It’s “finance” COP, which means people are worrying about how much climate finance is debt, and how much ought to be grants. We should expect climate finance to be dominated by debt, because many climate investments involve producing something that can be sold for money, and scarce grant budgets are better allocated elsewhere.
The costliest climate investments are often in things like renewable energy generation, storage and transmission, and green transportation. Or perhaps water recycling, treatment, desalination, transportation and end-use efficiency. Looking to the future, we can expect hydrogen production, its conversion into other chemicals and fuels, storage and transportation. Green cement and steel. All of these are things that businesses and households will pay for.
These things tend to be capital intensive, so when the outputs are sold much of the revenue goes towards recovering upfront spending. If that upfront capital investment was covered by grants, that could result in cheaper electricity for businesses and households, cheaper hydrogen and cement, and so forth (another possibility would be higher profits for the businesses involved – private or state-owned). Lower prices sound appealing – many of BII’s investments are made with the intention of increasing the availability or reducing the prices of important inputs – but I think generally the right way to achieve that goal is to make investments that raise productivity, not to use grants to buy down costs.
The blunt fact is that development and climate grant budgets are not nearly large enough to cover many billion-dollar climate investment projects and are never going to be. Even if more money was available, covering climate investment costs with scarce grant financing should be done extremely selectively. We live in a world where people affected by wars and disasters have urgent and unmet humanitarian needs, and hundreds of millions more people have their everyday needs unmet. The best way of meeting those needs is often spending on services that are distributed without charge. That’s where lower income countries that lack domestic resources really need grant financing from richer donor countries.
There is a case for grant finance – or other forms of concessional finance – in climate investing. In the context of private investment, as a rule that would involve using relatively small amounts of grant finance to make something much larger happen, and at BII we would usually be looking for spillovers beyond the boundaries of the project itself, perhaps knowledge generation that helps a market develop (as with our ‘Kinetic’ Climate Innovation Facility).
Sovereign financing for climate investments can also generate revenues, either directly through the sale of goods and services, or indirectly via economic growth resulting in higher tax revenues. One of the potential reasons to prefer private investment over public, for some types of investment, is that it takes the pressure off countries limited ‘fiscal space’, when the ability to raise tax revenues is limited, debts are already high, and the need for spending in areas such as healthcare, education and social protection is high. In truth this rationale can be weaker than it may first appear – if a private enterprise can make its money back from charging customers, then in principle so can a state-owned enterprise. The relative merits of public and private provision is a big question that I will not attempt to tackle here – the point is merely that governments can also borrow to invest in things that generate revenues. [1]
The answer to the question of whether developing countries should borrow for climate, and how much climate finance should be grants, should reflect how much of that finance is going towards private and public investments to produce goods and services that can be sold (or will increase government revenues). We should expect a large proportion of climate finance to be debt, because that’s what a large proportion of climate investment should look like.
But not all of it. Spending to recover from extreme weather events (loss and damage), some forms of adaptation investment, and spending to help displaced workers in fossil fuel industries, do not generate revenue. We also should not expect poorer countries to spend much more on expensive but greener means of production, when cheaper browner alternatives exist – it is not their responsibility to be internalise the cost of global externalities. If rich countries want poorer countries to do that, they should provide subsidies. That’s where grant financing is wanted.
Footnotes
[1] In countries experiencing debt distress, even borrowing for investments that should generate future revenues may not be possible or is a bad idea. Insolvent countries need debt relief. Afterwards, a tighter focus on borrowing for productive investment would help prevent the cycle of overborrowing and crisis repeating.
