Chasing private capital and the impossible trinity of climate finance

I have a new paper on climate finance co-authored with V Anantha Nageswaran, Chief Economic Advisor, Government of India, and published by CESP. The Abstract

The paper makes the case that poverty alleviation, growth, and climate-related transition, which require both public and private funds, need to be pursued in parallel. Given the scale of these challenges, private capital mobilisation is imperative. However, this should not come at the cost of economic vulnerability and risk. The paper identifies a range of challenges that stand in the way of the smooth flow of resources necessary for the adaptive and other transitions associated with climate change. These challenges are examined across three dimensions – public and private, domestic and international, and equity and debt, and require both global and domestic actions. Such actions include separating the construction, operation and maintenance phases of projects, allocating a greater role to the public sector in the former, concessional capital to national development finance institutions to facilitate project pipeline development, using aid to de-risk countries as opposed to projects; leveraging environmental, social, and governance assets for climate finance in developing countries; eliminating flaws and biases working against developing countries in the credit rating process; ensuring fairer arbitration processes and revision of bilateral investment treaties; improving contract resolution processes; reducing informational asymmetries, and fostering greater transparency in climate finance. Finally, the study calls for the allocation of the climate finance burden on the basis of ability to bear, as failing to do so could lead to macroeconomic stress at the national and global levels.

One big takeaway is to put in perspective and urge caution on relying on private capital to finance climate mitigation and adaptation in developing countries. 

Another is to posit an Impossible Trinity of Net Zero. At any time, developing countries can achieve only two of the three - Net Zero transition, fiscal sustainability, and economic competitiveness.

Commitment to carbon neutrality will entail a higher cost of energy and will undermine competitiveness. If carbon neutrality and economic competitiveness both have to be preserved, then fiscal sustainability may have to be sacrificed. That is, the weaker sections of the population—households and businesses—may have to be compensated through subsidies and transfers. However, loosening fiscal prudence carries the risk of macroeconomic instability.

The full paper here.