The Problem: Projected climate change mitigation investment needs in developing countries- -including for low-carbon sectors–are significant, growing, and may not be met. Experts estimate new investments of up to $300 billion annually by 2020, growing up to $500 billion annually by 2030, are required to mitigate developing countries’ greenhouse gas emissions to levels in line with global targets.1 While industrialized nations have committed to mobilizing new funds of $100 billion annually by 2020 to meet these needs, this level of funding is far from what is required.
One Solution: Redirect the private sector’s growing investment in developing countries to help fill the growing climate finance gap. McKinsey estimates that the financial stock—that is, the total value of outstanding stocks and bonds—of developing countries grew by $11 trillion in 2011.2 By intervening to improve the investment attractiveness of climate change-relevant markets, the public sector has a significant opportunity to harness and redirect these significant private sector capital flows away from fossil fuel-driven sectors and toward lowcarbon development.
The Challenge: Mobilizing private sector investment will require better targeted public support that improves the risk-reward calculus of lowcarbon markets. The private sector seeks markets that exhibit (i) attractive returns relative to associated risks over an appropriate investment timeframe (“attractive risk-reward calculus”) as well as (ii) adequate size, liquidity, and transparency. These conditions are often absent in developing countries due to the nascent natures of both low-carbon and financial markets in these geographies.
Recommendation: To improve the risk-reward calculus of investments—arguably the most fundamental barrier to leveraging private capital—the public sector can complement support for lowcarbon policies with direct finance that manages the following risks:
- Political and macroeconomic risks. Political risk guarantees, interest-rate/currency exchange products, and local currency loans can help investors and project developers financially manage political (for example, political instability) and/or macroeconomic (for example, exchange rate volatility) risks. As these financing instruments are not easily accessible in poorer countries, by providing these instruments, the public sector can catalyze low-carbon investment in geographies where access to finance is most challenging.
- Low-carbon market risks, including policy, technology, and operational risks. These risks, which range from unexpected policy changes to technology failures, can affect both new and mature low-carbon markets. In newer low-carbon markets, public financing instruments like first-loss equity and debt investments and concessional loans can be instrumental in encouraging early investment. Projects in more established low-carbon markets—like solar, wind, and energy efficiency—can benefit from flexible loans, partial risk and credit guarantees, and risk sharing facilities.
Given the varied investment conditions across developing countries and their respective low-carbon markets, each market will require a unique combination of finance and policy support to scale-up private sector investment. Future WRI publications, drawing on private sector perspectives, will delve deeper into how public climate finance providers— whether governments, development finance institutions, or export-credit/aid agencies—can tailor direct finance to scaleup private sector investment in different markets.