Last week, I discussed the poor fiscal situation of the poorest countries. This week’s “New Global Financing Agreement Summit“Being in Paris presents an opportunity to address this challenge. It also presents an opportunity to make the investments needed to transition to a low-emissions economy.
That’s at the heart of a new paper by Avinash Persaud, who advised Barbados Prime Minister Mia Mottley on far-reaching issues bridgetown A reform agenda for the global financial architecture. exist”Partial foreign exchange guarantees smooth the road to green transformation in developing countries’, he analyzed how to provide sufficient affordable financing for renewable energy projects in emerging and developing countries, an issue that was also considered in last year’s expert group report Financing Climate Action.
Over the past 270 years, Europe and North America have contributed more than 70% of the anthropogenic greenhouse gas inventory. It also uses up almost all of the planet’s carbon budget. But today, emerging markets and developing countries generate about 63 percent of emissions, and that share is set to grow. So not only will emissions have to be slashed, but a significant portion of those cuts, especially relative to trends, will have to be implemented by emerging and developing countries. To achieve this goal, green transition investments in these countries (excluding China) would need to reach approximately US$2.4 trillion per year (6.5% of GDP) by 2030.
In high-income countries, 81% of green investments are financed by the private sector. In emerging and developing countries, the private share is only 14%. Even if this week’s summit turns out to be a complete success, official external aid is highly unlikely to fill the void. As Persaud points out, “global aid spending is less than one-tenth of the cost of the green transition”. Furthermore, “developing countries do not have enough room on their balance sheets to cover the required debt payments even if they wished to finance themselves”.
The solution is to secure private financing for potentially profitable projects. This accounts for about 60 percent of the required investment, with the remainder going to projects such as adaptation. The latter generate no direct financial return and must therefore be financed by official aid. But even if projects are bankable, Persaud points out, the punitively high interest costs of private lending to emerging and developing countries are, in theory, a daunting hurdle. Thus, for a similar solar farm, the average interest cost in major emerging countries is as high as 10.6% per annum, compared to just 4% in the EU.
However, according to Persaud, it is not project-specific risks that are responsible for this large discrepancy. a solar farm, pass Solar farms are no more risky in India than in Germany. The over-all risk premium represents the market’s estimate of macroeconomic (especially currency and default) risk. He also argues that these risks are not only exaggerated, but also cyclical: In periods of “risk on”, insurance overpays less than during periods of “risk off”.
This article calculates this by looking at the cost of hedging foreign exchange risk. Expressed as the difference between the price of buying foreign currency with domestic currency in the future (forward exchange rate) and today (spot exchange rate). This gap can then be converted into an annual percentage rate.
The evidence concludes that markets are too risk-averse: the risks are not as great as they fear. This is especially true when the market is at its most risk-averse: on average, the hedge’s “overpayment” was 2.2 percentage points when the cost was below its three-year moving average, but 4.7 percentage points when the cost was above its moving average percentage point average.
All in all, Persaud argues, we have a free lunch: stable speculators can make money by eliminating excessive risk premiums while doing good.
Why is there such a free lunch? Investors may simply be uneasy about an unfamiliar market. They may also be unhappy with this volatile market. In addition, stable speculators must hold large contrarian positions for a long time. Financing such positions at the required scale is risky: it is easy to run out of money long before the market sees it clearly. For these reasons, the market will continue to overvalue hedges.
As Persaud puts it, “Private investors are leaving money on the table. But more importantly, reaping greater societal gains from it . . . promoting green growth in lagging developing countries.” It’s a “global scale” market failure.
He then proposed a joint agency of multilateral development banks and the International Monetary Fund to provide foreign exchange guarantees and share currency risk. Projects can come from guarantee agencies of multilateral development banks. Guarantee agencies can then prioritize projects with the most significantly positive impact on the climate. To limit the risk of losses, the agency will wait until the cost of hedging is above the three-year average, when the risk is deemed significant.
In short, this clever paper makes four points: first, macroeconomic risks make climate projects in developing countries unfundable; second, these projects cannot tackle global climate without large-scale funding challenges; third, markets exaggerate these risks, especially in times of economic downturn; and finally, the expected benefits of official intervention will outweigh the costs, in part because of the high stakes.
If you’re not convinced by that logic, what’s your plan for financing the massive investments the world needs? After all, investing in rich countries alone won’t solve climate change.
martin.wolf@ft.com
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