Inside the murky world of climate change finance

Inside the murky world of climate change finance

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If you wanted to impress the world with your generosity, donating a ton of gold to charity would attract a lot of attention. But suppose you had only a kilogram of gold. How would you achieve the same effect? In that case, you could say you were donating a ton of gold and sugar and remain vague about the proportions.

This is precisely the tactic now playing out in the world of climate finance. At COP27 in Egypt in November, South Africa launched its Just Energy Transition Investment Plan, based on $8.5 billion in grants and loans from the US, the EU, Germany, France, and the UK. A week later, the US, Japan, the EU, and several other governments pledged $20 billion to accelerate Indonesia’s transition from coal to clean energy.

However, while it may seem that South Africa and Indonesia have been given billions of dollars, wealthy countries are effectively promising to provide gold and sugar while trying to hide that they are actually offering mostly sugar.

Just Energy Transition Partnerships are an indeterminate blend of grants, concessional and ordinary commercial loans, World Bank loans and guarantees, and private-sector equity. But these forms of financing could not be more different.

Suppose these billions of dollars were given to Indonesia or South Africa as grants. After the money has been used to build new clean-energy capacity, the recipient country would be left with an old coal-fired plant it did not use, a new plant for which it owed nothing, and the old, coal-related debt to service. In the case of a commercial loan, it would be left with both the old and new debts but just one plant to generate the revenue needed to repay them. For this reason, including grants and commercial loans in the same package is like adding sugar to gold.

Just as the world has improved carbon accounting, it must do better at determining the efficacy of climate finance.

Ricardo Hausmann

Concessional loans are different. While the recipient country would be left with two loans and just one operating plant, the debt is less onerous because it is cheaper than what the government could have obtained on its own.

Guarantees are similar. For example, if a country or a multilateral institution such as the World Bank guarantees a loan, the recipient government obtains a benefit equal to the difference in the interest rate at which it can borrow on its own and that of the guarantor. In the case of Indonesia, for example, this difference is barely 153 basis points vis-à-vis the US, meaning that the subsidy component is a small fraction of the guarantee’s face value.

Like commercial loans, equity investments should not be counted at all, even if the investors have signed on to the Glasgow Financial Alliance for Net Zero initiative. While equity investors take on more risk, they also expect higher returns. That would force recipient countries to service their old coal debts and pay high dividends to make the equity investment viable.

Lastly, while World Bank loans are slightly cheaper than what South Africa could get independently, there is presumably a limit to how much it could borrow. Just Energy Transition programs must be accompanied by increased World Bank lending to recipient countries. Otherwise, these countries would need to refrain from making critical investments in water, education, and infrastructure. This would not help them reduce their net-zero transition costs.

In sum, announcements of Just Energy Transition Partnerships use economically meaningless amounts that merely sound big. Unless this practice is stopped, future programs will contain less gold and more sugar. Just as the world has improved carbon accounting, it must do better at determining the efficacy of climate finance.

  • Ricardo Hausmann is a professor at Harvard's John F. Kennedy School of Government and director of the Harvard Growth Lab. © Project Syndicate 2023
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