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Dodgy climate finance

Apr 11,2023 - Last updated at Apr 11,2023

CAMBRIDGE — Suppose you wanted to impress the entire world with your generosity. Donating a ton of gold to charity would certainly attract a lot of attention. But suppose you had only a kilogrammeme of gold. How would you achieve the same effect? After all, a ton sounds much better, a thousand times better, actually, than a kilogrammeme. In that case, you could say you are 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. During November’s United Nations Climate Change Conference (COP27) in Egypt, South Africa launched its Just Energy Transition Investment Plan, based on $8.5 billion in grants and loans from the United States, the European Union, Germany, France, and the United Kingdom. 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.

The goal of these financing packages is to enable an inclusive net-zero transition. Indonesia and South Africa still rely primarily on coal-fired power plants that can produce cheap electricity for many years to come but also emit massive amounts of greenhouse gases. Having accumulated significant debts building these plants, the national power companies (and the governments that would be tasked with bailing them out) depend on earnings from cheap electricity production to manage debt-servicing costs. To reduce emissions, wealthy countries are seeking to encourage Indonesia and South Africa to invest in renewables so that dirty plants can be decommissioned sooner.

This is a laudable goal. But the announcements misrepresent the amount of assistance being provided. 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 deliberately trying to hide the fact that they are actually offering mostly sugar.

Announcements of new Just Energy Transition Partnerships typically speak of 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 from one another.

Suppose, for example, that the billions of dollars mentioned in one of these announcements were given to Indonesia or South Africa as a grant. In that case, after the money has been disbursed and used to build new clean-energy generation capacity, the recipient country would be left with an old coal-fired plant it does not use, a new plant for which it owes nothing, and the old, coal-related debt it must service.

By contrast, if the country receives a commercial loan, it will be left with both the old and new debts but with just one plant to generate the revenue needed to repay them. To be sure, Indonesia and South Africa can access financial markets independently. But to self-fund decarbonisation, they would have to keep a lid on the total amount of debt that they take on and cut back on other borrowing. For this reason, including grants and commercial loans in the same package is akin to adding sugar to gold.

Concessional loans are a bit 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. Such loans are typically counted in terms of the net present value of the implicit subsidy, which is a function of the loan’s maturity and the difference between the market rate and the concessional rate (none of which are public).

Guarantees are somewhat 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 programmes 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, a former minister of planning of Venezuela and former chief economist at the Inter-American Development Bank, is a professor at Harvard University’s John F. Kennedy School of Government and director of the Harvard Growth Lab. Copyright: Project Syndicate, 2023. www.project-syndicate.org

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