Economic safeguards against climate change: De-risking as a pathway to sustainable development
De-risking is not just a financial imperative but a strategic necessity for Bangladesh. It is the linchpin that can unlock the doors to the vast sums required from MDBs, private financiers, and other funding avenues
The urgency of climate change demands a significant shift in how we finance the transition to a low-carbon economy, particularly in developing economies like Bangladesh, where the need for sustainable infrastructure is paramount. As a nation heavily impacted by climate effects, Bangladesh faces the dual challenge of pursuing economic development while managing vulnerabilities to frequent and severe climate-related events such as cyclones and flooding.
In this context, the concept of 'de-risking' climate finance can be a critical strategy in discussions among think tanks, development finance institutions, and multilateral banks. This approach aims to make climate-related investments more attractive to the private sector by reducing financial risks.
However, despite widespread acknowledgement of the need to leverage public finance through blended finance models, there remains a significant gap in understanding and implementing these practical approaches.
The imperative for climate financing in Bangladesh is underscored by its acute vulnerability to climate impacts and the stark discrepancy between current investment levels and the needs projected for sustainable, climate-resilient development.
The Global Landscape of Climate Finance 2021 report illuminates this gap, noting that while global climate finance has reached $632 billion, South Asia's share is less than 5%, with a mere fraction directed towards adaptation and resilience. For Bangladesh, a nation contributing only 0.4% to global greenhouse emissions yet ranking seventh in weather-related loss events, the disparity between its climate finance inflows and the actual requirements is particularly pronounced.
De-risking in the context of climate finance involves a series of strategic interventions designed to minimise the risks associated with investments. In the realm of finance, where the cost of capital is intricately linked to risk, the concept of de-risking becomes a critical tool for funnelling more affordable capital into environmentally beneficial projects.
De-risking works by tackling the different layers of risk that collectively hike up financing costs. These layers include the risk of a country defaulting (sovereign risk), the uncertainties of the political climate (political risk), the inherent dangers in a business venture or specific project (business/project risk), and the instability of currency values (currency risk).
To break it down, de-risking is about shifting these risks around to where they can be best managed. Take sovereign risk as an example: this can be spread out across a global institution, much like the safety nets provided by international development banks. Political risks can be smoothed over with solid, reliable policies that make for a stable investment environment. Risks tied to specific businesses or projects can be distributed in a way that aligns with the varying risk appetites of different investors.
The Global Landscape of Climate Finance 2021 reported a stark discrepancy between current investments and the estimated annual requirement of $4.4–$5 trillion for climate investments. This shortfall is particularly acute in developing economies, where the potential for clean energy, such as solar power, is inversely related to the actual investments received.
Furthermore, the outdated transmission and distribution infrastructure in many developing countries increases the cost of cleaner electricity, necessitating investments that are not only climate-smart but also financially viable.
With operating costs for renewable energy being relatively low, the financial viability of such projects is heavily dependent on the cost of capital. High-risk premiums, driven by the various risks mentioned earlier, inflate the cost of finance, making renewable energy less competitive compared to fossil fuels.
Many developing countries are employing innovative de-risking strategies to encourage investment in climate-smart agriculture and sustainable energy, which are critical for resilience to climate change.
For instance, India's approach to de-risking climate finance in the renewable energy sector is exemplified by the significant investment in offshore wind energy projects through the Viability Gap Funding (VGF) scheme. This initiative, valued at ₹7453 crore, allocates ₹6853 crore specifically for the installation and commissioning of 1 gigawatt (GW) of offshore wind capacity, distributed equally between Gujarat and Tamil Nadu.
An additional ₹600 crore is designated for upgrading two ports to support the logistics needs of these projects. This strategic financial support encourages private investment in infrastructure that might otherwise be deemed too risky or unprofitable. The expected outcome is not only the generation of approximately 3.72 billion units of renewable electricity annually but also a substantial reduction in CO2 emissions by nearly 3 million metric tonnes each year.
In sustainable agriculture, F3 Life in East Africa is pioneering an approach that offers farmers more favourable credit terms when they adopt climate-smart agricultural practices. This approach isn't just theoretical—it's practical and already in motion.
Consider the agricultural sector, where bolstering resilience against climate change can lead to lower chances of loan defaults. This, in turn, means lenders can offer lower interest rates, benefiting both the agriculturalists and the financial institutions backing them. A prime example of this in action is the collaborative effort by Rabobank and the UN Environment Programme, which has set up a $1 billion fund to support sustainable farming with a blend of public and private money.
This fund isn't just about handing out money; it's equipped with safety nets like guarantees or insurance to protect investors from the unpredictable nature of agriculture, which is heavily influenced by climate variability. By cushioning these risks, the fund lowers the entry barriers for private investment, encouraging the flow of money into farming methods that are not only eco-friendly but also economically sound and supportive of stable food supplies.
Bangladesh is also making strides through various initiatives that enhance the attractiveness and feasibility of such investments. The development partners have implemented several mechanisms to mitigate risks and encourage both domestic and international investment in the renewable energy sector.
Additionally, Bangladesh is benefiting from international financial mechanisms that blend loans and grants to lessen financial risks for renewable energy projects. The European Investment Bank (EIB) and the European Union, for example, have allocated €395 million to support the installation of an estimated 750 MWp of renewable energy capacity. This package includes concessional loans and grants, which provide a cushion against financial uncertainties and enhance the project bank.
Moreover, the World Bank's $185 million investment to increase renewable energy capacity in Bangladesh is another example of de-risking through international support. These institutions have been pivotal in fostering a conducive environment for climate-smart infrastructure and sustainable practices. However, the challenge remains to scale these investments by nearly 600% to align with the 2030 sustainable targets, a daunting task exacerbated by the economic repercussions of the Covid-19 pandemic.
Future efforts to enhance de-risking in Bangladesh could focus on expanding and diversifying financial instruments. Risk guarantees and insurance products employed at a large scale could safeguard against climate-induced agricultural losses, while blended finance instruments could leverage public funds to entice private investment.
For example, a portion of public funds is used to guarantee initial losses of up to 20-30% for an irrigation company that wants to innovate with flood-resistant technologies, which can attract more private capital. The issuance of more green bonds could earmark capital for resilient infrastructure projects, and the establishment of robust policy frameworks could alleviate regulatory uncertainties.
Moreover, standardising definitions and methodologies for climate finance and fostering access to reliable data will be foundational for directing funds effectively towards adaptation. However, to truly harness the potential of climate finance, a comprehensive climate finance portal should be established to ensure transparency and accountability.
In conclusion, de-risking is not just a financial imperative but a strategic necessity for Bangladesh. It is the linchpin that can unlock the doors to the vast sums required from MDBs, private financiers, and other funding avenues. By implementing de-risking measures, Bangladesh can secure the investments needed to fortify its defences against climate change and march towards a resilient and sustainable future.
Mujtaba Rafid Rafa serves as an Assistant Secretary at the Ministry of Foreign Affairs in Bangladesh.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.