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How can developing nations close the climate finance gap?

COMMENT: Cash flows from rich to poor remain slow, but developing nations aren’t wasting time waiting 

Kigali, capital of Rwanda (Pic: Oledoe/Flickr)

Kigali, capital of Rwanda (Pic: Oledoe/Flickr)

By Nanki Kaur

Progressive countries, including some of the world’s poorest, are acting to green their economies and build resilience to climate change.

There’s also a growing appetite for investment in these areas. In 2012, governments and investors poured an estimated US$359 billion into projects targeting low carbon and climate resilient development.

But a closer look at the numbers reveals three big gaps.

-First, the sum invested to date is a tiny fraction of the trillions of dollars it will cost to decarbonise the global economy and adapt to the impacts of climate change. For developing nations, this gap is especially worrisome. Rwanda, for instance, estimates it faces a financing gap of approximately US$100 million per year over the next 20 years for investments in climate resilience and green economy.

-Second, private investments dominate climate finance, accounting for 62 per cent of the total. But most private finance both originates and stays in developed countries where investors are more comfortable with risks. This means developing nations need to target international sources of public finance to fill their funding gaps.

-Third, 94 per cent of money invested in 2011 targeted mitigation – primarily renewable energy and energy efficiency. This trend has significant implications for the majority of developing nations which have low carbon emissions.

They must instead prioritise adaptation and will support green economy initiatives only if they contribute to development objectives.

The challenge for developing nations is that the costs of making the transition to climate resilient green economies will be huge, and the actions needed come with very specific financing needs.

On one hand, green economy initiatives have the potential to bring returns on capital investments and so can attract private finance. One the other, climate resilience is often a public good, and would ordinarily need public finance in the form of grants.

Over the past year we have worked with seven countries —Bangladesh, Ethiopia, Kenya, Nepal, Rwanda, The Gambia and Zanzibar — to identify ways public sector actors can respond to this context and the emerging appetite for investment in these areas.

In March 2014, policy makers met in Addis Ababa and identified the following three steps.

Intermediaries

First, these countries have started to recognise the roles of a range of intermediaries, such as multilateral development banks and national financial institutions, in mobilising and disbursing climate finance.

There is also an increasing trend towards establishing national climate change funds such as those set up in Bangladesh, Ethiopia and Rwanda. These support a more programmatic approach to climate finance, drawing in funds from national and international sources and managing the money to best effect.

Rwanda’s fund has been designed to evolve as different sources of finance and new investment areas become viable.

In the short to medium term, the Ministry of Natural Resources manages the fund to mobilise and disburse public sources of finance, while the Development Bank of Rwanda manages a credit facility to incentivise private sector investment.

If investments into low carbon climate resilient development become commercially viable, the Fund has the scope to evolve and be managed as a venture capital fund over the long term.

If investments into become commercially viable, the Fund has the scope to evolve and be managed as a venture capital fund over the long term.

Rwanda is unique in that it has adopted a pioneering approach, because it foresees big shifts in the financial landscape and a future in which purely private investments will dominate.

It is using financial intermediaries to create a phased approach to managing climate finance.

Instruments

Second, countries are using a range of economic and financial instruments to target different investors and the specific investment needs of climate resilience and green economy.

For instance, Ethiopia and Kenya are using economic instruments such as power purchase agreements and feed-in tariffs that aim to secure and enhance the financial returns from high risk investments in renewable energy.

Bangladesh and Ethiopia are using financial instruments such as insurance and guarantees to reduce the risk to investors. Public sector entities in all seven countries use grants and concessional loans to finance investments in climate resilience.

National financial institutions like private banks and micro-finance institutions are also using capital instruments like debt and equity finance to un-lock private capital.

Planning systems

Third, policymakers are focusing significantly on financial planning systems – especially institutional arrangements and budget and planning systems.

Every dollar needs to generate several more. They are keen to ensure that institutions with existing capacity – especially absorptive and financial management capacity – take the lead in managing climate finance, to achieve investment outcomes that are greater than the sum of their parts.

Examples of such institutions include:

  • Ethiopia’s Ministry of Finance and Economic Development is responsible for the financial management of the country’s Climate Resilient Green Economy Facility.
  • India has accredited its National Bank for Agricultural and Rural Development as its implementing entity under the UNFCCC Adaptation Fund – making it responsible for accessing and managing multilateral sources of climate finance.

Policy makers are also keen to ensure that institutions such as national planning commissions should lead efforts coordinate action on climate change, especially funding decisions, as their ‘bird’s eye view’ of investment priorities across sectors is advantageous.

This enables them to allocate finance into a cohesive investment portfolio that ensures the supported projects do not duplicate existing activities within development plans.

In Rwanda a team from the Ministry of Finance supports the national climate change fund’s technical team to do this.

Policy makers are keen to integrate climate resilience and green economy goals into planning and budgetary systems in order to ensure the long-term sustainability of climate finance, and to manage funds more effectively.

Nepal’s climate change budget code and Rwanda’s on-budget approach to finance disbursement provide interesting examples of how such systems can achieve this.

Creating not waiting

These evolving trends in the design of intermediaries, economic and financial instruments and financial planning systems show how many developing nations are taking important steps to ensure they are ready to receive, manage and disburse climate finance from both public and private sources as they make the transition to climate-resilient green economies.

They are not just sitting waiting for money to flow. They are setting up the systems and institutions that will create new money from old.

Nanki Kaur is a senior researcher in IIED’s climate change group

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