Climate finance 101

Hello, my name is Avinash Posaud. I'm the Special Advisor on Climate Change to the President of the Inter-American Development Bank. This podcast, the first in a series leading up to COP 13 Bel-M, aims to get at the underlying issues around climate finance, in jargon-free language, and pointing the way forward with ambitious yet practical solutions. Reducing harmful emissions, adapting to climate shocks, responding to climate loss and damage costs a dizzying amount of money when measured in dollars and cents. But not a lot, when we consider the annual amount of investment in the world, 30 trillion dollars every year, or when we consider the total returns from investing in reducing emissions, 300%. Or the cost of not doing so, 25% of GDP and rising. Or when we consider the economic savings from adaptation, 1,000% of the cost of resilient infrastructure. The evidence tells the story with increasing clarity. Most recently in two studies by the World Resources Institute called Strengthening the Case for Adaptation, a triple-dividend approach, and by a report by the Inter-American Development Bank, Peril and Promise. We are reducing emissions, adapting to change, responding to climate impacts, too slowly. Not because we don't know the science, or we don't have the tech or the money, we have all we need, it's just in the wrong place. Three broad interventions could change that, and they illustrate the issues well. Let's kick off with adapting to climate shocks. Global average temperatures are approaching 1.5 degrees higher than the levels we've enjoyed for most of modern human civilisation. Triggering more prolonged droughts, more extreme heat days, wetter, stronger storms, larger floods and rising sea levels. Developing countries are feeling these effects most heavily because they sit in a wide band around the equator. Climate impacts are costing the poorest countries over $150 billion per year and rising. And now that it ensures no better the frequency and impact of climate shocks, those particularly vulnerable to climate are like those with a pre-existing medical condition. They all struggle to access insurance pools with the less risky. Soon, ensuring climate risks will be mainly a way of spreading losses over time. But even that advantage will diminish as climate disasters become more frequent. If the loss is $150 billion a year, annual premiums will be more than $150 billion. And if they rise to $250 billion, premiums will follow. There's no magic or leverage from climate insurance. The premium will only not increase with climate loss if the coverage falls. Building resilience is the best insurance for climate change. And there's extraordinary leverage here in a study of 320 adaptation projects. In 12 countries that initially cost $133 billion, the World Resources Institute found the total economic returns to be $1.4 trillion. Our own analysis here at the IDB confirmed comparable results. Every dollar spent on resilient public infrastructure yields $10 in savings. From avoided economic losses due to climate related disasters, the avoided productivity losses, improved health outcomes, that's an economic return of over 20% per year on the original investment. Vulnerable countries should begin by bringing forward resilience investments. They don't because their debt would become too high and would rise in costs. That's where multilateral development banks step in. Such as the World Bank and the Inter-American Development Bank. These are not-for-profit banks with government shareholders comprising about half-developed and half-developing who have committed sufficient capital in case of loss to enable the banks to borrow and on-lend to countries at some of the lowest interest rates in the world. If the economic return on adaptation investment is 20% per year, then borrowing to build it at a cost of 4% per year is the prudent thing to do. Multilateral development banks could finance the entire adaptation of public infrastructure of vulnerable countries if they double the amount they lend to developing countries or they lend or they mobilize to developing countries. That will require the banks, the multilateral development banks, the MDBs to take a few essential inexpensive steps. First, recognizing that debt for resilience is prudent in debt sustainability analysis while under-investing in the resilience is not prudent. This will enable countries to be able to borrow more above current limits and the MDBs to raise the amount they can lend to those countries. Countries will need support in developing national adaptation plans linked to commitments to lend against good plans. I will discuss an exciting initiative, for instance, that we're launching at COP, with James to make all schools heat-ready in a future podcast. MDBs struggle to disperse funds sometimes, either due to their quality control, or sometimes because they need new instruments. Finally, to remain a low-cost borrower and lender, shareholders of these MDBs will need to give more assurances to the banks so they can support their capital or re-channel some of their allocation of special drawing rights, something that could be the topic of a future podcast. The issues, yes, are complex, but they're not expensive and the savings in countries are enormous. Many people understandably object to poor countries' borrowing money to protect themselves against the changing climate primarily caused by the earlier emissions of wealthier larger countries. Vulnerable developing countries already have high debt levels from absorbing climate loss and damage. The MDB steps we described earlier will increase the fiscal space of developing countries. But the issue of whether to use grants or these low-cost instruments of debt depends on what else grants could be useful, because we live in a world of scarce resources. Today, all of the overseas development assistance in the world is not enough to address the loss and damage caused by climate impacts. The poorest and most vulnerable people are currently bearing it themselves through the loss of homes, loss of their homes, their livelihoods, income, health and schooling, even the most high-profile disasters, such as the 2022 Pakistan floods and the 2024-25 Brazilian floods. Even there over 80% of the actual money spent came