India is an excellent example of the scale of climate financing required. Thanks to a massive governmental push in the last eight years, India’s solar and wind projects attracted $66 billion in investment. Going forward, this is expected to reach $1.15 trillion in the next eight years to realise India’s climate ambitions of 450 GW of renewables by 2030, infrastructure for transmission and storage, and the Green Hydrogen Mission. Out of a total required investment of $1.15 trillion, the debt requirement will be around $850 billion, and the equity requirement will be about $300 billion. The domestic debt markets will find it hard to realise these amounts. As a result, India will have to rely on foreign sources for 40%-60% of the debt requirement.
On a global scale, climate financing may not be a macroeconomic problem because a fair amount of funds is available in developed countries, whereas the requirements are growing exponentially in developing countries. Indeed, the estimated annual investment requirement of $4-5 trillion to reduce emissions in developing countries is significantly smaller than the global annual savings of over $22 trillion and the global Gross Domestic Product of $94 trillion.
Borrowers in developing countries can borrow foreign funds at a cheap rate but the key issue is that their landed cost is not competitive. There are many reasons for this, including liquidity and convertibility risks that can’t be easily mitigated over a long period. The high costs of hedging (usage of financial instruments or market strategies to offset the risk of adverse price movements) and the absence of a long-term hedging market exposes projects to currency risks in the medium-to-long term. The problem is exacerbated if the money is borrowed in a currency other than the US dollar or Euro as it requires two-pronged hedging.
The need for help with the costs of foreign exchange hedging for developing countries is well recognised with some international mechanisms also in place. But these are generally restricted to only a limited number of currencies. The need is for an institutional way forward at the global level so that large-scale actions can significantly reduce premiums over and above the currency depreciation rate, making green projects funded by offshore financiers less risky and more cost competitive for both the lender and the borrower.
This can, perhaps best done through an International Foreign Exchange Agency for Climate Change, which could operate an international platform to lower the cost of foreign exchange hedging in developing countries for green projects. Such a global agency could encompass many currencies, allowing for the financing to be structured as a global pool wherein exposure in various currencies would provide a natural hedge.
The key questions relate to pricing and residual risks. The former would need to factor in pay-outs, including in the long run, but kept at a level that eases and facilitates flows to green projects in developing countries. Given geopolitical realities and global economic weightages, such an agency should be created as part of the Bretton Woods Institutions system (BWIs), linked to the World Bank or the International Monetary Fund (IMF). The United Nations and its agencies could also be roped in. The developed world will have a certain comfort with BWIs, given the history of their control over the institutions’ governance structures. The developing world would have a say, and the agency would be able to leverage systems developed by them.
In 1944, the Indian delegation at the Bretton Woods Conference ensured that the mandate of the global financial institutions included development finance. This was, perhaps, the most significant global action to push the development agenda. As G20 president, New Delhi must consider laying the groundwork for an international institutional arrangement to help in climate financing and sustainability in developing countries. It would also be a lasting legacy of PM Modi, a recognised climate champion. Further, with Ajay Banga, the likely new head of the World Bank also showing interest in the climate, his appointment could institutionalise this arrangement.
Though the world appears to be divided, there also appears a certain willingness to work towards mitigating the great climate and sustainability challenges of the day. When the first summit-level G20 was convened in the wake of the global financial crisis of 2008-09, it used its leverage through the IMF to fix the global economy. It’s time to do the same for the climate crisis and sustainability.
Manjeev Singh Puri is former ambassador, lead negotiator, UNFCCC, and distinguished fellow, TERI.
Manish Chourasia, MD, Tata Cleantech, contributed to this piece.
They were supported by senior colleagues at TERI and the TATA group
The views expressed are personal