By Yemi Olakitan
The University College of London, in its latest research released on Friday, October 20, 2023, has highlighted a concerning trend: the erosion of trust between wealthy and impoverished nations due to the unequal distribution of climate financing.
The study underscores the urgent need for a radical shift in the architecture of climate financing, with a strong emphasis on ensuring an equitable allocation of funds between affluent and struggling countries.
Despite the projection of increased energy consumption in developing countries for economic growth and improved living standards, the bulk of climate funding continues to flow to developed and emerging economies, particularly those in East Asia, the Pacific, Western Europe, and North America.
In stark contrast, a mere 25% of this funding has reached other nations, with a paltry 5% directed toward addressing climate change in Africa.
One of the factors exacerbating this disparity is the differing investment risk profiles across countries. Equity investors and financial lenders apply higher country risk premiums to regions considered riskier.
For instance, countries like Zambia and Ghana in Africa face premiums of approximately 18%, attributable to low business confidence, inadequate regulatory quality, and slower economic and financial development. In comparison, more stable countries like South Africa and Morocco may see premiums as low as 4%.
Another substantial barrier to investment is the limited access to electricity in the poorest developing nations, particularly in many sub-Saharan African countries.
This hampers their ability to attract capital, underscoring the importance of government initiatives aligned with the Sustainable Development Goals (SDGs) to expand electricity access.
Furthermore, countries with predominantly rural populations that struggle to electrify their regions face a disadvantage in accessing private financing. Climate vulnerability also diminishes a country’s attractiveness for low-carbon investments.
To bridge this financial gap in developing nations, multilateral development banks and international institutions must enhance their financing capabilities and relax lending criteria.
This can be achieved through offering below-market interest rates, extending grace periods for loan repayments, and broadening the scope of available financing options.
An example of such an initiative is the Resilience and Sustainability Trust (RST) of the IMF, which provides extended and affordable financing for addressing long-term climate-related challenges, with Rwanda leading the way as the first African nation to leverage the RST for climate goals.
These institutions should also implement robust de-risking mechanisms to handle investment risks and create a conducive investment environment.
A more significant redistribution of IMF special drawing rights (SDRs) offers a promising strategy. The Bridgetown Agenda proposes using SDRs as global reserve assets to mitigate currency risk, thereby providing vital liquidity support for low-carbon initiatives.
Specifically targeting the least developed and most climate-vulnerable countries ensures a fairer distribution of financing and directs resources where financial capacity is lacking.
Global capital raising methods can counteract increased climate risks, enhance resilience, and promote investments in the most vulnerable nations.
These approaches can be applied, especially in post-climate-disaster reconstruction grants. Innovative tools, such as debt-for-climate swaps, should also be made available to incentivize climate action.
These agreements involve restructuring a developing country’s debt in exchange for funding climate change mitigation and sustainability programs.
Ultimately, aligning public and private finance more effectively can mobilize capital and break the path-dependent funding cycle.
International efforts should focus on establishing a robust foundation for renewables, instilling market confidence and enabling the mobilization of private finance at a large scale.
These efforts should work in tandem with domestic policy tools to support comprehensive renewable energy roadmaps and create networks of interdependencies beyond project-specific incentives.