from local or national governments. And more than half of the loss and damage went unaddressed. Loss and damage generate no returns for the private sector or savings for the public sector, so it can only be funded in grants. And so every dollar of a grant spent on mitigation the private sector could fund, or adaptation that the MDB could lend towards, is a dollar taken away from the vulnerable for their loss and damage. We should concentrate grants on responding to loss and damage. And we will need new revenue sources too. It's an essential principle in economics that the polluter should pay for the economic costs of pollution, so that instead of polluters being incentivised to get around the regulation, they're incentivised to reduce their pollution and invest in alternatives. There's enough money to be diverted by governments to the fund for responding to loss and damage, by reducing harmful subsidies and charging levies for harmful pollution. We should fill the fund. Finally, let's turn to the elephant in the room. Mobilising private sector capital to reducing missions in developing countries. Much-promised little scene. Institutional investors, including the pension funds of insurance companies which collect our monthly contributions and premiums, they manage today almost $130 trillion in investments and invest over $30 trillion every year. Less than 2% of that is invested in developing countries. Even though this is where 60% of the growth is, everyone is losing from that. Pensioners and insured individuals such as you and me have 98% of our money invested now in assets where only 40% of the growth is. Developing countries, where investment opportunities are large, where the pool of domestic savings is small, they're developing countries and these countries are starved of international capital, so they end up with expensive money or a high cost of capital. And because of that high cost of capital, investments in renewable energies that make commercial sense in rich countries do not make sense in the very developing countries that are now producing 60% of harmful emissions. If we could lower the barriers to the flow of capital, the cost of capital in developing countries would decrease, allowing investments in cheaper and more secure energy, supercharging the energy transition. It's the most effective growth strategy available for developing countries as Lord Stern and Amar Bhattacharya have often argued. When people in developed countries discuss the barriers to the flow of finance, they often focus and start on the riskiness of developing countries. But one of the main barriers to the flow of money is the way the international system and finance is organized. Safety is defined as being in a small number of countries with a historically large economic trade and military reach, reinforced by modern accounting and rating standards, and risk is everywhere else. In a crisis, capital still flees to these countries, these G7 countries, primarily enabling these countries to implement policy responses such as cutting interest rates and expanding spending that mitigates the crisis for them. In contrast, the rest of the world is forced to do the opposite as capital flees, exacerbating their crisis. During the COVID-19 crisis, for instance, developed countries slashed interest rates to zero, ran up massive deficits to pay for cash transfer schemes and vaccines, and emerged from the crisis first as a result. Developing countries were unable to do that, suffered bigger economic downturns and slower recoveries, common crisis, different volatility. But we're the story that this is all discriminatory ratings or poor perceptions. The volatility is really enough, and it's a volatility that is hard for a system reliant on commercial banks funded with overnight deposits to manage. And this is not solved by financing projects in local currency, as that would merely increase the demand for the limited amount of local savings and raise the cost of local capital. The solution is to create a conduit that transfers capital from where it is cheap to where it is expensive, by mitigating the foreign exchange risk. We can do that by shifting part of this FX risk to those who have inflation-proof revenues, and the remaining part to long-term players like development banks or reinsurers, who because of their AAA rating, can provide unsubsidised but cheaper insurance for long-term risks than short-term banks can. We at the IDB have developed an initiative that does just that, providing money to local banks and investors to invest more in projects aligned with national plans by buying their existing performing assets and converting them into rated securities in the currency of institutional investors, thereby ensuring a continuous recycling of capital. There will be much activity, diversification, ratings and insurance, but no public subsidy. The plan is called a Reinvest Plus and builds on an earlier IDB initiative with the Brazilian government called EcoInvest. We can discuss it further next week. Let's conclude. When it comes to climate finance, think about revenues, savings, costs. MDBs can unblock the private sector from financing commercially viable transitions where the revenues are in developing countries by lowering the cost of capital through an MDB-supported but not subsidised conduit that addresses the central obstacles to the flow of capital, FX volatility, ratings and diversification. This is scalable to the amount of the international private sector flows we need. MDB shareholders can increase the amount MDBs can lend to climate-runnable countries for adaptation through increased prioritisation on adaptation, new instruments, more SDRs and perhaps in return for evidence of more impact, more callable capital. This is scalable to cover the adaptation needs of climate-runnable countries. Donors can concentrate existing grants on addressing loss and damage of the most vulnerable people such as those in small islands but also the urban and rural poor in big developing countries and augment these grants by removing subsidies and raising levies on harmful pollution. These three interventions, things we can do that are scalable, affordable, practical, I believe they'll make a difference. Thank you very much, speak to you next week. [BLANK_AUDIO]