This story is part of our Decoding Sustainable Finance series, where we attempt to break down complex terminology surrounding the latest regulations and trends in sustainable finance.
The developing world needs more financial support to cope with climate breakdown. More emerging economies are now calling for climate aid to be debt-free: grants, not loans.
Lower-income nations argue that adapting to climate risks and chipping in to sustainability efforts shouldn’t saddle them with more financial burden, especially since they contributed little to global warming.
Such calls for climate grants pervade global negotiation tables, from the upcoming loss and damage fund to clean energy deals for some of the world’s largest emerging economies.
As it stands, grants form a small portion of funding deals, even as more loans materialise. Indonesian policymakers have in recent months baulked at possibly having under 1 per cent of its US$20 billion Just Energy Transition Partnership (JET-P) with wealthy donors come without repayment obligations.
Eco-Business takes a look at the key issues around financing for climate-vulnerable countries, whether debt-free solutions could make up a bigger slice of available funding, and how grant funding can be best put to use.
How much grant funding is flowing?
Not much, looking at their overall share of landmark deals, though this varies by recipient and purpose of the funding.
In the US$100 billion-a-year climate funding agreement for developing nations struck last decade, grants made up about 20 per cent of all transfers between 2016 and 2020, according to a tally by the Organisation for Economic Co-operation and Development (OECD). The rest were mostly loans, though some were “concessional” – for instance offering below-market interest rates.
Grants, generally, did go to those who needed them most. About 60 per cent of funds disbursed by wealthy countries to the most vulnerable nations – the least developed and island states – were debt-free, the OECD study showed.
But the overall proportion, after adding in contributions from the private sector, will certainly be lower, since businesses have not been providing grants. Corporations contributed roughly 20 per cent of total funding.
More grant money under the deal went into climate adaptation efforts – for instance improving drainage systems, or setting up early warning equipment against typhoons. The idea is that these projects do not generate revenue, so loans are untenable.
But this reasoning could also explain why overall, most climate finance, in the form of loans, has gone towards climate mitigation. Funding for new solar panels, for example, can be repaid with proceeds from selling electricity.
It is also worth noting that the promised US$100 billion a year was not dished out in full. The target was never reached, with only US$83 million of grants and loans disbursed in 2020, with even lower sums paid out in earlier years.
Within Southeast Asia, 17 per cent of climate funds from 2000 to 2019 were grants, according to a tally by Singapore think tank ISEAS-Yusof Ishak Institute using OECD data.
In line with the trend of mitigation projects getting less love, grant proportions have been much lower in the JET-P deals – partnerships that wealthy donors and financial institutions form with emerging economies struggling to switch from coal to clean energy.
South Africa, the first country to sign a JET-P deal, would be getting 4 per cent of its US$8.5 billion package as grants. Major donors include Germany, the European Union, and multilateral financier Climate Investment Funds.
The grants would mainly be used for administration, research and training, according to its investment plan released end-2022. The South African government has said it would be seeking to raise the grant proportion in the future, and highlighted particular needs in boosting nascent industries like electric vehicles.
Indonesia, second in line for JET-P, has delayed publishing its investment plan and confirmed funding figures till the end of the year. But an official said in June the grant tranche could be just US$160 million – half of South Africa’s, and just 0.8 per cent of the US$20 billion pledged to the populous Asian nation.
International transfer of grants is “a little more complicated” than providing local support, said Dr David Broadstock from the National University of Singapore.
The benefits aren’t locally retained, and the grantor needs to place value in “global benefit over and above the opportunity cost of disbursing the same monies in their home countries”, explained Broadstock, who is the senior research fellow and energy transition lead at the varsity’s Sustainable and Green Finance Institute.
Still, Indonesia’s JET-P deal needs closer to US$2 billion in grant funding, not US$160 million, according to Fabby Tumiwa, executive director of Indonesian think tank Institute for Essential Services Reform (IESR).
Apart from needing money for policy reform and research, it’s needed to deal with unemployment from closing coal plants and coal mines, where 250,000 people are directly hired. Indonesia is the world’s largest coal exporter.
“You cannot create a rate of return on [such initiatives]. They are not profit-making programmes,” Fabby said.
While clean energy projects could pay for themselves by way of future returns, more support is needed because of the pace at which the transition is to happen, he added. Indonesia currently gets under 10 per cent of its power from renewable sources – most of which comes from hydropower and subterranean heat.
The country’s solar and wind industries have been struggling to grow. But under the JET-P deal, the country has to increase the renewables fraction to 34 per cent in seven years’ time.
Existing loan schemes come with sizable interest rates, Fabby noted. For infrastructure projects, domestic banks’ rates are about 9 per cent; the Asian Development Bank’s around 5 per cent. The numbers could climb amid economic headwinds, he said.
The calls for grants in funds meant for climate protection are growing louder too.
