BackGreen bonds and guarantees: Key tools to contain global warming
Huge sums of capital are needed for a transition and India has done well to create an enabling framework for green finance.
PremiumThe science required for a fundamental transition from fossil fuel-based to non-fossil fuel-based production is now known. Some are still at the experimental frontier or too costly to implement, but other technologies such as green hydrogen and especially renewable energy are now commercially viable and being rolled out at scale. But these are not being rolled out at anywhere near the scale required to avoid the catastrophe which awaits if average temperatures rise 1.5° Celsius above per-industrial levels. As explained in my last column (Mint, 28 April 2023), the binding constraint in containing global warming is finance, not technology. Can enough resources be mobilized to finance the huge investments required to bring about this fundamental technological transformation? This question was addressed in a panel discussion at the National Council of Applied Economic Research (NCAER) on 15 May 2023, led by Gautam Jain of the Columbia University Centre for Global Energy Policy, which I had the privilege of chairing. Other panellists included Gagan Sidhu of the Council for Energy, Environment and Water, Neha Sharma of Climate Bond Initiative, and Praveen Kumar of NCAER. I have drawn on Gautam Jain’s presentation, among other inputs, for this column.
Let me first address the issue of legacy and responsibility. Global warming is not a consequence of emissions today. It is the consequence of cumulative emissions of CO2 over centuries which remain suspended in the atmosphere. As the accompanying table shows, just six countries account for 64% of the cumulative CO2 emissions since the industrial revolution (1751 onwards) that have driven global warming: the US (26%), China (12%), Russia (11%), Germany (6%), UK (5%) and Japan (4%). The moral responsibility of countries which account for so much of this global warming is very clear. Unfortunately, this does not count for much in global geopolitics.
For more than 30 years since the Rio de Janeiro Earth Summit of 1992, emerging market and developing economies (EMDEs) have been demanding that the ‘polluter pays’ principle should apply globally, as it does within countries, especially developed countries. However, that demand has had no traction. Meanwhile, time is running out. Unless massive investments are made during the next 5-7 years, the window for containing global warming below 1.5° Centigrade may close. It is best to look for more effective, timely alternatives while sustaining a discussion on the fulfilment of legacy responsibilities for compensation in the future.
One fairly robust estimate is that the required investment in clean energy projects for effective mitigation is about $5 trillion a year. Of this, about 20% (i.e., $1 trillion) is the requirement for EMDEs excluding China. As against that the annual funding available this year is only $ 1.4 trillion or 30%. For EMDEs (excluding China) the amount available is only $150 billion, which is around 15% of the requirement. Can this huge gap be filled? Multilateral development banks (MDBs) cannot meet this massive financing gap. Some estimates suggest that the maximum additional annual financing that MDBs can collectively mobilize for all purposes, including climate finance, is only $1 trillion. There is much scepticism even about this estimate (see Mundle, Mint, 28 April 2023, cited above). That leaves the private sector. But private investors invest for profit, so the question arises whether climate financing can generate enough returns, adjusted for risk, to pull in private funds of around $5 trillion a year. Important innovations here include the green bonds and allied instruments like transition bonds, sustainability bonds and sustainability linked bonds. This asset class of thematic bonds, including social bonds, originated in 2007, but it took a while for the market to accept them. During the past five years, the flow of these assets has grown annually at a phenomenal rate of 55% to a total issuance of $3.5 trillion. There is much room for further growth, since the global bond market is estimated at $ 130 trillion and green bonds, which have led the growth of this asset class with a 60% share, trade at a significant premium. Some estimates suggest that the volume of green bonds could indeed grow to the asking amount of $5 trillion by 2025.
The catch is that global warming will have a disproportionately high impact on EMDEs compared to developed economies, but only 10% of green bonds and other thematic bonds have flowed to EMDEs (excluding China). Here, MDBs can play a key leveraging role. Foreign investors are reluctant to invest in EMDE bonds because of political and other perceived risks as well as currency risk in case of local currency bonds. MDBs can use their limited funds to provide insurance and risk guarantees which can leverage climate finance many times larger than their own funds. EMDE governments need to develop a green bond frameworks and taxonomy and also strengthen ESG mandates. This will enhance the demand for thematic bonds. India has done well by issuing a green bond framework last November. The country also undertook other measures that enabled the successful issue of two local currency bonds that have been trading at a premium.
Sudipto Mundle is chairman, Centre for Development Studies. These are the author’s personal views.
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