This year at G20, agreeing to agree
The war on climate change cannot be delayed because of the conflict in Ukraine. G20 cannot afford not to act
Common ground
But improving financing available is necessary for progress on most aspects. While emerging and developing economies (EMDEs) tend to emphasize development financing for reaching SDG goals, advanced economies (AEs) emphasize the creation of global public goods (GPGs) in particular the mitigation of climate change risk. But convergence is possible since there is large overlap between SDGs and GPGs. The poorest suffer the most from natural disasters. Flood resistant drainage systems in cities, smart green infrastructure and better air quality improve health and development goals, and reduce distress migration to AEs. Of course climate finance should add to and not substitute for ongoing development assistance.
There is a coming together for a second reason also. EMDEs tend to ask for public money to compensate for all the carbon AEs have put in the atmosphere. But AEs feel they have little to spare after spending on the pandemic and the Ukraine war effort. They have not delivered even the $ 100bn pa promised earlier by 2020. Current estimates of requirements for EMDE mitigation financing go to 4tr$ pa till 2030.
Governments may feel constrained but estimates of private finance run into hundreds of trillions. If even a fraction of this would come for climate finance the required 4 trillion becomes feasible. But private finance finds EMDEs to be risky. Only 20% of global climate finance goes to EMDEs and is 4 to 8 times more expensive. Therefore public funds can play an essential role in de-risking lending to EMDEs and reducing its cost, thus attracting more private finance. This can be done through the MDB system and local development finance institutions; through blended investment programs that combine public, philanthropic, institutional and private investors with optimal allocation of risk to each; through financial innovations such as hybrid and first loss funds. AE spending would boost their own economies since using public funds to leverage private lending could create opportunities for their own companies.
Companies are sensing business opportunities in the many innovations required to move to net zero carbon impact. Some sharing of initial risk, better country information and plans and a pipeline of ready projects can get them moving.
Volatility and cost of finance
One major cause of high country risk premium and borrowing costs for EMDEs is volatility of their currencies. There is a fear of a large depreciation. Since this is not actually observed in the data the currency risk premium charged is excessive.
Moreover, over the past 2 decades, emerging market (EM) currency volatility is largely due to global risk-on and –off originating in AEs. Quantitative easing and zero AE policy interest rates aggravated surges of capital inflows in search of yield that became outflows to safe havens whenever global risk rose. This volatility was a major reason for the broad-based slowdown in EM growth after the global financial crisis (GFC). EMs are told that regulation will increase their borrowing costs but it is actually unregulated excessively volatile flows that do so.
The G20 was convened after the GFC and naturally financial stability was the major item on its agenda. But by 2016 the view was that enough had been done. But the reforms were lop-sided, heavily focused on large AE banks and ignored the resulting arbitrage to non-banks that now became the source of flows to EMs.
Prudential regulation and financial stability
Although this impact on EMs was ignored, financial stability is back on the G20 agenda since regulatory imbalances and financial fragilities are affecting AEs themselves. There have been a number of episodes in AEs, with case by case responses to outflows from money market funds in 2020, the problems in pension funds in the UK in 2022 and failures in US small banks in 2023.
If G20 pushes for a principle-based response that addresses weaknesses such as arbitrage and excess volatility, this would reduce spillovers to EMs, their country risk and borrowing costs. AEs underuse prudential regulation of non-banks although their academics have long pointed out that these instruments are required for financial stability. Their regulators need to be strengthened against political lobbies that undermine regulation. The current episode of monetary policy tightening is clearly showing that other instruments must be (and have been) used to moderate financial risks and spillovers and allow monetary policy to focus on inflation.
G20 can ask the Financial Stability Board to come out with minimal regulatory standards affecting cross-border flows. Regulation needs to be right-sized to become light, universal and market friendly. At present EMs are forced to over-regulate since AEs under-regulate.
If anywhere close to the estimated requirements of climate finance materializes, it will require current account deficits in EMs to widen. This is a red flag for credit rating agencies and carries risks. Better global safety nets, such as automatic access to multilateral and bilateral swaps, are required then for EMDEs to safely allow entry to more foreign inflows.
Furthering implementation
A major obstacle to increasing public finance for the Bretton Woods system is the absence of governance reform. Country voting rights no longer reflect economic power. But the MDB system is much larger than just the World Bank. Countries may commit to increase funding if they can choose where to put it in a contestable system that attracts funds conditional on delivery.
Among other improvements in customer service, if databases with the IMF and the World Bank are made available for the private sector they would better to able to design low cost portfolio hedging and insurance strategies that can compensate for missing long term hedging markets and reduce the cost of EMDE borrowing.
The effects of climate change are becoming more and more obvious. Unprecedented heat waves, fires and floods are affecting so many countries regardless of location. There is intense pressure from activists across countries. G20 cannot afford not to act. The war on climate change cannot be delayed because of the Ukraine war.
The time is ripe for creating public goods that benefit all countries, and to which each contributes. For example, debt for nature swaps can reduce debt stress in low income countries but it requires better measurement and accounting standards from those countries. Mutually shared costs, rewards and efforts can be energizing.
The author is chair of a T20 task force on the International financial architecture
The views expressed above belong to the author(s).
