A recent study from the Istituto Affari Internazionali (IAI) has argued that several shortcomings in the climate and development finance systems undermine the capacity of countries in the Global South to tackle climate change.1 Insufficient resources, lack of focus on adaptation, inadequate management of climate risks, the vicious circle between indebtedness and climate vulnerability are some of the major obstacles.
The G20 is the primary venue where global financial governance reforms can be initiated. Over the summer key G20 meetings have taken place, thus it is interesting to evaluate which direction the most influential nations are taking with regards to supporting developing countries in tackling climate change. This is particularly relevant in light of the upcoming COP26, where climate finance will be very high on the agenda.
A first key observation is that the cross-sectoral nature of this subject stands in the way of more rapid and ambitious steps forward. It extends across three different areas (finance, development and climate) requiring strong cooperation for which, nevertheless, no clear mechanism has been established within the G20.
The Energy and Climate G20 Ministers in Naples reaffirmed their commitment to the Paris Agreement, underlining the principle of common but differentiated responsibilities. They also reaffirmed support for the commitment to mobilise USD 100 billion per year by 2020 as climate finance directed to developing countries. However, these commitments represent the bedrock of climate diplomacy and reiterating support is the minimum starting point, very far from meaningful steps forward.
Firstly, it would have been important to acknowledge the disproportionate contribution of wealthier nations to greenhouse gas emissions and agree on the notion that climate finance represents a compensation for this historical responsibility, rather than aid. Secondly, the G20 failed to address the multiple issues lying behind the USD 100 billion commitment. The latest data show that climate finance provided by rich nations to developing countries never exceeded USD 79.6 annually.2 While current estimates of climate finance needs range between USD 1.6 trillion to USD 3.8 trillion annually,3 revealing that the existing commitment is severely insufficient. Moreover, the issues of climate finance double-counting and over-reporting, which are estimated to inflate the underwhelming numbers on climate finance by a third,4 were also ignored.5 Finally, it is disappointing that the G20 did not decide on any progressive increase in climate finance towards 2025, when the next target must be set.6
Distribution of climate finance is also severely skewed towards mitigation (around 72% of the total), while adaptation and the “loss and damage” caused by climate change are underfunded, despite being pressing issues for developing countries. Encouragingly, in Naples G20 Ministers have argued strongly for the need to redirect resources towards adaptation. However, no concrete commitment was adopted and “loss and damage” was not even mentioned.
It is underwhelming that the G20 failed to address these key issues. Especially because they are among the most urgent and divisive issues on the COP26 agenda, in particular the question of setting financial commitments for “loss and damage”. The G20 would have been an important opportunity to initiate discussions and reach preliminary agreements within the most influential nations, increasing the likelihood of success for the upcoming Glasgow negotiations.
The interplay between debt and climate vulnerability
Data show that debt-creating instruments account for almost 60% of climate finance, while 76% of climate multilateral loans are non-concessional.7 This is a major issue. The physical and economic damages of climate change undermine capacity to repay existing debt, while reconstruction following a climate disaster is often financed through loans, further worsening debt sustainability. The accumulated debt hinders investments in adaptation and resilience, thus exacerbating climate vulnerability. In addition, due to the increased risk of climate events, in vulnerable countries the cost of borrowing is higher than elsewhere, further reducing the available fiscal space to invest in climate action. 8 This direct link between indebtedness and increased climate vulnerability in the Global South has been overlooked in relevant G20 ministerial meetings so far.
Nevertheless, the G20 Finance Ministers and Central Bank Governors in Venice addressed the issue of debt management in developing countries in the post-pandemic context, reaffirming commitment to implement the Common Framework for Debt Treatments beyond the DSSI. Despite being a positive initiative, unthinkable before the pandemic, the Common Framework is not a sufficient answer to the unfurling triple health, debt and climate crisis in the Global South. A more adequate response would be the creation of a permanent multilateral sovereign debt workout mechanism that prioritises climate action and other SDGs over debt service and ensures orderly, fair, transparent, and durable debt crisis resolution.9 The G20 would be the preferential venue to build consensus around this reform, but to date this is a very unlikely outcome.
The integration of climate risks
The COVID-19 pandemic has reminded us about the importance of investing in risk reduction and resilience, as well as the cost of inaction. Unmitigated climate change could lead to average income losses of over 20% of GDP by 2100 and significantly higher in the Global South.10 Therefore, focusing on a better understanding and management of climate risks is an urgent priority. The G20 in Venice clearly stated the need for a more systematic integration of climate risks, taking a significant positive step. However, no specific reference was made to inadequate management of climate risks within the development finance system. The Sustainable Finance Working Group is expected to present an extensive set of recommendations that will feed into the G20 Finance Ministers meetings in October, hopefully leading to some ambitious outcomes.
Some of the key aspects that should be addressed include integrating climate risks in all development programmes to prevent investing in maladaptive solutions, as well as scaling-up support for governments in vulnerable countries to mainstream climate risk analysis in their budgeting and planning processes. Secondly, the G20 should call on the IMF to strengthen its approach on climate risks. In its recent review of Article IV surveillance, the mechanism used to assess the economic health of member countries and identify risks for economic and financial stability globally, the IMF has recognized the need to factor in climate change. However, it failed to define a mandatory and systematic monitoring system, and is particularly vague on the assessment of climate mitigation policies. Therefore, the negative spillovers of inadequate emission-reduction policies in the largest emitting countries might be completely overlooked, while they represent a major risk for the economic and financial stability of climate vulnerable developing countries.
Moreover, the G20 should promote an open review of the IMF Debt Sustainability Analysis (DSA) in order to evolve towards a debt sustainability concept that includes considerations on climate risks. The DSA proved to be inadequate in several cases. For instance, in 2019 cyclones Idai and Kenneth hit Mozambique causing over USD 873 million worth of damages. As climate vulnerabilities were not considered in the country’s DSA, it did not qualify for the IMF emergency debt relief, despite being in a situation of debt distress even prior to the cyclones.11 This left Mozambique with no option but to take on more loans to finance reconstruction, further worsening debt sustainability and consequently increasing climate vulnerability. In addition to the DSA open review, the G20 should build consensus on setting an appropriate financial commitment for “loss and damage” and promote the creation of a specific debt relief mechanism to allow immediate access to already available resources in the aftermath of a natural disaster. This would be a remarkable outcome for the fall meetings, yet unlikely.
In conclusion, the Energy-Climate ministerial meeting was significantly lacking with regards to climate finance despite strongly underlining the need to refocus on adaptation. The approach adopted by the Finance Ministers with regards to better integration of climate risks is promising but lacks focus on the Global South. It remains to be seen what the influence of the Sustainable Finance Working Group will be on the outcomes of the Finance Ministers meeting in October. So far, the most striking element is that no concrete commitment has been adopted with regards to the pressing issue of supporting developing countries in tackling climate change. The G20 is moving some steps forward by giving more relevance to critical issues for the Global South, but without any concrete measures and adequate financial commitment, climate change is still moving faster.
Author: Giulia Sofia Sarno, IAI.
The author would like to thank Francesco Rampa, ECDPM and Steffen Bauer, DIE for their feedback and support in editing this blog.
The views are those of the authors and not necessarily those of ETTG.
5 Double-counting refers to the phenomenon of reporting resources allocated to support climate action in developing countries both as climate finance and as development finance.
8 Bob Buhr et al, Climate Change and the Cost of Capital in Developing Countries. Assessing the impact of climate risks on sovereign borrowing costs, United Nations Environment Programme, Imperial College Business School, SOAS – University of London, 2018