Financing Green Transitions

Samir Saran

More than three years after the Paris Agreement was finalised at COP21, it is evident that the developing world is unlikely to receive even the modest amount of US$100 billion annually in climate finance by 2020. This is primarily a result of the collective failure of the developed world to meet their moral and real climate obligations that pre-date the Paris Agreement. This lack of finance for climate action is exacerbated by the fact that the international financial community—banks, asset managers, investors and capital markets—have failed to align their operations with the goals of the Paris Agreement. The involvement of international financial investors, both private and multilateral, in financing green transitions in developing countries has so far been feeble, sporadic and arbitrary. Unless these resources can be leveraged to cater to the development needs of emerging economies, there is a real possibility that the green transitions that we all seek will be incomplete and mostly underwritten by the world’s poorest citizens.

For the past two years, ORF and the MacArthur Foundation have attempted to create a new framework to ensure that the global financial community better responds to the imperatives of the Paris Agreement. Our research acknowledges that official aid and grants are insufficient to meet the burgeoning energy and infrastructure needs of emerging economies. There is no doubt that we require new financial instruments and pipelines to support sustainable development in much of the world. This publication, comprising of 11 policy essays on the subject of climate finance, discusses this objective through multiple lenses. It is a culmination of our efforts to work with a global network of experts and stakeholders to identify bottlenecks and provide new solutions to ensure that emerging economies can access finance to meet their green development goals.

Our series on financing green transitions has largely focused on India, and for good reason: It will be the first large country that must transition to a middle-income economy in a fossil fuel-constrained world. India is also constricted by the same political, regulatory and financial challenges that confront much of the developing world. Given the weak efforts of the developed world to assist the developing countries so far, India has had to chart a path largely through its own economic and financial arrangements. Therefore, an assessment of India’s capacity to now leverage international financial flows and its ability to undertake a low-carbon transition may well provide a reliable template for developing countries to emulate.

Through 11 essays, we explore three broad themes: the role of international investors and institutions; India’s own development policy choices and lessons therein for other developing countries; and the role of human capital in climate-resilient investment.

Our first set of essays analyses the behaviour and financial practises of international financial institutions, investors and credit rating organisations. In “An Incomplete Transformation”, Mihir Sharma argues that Multilateral Development Banks have failed to create bridges between private capital and clean energy/climate resilient infrastructure demands in developing countries. He calls on MDBs to adapt to developing world priorities, crowd-in private capital, and streamline operational activities in emerging economies. In “Financing Climate Resilience”, Vikrom Mathur and Aparna Roy highlight the bias of international investors towards investing mostly in mitigation efforts. Conventional wisdom in the private sector holds that the costs of adaptation and resilience should be borne by governments. Taking a different approach to the problem, Mathur and Roy offer solutions focused on commercial and business opportunities. In two pieces, “Rating Resilience” and “Ratings for Renewable Energy”, Aled Jones studies the limitations of current literature and practices relating to credit rating of infrastructure projects and renewable energy projects and proposes a more holistic framework of risk metrics for both renewable energy and climate resilient infrastructure. Finally, in “The Political Economy of Basel”, Mihir Sharma outlines how the Basel norms have been designed to respond to the interests of a select group of developed nations. He argues that by prioritising macroeconomic stability and implementing new liquidity restrictions, these actors have failed to consider adverse implications on cross-border flows, especially with regards to long-term green investments.

The next set of essays focuses on India’s domestic challenges, particularly in its infrastructure and urban development policy and its efforts to transition to a low-carbon economy. In “PPP model, regulatory oversight and private financing: Evolutionary trinity of India’s infrastructure”, Gautam Chikermane offers a comprehensive historical account of the political economy of India’s infrastructure policy, documenting the many failures that have plagued it. Given that a stable infrastructure policy will have significant implications for green investment choices, Chikermane’s study of India’s policy failures provides valuable lessons. In “Financing Urban Infrastructure for an Evolving India”, Pritika Hingorani, Sharmadha Srinivasan, and Harshita Agarwal examine the reasons for the lack of private-sector involvement in India’s climate-resilient urban infrastructure. They analyse the current regulatory regime for urban infrastructure in India and provide a set of solutions, advancing both public and private sector participation in the future. In “Moving from Growth to Development: Financing Green Investment in India”, Neha Kumar, Prashant Vaze and Sean Kidney explore new financial instruments that India can employ to finance its green infrastructure needs. They outline how India can more effectively scale its green bonds market, leverage international debt capital markets, and harness blended finance to achieve this objective. Finally, in “India and the World,” Aparajit Pandey and I outline three key structural barriers that threaten to undermine India’s rapidly growing green energy sector: the state of its distribution companies, underdeveloped financial markets and inflexible international credit and risk assessment practices. Offering case studies from India’s state and municipal level policies, we argue that India’s ability to succeed in its low-carbon transition will open new pathways for emerging economies around the world.

