How tapping into domestic savings is key to securing low carbon futures

Emerging markets are in urgent need of financing to support their low-carbon transition. While the world’s attention has been shifting to attracting international private finance into the developing world, mobilising domestic capital will be just as important.

Foreign currencies
Most purchase agreements for clean energy in developing coutnries are denominated in US dollars, exposing project cash flows to fluctuations in the value of the local currency. Image: Jason Leung / Unsplash

Emerging markets are in urgent need of financing to support their transition to clean energy and low-carbon growth. For many, an important question remains: where will this financing come from?

The world’s attention has been shifting toward bringing international private capital—and particularly institutional investor finance—into the developing world. But significant barriers remain.

While private investment flows have grown from US$6 billion in 2010 to US$29 billion in 2019 in the top 20 emerging markets, flows into the remaining 84 markets remained flat at US$3 to 4 billion over the same period.

One key obstacle is the scarcity of projects that meet the “risk-return” profile most institutional investors want, together with a lack of taxonomies and reporting standards.

Another fundamental barrier is that clean energy technologies in developing countries typically require large up-front capital expenditure that is financed through foreign borrowing. As a consequence, most purchase agreements are denominated in US dollars, exposing project cash flows—and ultimately consumers—to fluctuations in the value of the local currency.

That risk might disappear if clean energy technologies were to be financed in domestic currency. However, domestic capital markets and the banking sector in most countries are not deep enough to provide long-tenor local currency solutions. 

The answer, then, is to connect countries’ domestic savings—insurance, pension funds, commercial banks—to local projects. In Sub-Saharan Africa alone, local pension funds collectively manage around US$350 billion of assets. Imagine how far these funds could go towards financing affordable renewable energy solutions.

Another important consideration is that domestic financing is often the only source available to small and medium-enterprises (SMEs). SMEs represent 90 per cent of private companies and 60 to 70 per cent of employment, and are responsible for the livelihoods of over two billion people. They also account for about half of all greenhouse gas emissions.

As large companies demand that their global supply chains meet their environmental standards, small suppliers are likely to face intense pressure to go green. For example, a staggering 79 per cent of all multinational corporations interviewed by Standard Chartered say they will start removing slow-to-transition suppliers by 2025. So, how do we link key players like banks, utility companies, government agencies, pension funds, and suppliers of energy equipment to build domestic capital markets and capacity?

First, we need to identify and create the right in-country projects and the mechanisms to pool capital to fund them. Second, public finance and regulatory reform—with strong policy frameworks, taxes, and subsidies—can make projects more attractive to local investors and entrepreneurs. And third, both international and domestic blended finance can de-risk investments, helping scale up existing opportunities and launch new ones.

But above all, the domestic financial sector needs to be equipped to assess opportunities and to roll out the instruments that are needed to effectively guide green finance – from green bonds to sustainability-linked finance.

The International Finance Corporation’s Green Banking Academy is one initiative that has been working to address that need. More of these advisory opportunities are required for domestic financial institutions to develop green portfolios, design new financial products, and assess their own vulnerability to climate-related risks.

When it comes to advancing the climate transition, mobilising domestic capital could be as important as attracting international finance–and ultimately help create a bigger local market for global investors.

Vivek Pathak is Global Head and Director of Climate Business at the International Finance Corporation (IFC).

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