Making Climate Finance Affordable

Rebecca Ray and Ulrich Volz

Rebecca Ray is a senior academic researcher at the Boston University Global Development Policy Center. Ulrich Volz, Professor of Economics and Director of the Centre for Sustainable Finance at SOAS, University of London, is Co-Chair of the Debt Relief for Green and Inclusive Recovery Project.

BOSTON/LONDON – Emerging-market and developing economies (EMDEs) will need an estimated $2.4 trillion in climate investment annually to meet climate goals, according to the Independent High-Level Expert Group on Climate Finance, with $1 trillion coming from external sources. Achieving the United Nations Sustainable Development Goals (SDGs) will require even more financing: an increase of $3.5 trillion in new investments annually by 2030. These are daunting figures. But they are also nonnegotiable.

Raising trillions of dollars in new external finance would be difficult at the best of times. It is even trickier when the world is facing an escalating debt crisis. After examining newly available data on 108 EMDEs, the Boston University Global Development Policy Center found that more than half – 62 countries – are already at high risk of debt distress. Moreover, an additional 33 countries are severely constrained in their ability to access capital markets, owing largely to poor economic-growth prospects following the COVID-19 pandemic, advanced-economy interest-rate hikes, and below-investment-grade bond ratings.

The vast majority of EMDEs are thus facing debt distress or prohibitively high borrowing costs. But these are precisely the countries that are most in need of financing to meet climate and development goals. Of these 95 countries, 83 have higher needs for investment in climate-change mitigation (lowering emissions) or adaptation (building resilience against extreme weather events) than the typical (median) country. And 73 of them have more potential to expand their national protected areas, either on land or in their coastal waters, than the typical country.

A key problem is that investments in, say, protecting nature do not necessarily boost short-term economic growth. Instead, they build long-term resilience – including a greater ability to withstand extreme weather events like hurricanes and droughts – thereby making future crises less likely. This includes future debt crises: climate vulnerability and nature loss can undermine debt sustainability, and climate change increases sovereign risk and the cost of capital.

To break the cycle of environmental and economic crises, and move toward a new cycle of sustainable growth, countries must invest now. That is why any strategy for addressing climate change and delivering on the SDGs must include measures to lower barriers to new finance, including targeted debt relief and more creative financing arrangements.

Debt relief is unavoidable. An ambitious debt-relief initiative akin to the Highly Indebted Poor Countries Initiative, which the International Monetary Fund and the World Bank established in 1996, should be created to provide meaningful debt relief for the dozens of countries facing full-blown sovereign-debt crisis.

For this to work, all creditors must actively participate. To understand why, consider that at least half of the total external sovereign debt stock in 27 debt-distressed countries – many of which are low-income countries or small island developing states – is owed to multilateral creditors. This means that, even if all bilateral and private debt were canceled, some of the world’s most vulnerable countries would remain weighed down by debt.

Major creditors must also take steps to reduce the cost of capital for certain types of investments, such as those that advance climate goals. To this end, many proposals have already been put forward. For example, Sustainable Future Bonds may allow for longer repayment terms and lower interest rates, making them better suited for investments with longer-term payouts.

Multilateral development banks (MDBs) also have an important role to play in providing EMDEs with easier access to capital. For example, they can raise the threshold for countries to access concessional lending, pursue capital increases that support higher lending, and work with governments and the private sector to reduce and share risks.

Making financing for climate action and conservation affordable is among the most urgent challenges confronting the world. The solution is clear: a combination of targeted debt relief, credit enhancements, and MDB reform. But so far, there has been a lack of will to implement it. If this does not change soon, we will learn firsthand that the costs of inaction far outweigh the costs of prevention.