A global “loss and damage” fund, to help low-income countries rebuild after climate disasters, has to be “grant-based or [involve] extreme, extreme, extreme concessionality”, including for long-term reconstruction projects, said Mohamed Nasr, lead climate negotiator for COP27 climate summit host Egypt, in June this year.
The loss and damage fund is to be established at the end of the year, but its rules are as yet unclear.
Similar calls are being made for the “New Collective Quantified Goal on Climate Finance”, or NCQG, which would essentially be the follow-up deal to the US$100 billion agreement up till 2020. The NCQG is expected to start from 2025.
“The NCQG should prioritise grants first, then highly concessional finance, over non-concessional loans and equity, potentially by establishing subgoals for the first two desirable categories of instruments,” the Climate Action Network, a global group of civil society organisations, wrote in a feedback paper to the United Nations.
“The new goal won’t be adequate unless it is responsive to the needs of developing countries…indebtedness caused by the over-lending is undermining governments’ ability to address the needs of citizens, actively causing harm to populations,” it said.
Another way to look at grant value is calculating how much savings concessional loans provide recipient countries, compared to commercial borrowing.
Looking at climate finance through this lens, the US$59.5 billion of funding that wealthy nations provided annually in 2017 and 2018, the “grant equivalent” value drops to at most US$22.5 billion once repayments are made, according to charity Oxfam. The US$68.3 billion of public finance in 2020 has a grant equivalent value of US$24.5 billion, Oxfam said.
Such perspectives have led to accusations of bloated finance numbers, and demand for donors to more clearly specify the true value of their climate loans.
Stretching the dollar
The shortage of grant financing means each dollar must be put to good use. In mitigation projects, this means having a clearer picture of how grants can crowd in additional financing – a difficult task in practice, according to Broadstock from the National University of Singapore.
“Grants can be a powerful way to mobilise environmental efforts,” Broadstock said.
But they should be used as a “partial support mechanism” that unlocks potential for capital-constrained investment that may not otherwise materialise due to high risks or long payback periods, he said.
Such crowding in of additional finance with grants appears to still be a work-in-progress. A policy paper published earlier this year by United States-based non-profit Center for Global Development found big differences in co-financing levels across different multilateral environmental funds.
While the Climate Investment Funds could crowd in US$8.90 per dollar of grants with about a quarter of its portfolio being grants, another major financier, the Green Climate Fund, could only achieve US$2.80 with grants making up 40 per cent of its disbursements.
The Global Environment Facility, whose entire portfolio is made up almost entirely of grants, achieves US$9.20 of co-financing per dollar of funding.
“While grants are essential for some purposes, they do not necessarily lead to high co-financing ratios,” the paper concluded.
The risk to avoid, Broadstock said, is having businesses grow reliant on grants, citing how the wind industry in China rose rapidly on domestic subsidies, but shrank once support was lifted.
“[Over-reliance on grants] is a fairly low risk, but still a possible outcome,” he said.
Indonesia has received fewer grants over the years as the country develops, Fabby from IESR noted. This means the nation has to provide more public financing for itself, and look to maximise impact from such expenditures.
“The reality is that free money is becoming scarce,” he said.
Expanding the pool
Experts say generating more public-sector donations could remain challenging, at least in the short run, with countries still grappling with the tail end of Covid-19 and the economic fallout from Russia’s invasion of Ukraine.
Broadstock said he remains optimistic for an uptick.
“In the past few years, we have seen some things that caused us to change our focus. In the past 18 months or so the focus is coming back, [and so] the capital will begin to reallocate,” he said.
As it stands, 37 per cent of bilateral public climate funding is in the form of grants, with the proportion remaining stable between 2016 and 2020, OECD data shows. Major climate finance providers, such as Japan and Germany, still issue out primarily loans.
There is also growing pressure on multilateral development banks – for instance the World Bank, or the Asian Development Bank – to reform their climate funding strategy. Between 2016 and 2020, 7 per cent of climate finance provided by such institutions were grants.
Private philanthropic giving in climate mitigation has been growing, with up to US$12.5 billion disbursed for mitigation efforts in 2021. However, most funding is still focused on North America and Europe, nonprofit ClimateWorks noted.
New financing methods are being explored amid difficulties in scaling up existing funding models. For instance, carbon credits for difficult mitigation projects like coal power phaseout have been likened to a “grant-like tranche” in the capital stack. Meanwhile, debt swaps for environmental protection could help to alleviate developing nations’ existing repayment commitments.
Some, including Barbados prime minister Mia Mottley, are also calling for the use of more “Special Drawing Rights” (SDRs) – a form of global reserves by the International Monetary Fund – in climate financing.
SDRs are not simple grants, requiring a swap into actual currency before they are used. But proponents ask, if US$650 billion worth of the reserves can be issued during the Covid-19 pandemic, why can’t similar efforts be directed towards climate change?
Keen to learn more about the latest trends and developments in the sustainability space? Find out more at Unlocking Capital For Sustainability, our annual flagship event.