In our final set of essays, we examine the role of human capital in enabling greater green investment, focusing on leadership and gender. In “Pay for Sustainable Growth”, Charanjit Singh, analyses the executive pay of 31 of India’s top companies showing that by linking management compensation to short-term performance objective, companies are failing to integrate sustainability objectives into their long-term vision. The chapter proposes a restructuring of the private sector’s approach to executive compensation, focused on long-term sustainable economic growth. Lastly, in “Gender and Climate Finance,” Vidisha Mishra posits that even though women and marginalised groups are likely to be more exposed to climate change related risks, they are severely underrepresented in the investment and regulatory classes. Her essay then unpacks the opportunities and benefits of meaningfully building gender concerns into climate finance mechanisms.

Our contributors have attempted to explore the reasons behind the significant shortfall in private finance in relation to low-carbon investments. They have also collectively offered solutions, both domestic and international, with regards to the flow of finance for climate projects. The success of these solutions, however, will be predicated on some boundary conditions that developing economies and the international financial community must meet.

First, developing countries must reclaim the power grid. The large-scale subsidisation of power in the developing world has created significant distortions in energy use, pricing and policy. State-level reform in India suggests that splitting the electrical grid for agricultural and non-agricultural sectors, implementing a credible metering system and providing subsidies as direct benefits can have significant positive effects on the power sector. Without a viable grid, green investments are likely to remain unviable.

The second is to build capacity amongst international investors to understand risk and opportunity in developing states. There is generally a bias stemming from lack of knowledge (information) and capacity (human resources) to assess risks in emerging economies. This ultimately translates into an inability to understand the economic landscape of recipient countries. Further, as one of our authors has highlighted, there are few institutional attempts at gendering climate investments and finance. A lack of female representation in the investor community, especially from the developing world, invariably means that the concerns and voices of the most vulnerable are ignored as financial plans are scripted.

Third, developing countries must build innovative policy tools to leverage new financial instruments and mechanisms. Currently, regulations related to debt and equity markets restrict the flow of international capital into climate action projects. Emerging economies must co-opt their financial sector in the fight against climate change. Financial markets that allow for debt financing and locally issued green bonds for example create a diverse set of instruments that different types on investors can rely on. More ambitious measures can include the creation of a “green investment bank,” which allow the crowding in of private investment in green assets.

Finally, there is a new imperative to overhaul regulatory systems around the world, both in recipient and investing states. Vast pools of money are held by multiple categories of investors, such as pension funds and insurance companies. However, existing regulations limit the ability of fund managers to invest in climate related projects. Further, international credit rating agencies reassess the methodology for assessments of green projects in developing countries. And perhaps most importantly, there is an urgent need to review the current set of Basel Accords as well as the next iteration of Basel IV accords. The macro-prudential regulations were designed to create a more risk-free international banking system but have unintentionally stymied the ability of the financial sector to contribute to climate resilience. The banking community must acknowledge that planetary risk is the largest systemic challenge to financial stability and that mitigating such risk is the most prudential practice.

While these solutions are far from comprehensive, they address some of the most persistent structural barriers to supplying and accessing climate finance. ORF and the MacAuthur Foundation will continue to explore new ways and means to ensure that developing countries can access financing to pursue their low-carbon transitions. We will also continue to study India’s own financial, technological and governance solutions in the hope that these experiences can benefit other countries and communities. We hope that the insights presented in this book will inform academics, business leaders and policymakers in their efforts to better understand the importance of the global financial community finally signing the Paris Agreement.

To read the full book, click here.

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