Closing the gap between existing and necessary climate finance: innovative climate finance for developing countries by a cooperation of MDBs, central banks and the private sector
Co-authored by Dr. Matthias Kroll, Chief Economist Future Finance, World Future Council
To meet the 1.5°C limit agreed in December 2015 in Paris it is necessary to rapidly replace all fossil fuels by renewable energies. In this context, the global new renewable energy (RE) investment figures presented recently by Bloomberg are very disappointing. After a decline of $40bn to $240bn in 2016, both first quarter totals of 2017 are $20bn lower than the first two quarters of 2016. This decrease in new RE-investments is not only in sharp contrast to the goals of the Paris Agreement, but also conflicts with growing interest of private finance in such investments.
The only good news is the unexpectedly quick decline in RE prices, providing more Gigawatts for the same money. But the present growth rate of RE-investments in terms of Gigawatts is still much too low to meet the Paris 1.5°C target.
While the reasons limiting RE growth in the industrialized countries are mainly due to the fluctuating investment frameworks (e.g. feed-in-tariffs) caused by changing governments and massive lobbying from the fossil fuel lobbies, the limiting reasons for RE-investments in developing countries are more linked to the overall uncertainty concerning the risks of such investments and their returns.
To accelerate RE-investments in developing countries the bankability of RE-projects has to be ensured. This requires guarantees and sufficient and stable prices to attract investors. But, at the same time, price levels in these countries need to respect the principle of energy affordability for all (SDG 7). To meet both these conditions a fundamental shift in the available financing is required.
Proposals to raise the huge amounts required every year by carbon taxes or emissions trading are attractive in theory, but very hard to implement, due to opposition from those who would have to pay the higher energy prices. Thus, due to massive lobbying, the current EU price for CO2 emissions is about 7€/t, while most experts state that €30 to €50 is required to meet the goals of the Paris Agreement.
So where can the funding come from? The national budgets of the developed countries can realistically finance only a small part of the grants required to make the necessary RE-investments.
An innovative tool for large scale climate finance
What is needed is an innovative tool which can provide the required amounts for the urgent climate finance investments in an immediate and stable way without burdening public budgets. Such an innovative tool can be created by a co-operation between developing countries, the Multilateral Development Banks (MDBs), the Green Climate Fund (GCF) of the UNFCCC, or other financial institutions which are involved in climate finance, and the central banks of the industrialized countries.
These central banks can support large scale climate finance by agreeing to:
- guarantee climate related credits from the MDBs
- purchase standardized ‘Green Climate Bonds’ issued by the MDBs, the GCF or other designated financial institutions.
A roadmap for the implementation of a 100% renewable energy strategy
Countries that want to implement a 100% renewable strategy should prepare a roadmap that outlines the necessary investments in terms of concrete projects, infrastructure and technology requirements. Then a MDB (or another designated institution) analyses the roadmap together with the relevant national authorities to ensure that the new investments are sustainable. Once a roadmap is approved, the necessary guarantees for credits, the required grants and currencies are identified.
The role of the guarantees
Disagreements on risks hold back many potentially profitable RE-investments. The approved roadmap would identify which RE-investments can be implemented, if guarantees for the credits from the MDB can stabilize the calculation basis and lower the risk sufficiently to reduce the interest rate to an acceptable level. As MDBs could realistically only cover a part of the total risk, central banks would need to cover the bulk of this risk. The MDBs would bundle different credits for RE-investments to generate a bond with a homogeneous risk category. Thus, the MDBs create a new standardized and low risk asset category which could be issued to private investors: The Central Bank backed Climate Bonds (CBBCBs). The guaranties of the central banks justify interest rates at the low level of AAA government bonds (e.g.: 1.5% or 2.5%). This low interest level would unlock a huge amount of additional RE-Investments. The low interest level lowers costs and makes it possible to sell the newly produced renewable electricity at a price which makes it ‘affordable for all’ (in line with SDG 7). The CBBCBs would make these RE-Investments low risk, long term and sustainable. Central banks would only be involved in case of a default with a small impact on their balance sheets.
The issuing of standardized Green Climate Bonds
If a RE-investment requires not only a guarantee to be profitable while providing affordable energy, but a onetime or permanent grant central banks can provide this too. In this case the MDBs, the GCF or other designated financial institutions, issue standardized and virtually perpetual Green Climate Bonds which are purchased by the central banks of industrialized countries. These standardized Green Climate Bonds establish new asset class created for central banks, because only central banks have the ability to purchase virtually perpetual bonds with very low (if any) interest rates. The capability of the MDBs to receive new and virtually repayment-free money by issuing Green Climate Bonds to central banks enables them to support many new RE-Investments.
A short guide to the financial tool of standardized Green Climate Bonds
Standardized Green Climate Bonds should be virtually perpetual (e.g. 100 years or longer) and practically interest free. Due to their perpetual duration, Green Climate Bonds would become permanent assets of central banks and thus form the foundation of regular money creation, reducing or abolishing the need for additional growth in the money supply. This would ensure that the GCF or the MDBs are at the receiving end of new and non-repayable money with which they can increase the profitability of many existing climate protection investments. Likewise, it will be possible to finance adaptation and mitigation measures that result in no immediate financial yield. Considering the current actions of central banks up to $300 billion p.a. could easily be found within the regular money creation process (WFC, 2015). Central banks can never become insolvent in their own currency due to their monopoly of issuing the legal tender – even if they purchase perpetual non-performing assets. The economic potential of central banks was seen during the bank bailouts, leaving no reason why they should not also contribute to stabilizing the global climate with a fraction of the funds previously used.
Ideally, all UNFCCC member states and their central banks would participate in this new Green Climate Bonds initiative. But the financing via standardized Green Climate Bonds could be started by a smaller number of countries. The advantage for states participating in the bond purchases would be that Climate Bonds purchased by their central banks would count towards their promised contribution to the $100 billion p.a. climate finance already agreed at COP16 in Cancun, without having to invest their own budgeted funds.
In the real economy, such additional demand (on RE-Infrastructure and the related consumption) would not lead to additional inflation since it would be globally distributed. The IEA has estimated that approximately $1 trillion p.a. in additional investments would be required to limit global warming to 2°C. Even if the new money creation to achieve the Paris 1.5°C goal succeeds in stimulating total investment and an additional demand of up to $2 trillion p.a. (including participating private capital), this would be a small stimulus package rather than an inflationary risk when seen in relation to the global economic output of around $80 trillion. Of course, the total required would be less if RE prices continue to fall.