicating the challenge of meeting climate financing needs through public funds. As such, mobilising private capital on a vast scale is essential to achieving climate objectives in emerging markets [3]. Yet, private actors also face considerable barriers in deploying climate finance in these regions. The effective implementation of sustainable finance taxonomies and disclosure requirements is often hindered by data and capacity gaps. If taxonomies are adopted, they tend to lack granularity and have limited coverage, leading to inconsistencies in disclosure while exacerbating uneven playing fields. Additionally, gaps in the regulatory environment, such as the absence of stringent risk assessment models, contribute to this challenge. Finally, the perceived absence of comprehensive, long-term transition strategies by governments stands out as a significant hurdle [6].?

?

Innovative Financing Instruments for a Sustainable Green Transition?

While challenges persist, it is important to note that not all is bleak. Many innovative financing instruments and success stories showcase the potential for achieving a sustainable green transition.?

?

These instruments can be classified into four distinct categories, each of which addresses different challenges. First, structured finance vehicles acquire green bonds from banks in emerging markets, targeting large institutional investors. Multilateral Development Banks (MDBs) either invest equity or offer credit risk guarantees to these structures to mitigate risks, enabling pension funds or insurance companies to participate in investments. Blended finance, on a broader scale, combines public and donor funds to reduce risks associated with infrastructure investments for private capital, thereby facilitating the mobilisation and amplification of private climate finance. Outcome-based sustainable debt instruments, such as sustainability-linked bonds, incorporate incentive mechanisms to address information imbalances between issuers and investors. In "pay-for-success" private financing of public sector projects, third-party investors, including private entities, provide initial investments and develop projects. The public sector then procures the project based on its sustainability performance, with compensation tied to predefined indicators, incentivising higher performance, and offering investors greater rewards for better outcomes. Public sector entities, including MDBs and Development Finance Institutions (DFIs), are key in deploying some of these instruments. To attract private capital, it is crucial to minimise the risks associated with financial assets in emerging markets. National development banks, MDBs, and DFIs can leverage their resources and expertise effectively to encourage private finance. By shouldering some of these risks, providing technical assistance and capacity building, and leveraging their reputation and expertise, these institutions can play a pivotal role in enticing private investors who may otherwise be reluctant to fund climate-friendly projects in emerging markets [7].?

?

The emerging market green bond fund established by the International Finance Corporation (IFC) and asset manager Amundi exemplifies the efficient use of MDB resources to attract private finance. The Amundi Planet Emerging Green One (AP EGO) fund was launched in 2018 and pooled green bonds issued by banks in various emerging market and developing economies. The fund aims to deploy $2 billion into green bonds within emerging markets. Supported by a cornerstone commitment of $256 million from the IFC, the fund aims to increase the capacity of emerging market banks to finance climate-smart investments. The partnership between Amundi and the IFC provides investors with an unprecedented opportunity to invest at scale, offering exposure to emerging market yields while contributing positively to the energy transition in regions where it is most needed [7].?

?

Bridging the Climate Finance Gap??

Average annual global climate finance flows reached nearly USD $1.3 trillion in 2021/2022. Yet, despite promising growth, these flows represent a mere 1% of the world's GDP. The CPI offers a further sobering insight into our future trajectory: under the average scenario, annual climate finance needs are projected to increase steadily from $8.1 to $9 trillion by 2030, before surging to over $10 trillion annually from 2031 to 2050. This underscores the urgency of increasing climate finance by at least five-fold each year to mitigate the most severe impacts of climate change [5].??

?

According to research conducted by McKinsey, an additional $2 trillion in financing per year is needed in emerging markets by 2030 to meet the Paris Agreement goals and cap warming at 1.5°C above pre-industrial levels (based on capital deployed in 2019). Bridging this substantial gap in climate finance will necessitate tapping into both domestic and international private and concessional capital [4].??

?

As the world navigates the challenges of climate change, the proactive pursuit of innovative financing solutions offers hope for steering emerging markets towards a sustainable and resilient future.?

Sources?

[1] CFI (2022a). Emerging Markets. Corporate Finance Institute. Available at: https://corporatefinanceinstitute.com/resources/economics/emerging-markets/.??

?

[2] CFI (2022b). Emerging Market Economy. Corporate Finance Institute. Available at: https://corporatefinanceinstitute.com/resources/economics/emerging-market-economy/.??

?

[3] Li, B., Natalucci, F. and Ananthakrishnan, P. (2022). How Blended Finance Can Support Climate Transition in Emerging and Developing Economies. IMF. Available at: https://www.imf.org/en/Blogs/Articles/2022/11/15/how-blended-finance-can-support-climate-transition-in-emerging-and-developing-economies#:~:text=Emerging%20market%20and%20developing%20economies.??

?

[4] McKinsey Sustainability (2023). Solving the Climate Finance Equation for Developing Countries. McKinsey. Available at: https://www.mckinsey.com/capabilities/sustainability/our-insights/solving-the-climate-finance-equation-for-developing-countries#.??

?

[5] Buchner, B., Naran, B., Padmanabh, R., Stout, S., Strinati, C., Wignarajah, D., Miao, G., Connolly, J. and Marini, N. (2023). Global Landscape of Climate Finance 2023. Climate Policy Initiative. Available at: https://www.climatepolicyinitiative.org/publication/global-landscape-of-climate-finance-2023/#:~:text=Developed%20economies%20committed%2084%25%20of.??

?

[6] Demekas, D. and Stallings, J. (2023). Challenges of Green Finance: Private Sector Perspectives from Emerging Markets. IFC. International Finance Corporation. Available at: https://www.ifc.org/content/dam/ifc/doc/2023/challenges-of-green-finance.pdf.??

?

[7] International Monetary Fund (2022). Global Financial Stability Report: Navigating the High-Inflation Environment. International Monetary Fund, pp.45–64.?