With the urgent need for climate action, it has become imperative to mobilize large-scale financial resources for both mitigation and adaptation. Several studies have estimated capital investment needs, particularly for mitigation measures, globally as well as for emerging market and developing economies (EMDEs). However, these estimates vary considerably due to differences in their underlying methodology, objectives, time period and baselines and scope of activities covered. More importantly, all these studies adopt a top-down approach and lack regional detail.
Unlike other studies, this study follows a bottom-up approach to assess climate finance needs due to the transition to a low-carbon economy in addition to the investments required in a business as usual (BAU) scenario. The study focuses on four major carbon emitting sectors namely power, road transport, steel and cement. While most other studies cover the energy sector, there are very few studies covering the steel, cement and road transport sectors.
This study examines three related aspects. First, it examines the climate finance needs of the nine EMEs that constitute the G20 (Argentina, Brazil, China, India, Indonesia, Mexico, Russian Federation, South Africa and Turkey) from 2022 to 2030.(1) No attempt has been made to estimate climate finance needs for the distant future beyond 2030 due to the many risks inherent in making such long-term forecasts due to uncertainty regarding technological and other potential developments. Very long-term estimates of investment and costs are liable to be intrinsically unreliable. All EMEs selected for this study together account for 30% of global gross domestic product (GDP), 47% of global population and 30% of global carbon emissions.
Second, given the important role of multilateral development banks (MDBs) in providing climate finance, this study also assesses the extent to which MDBs may be able to finance climate action in nine selected EMEs by 2030.
Finally, the study examines the capacity of nine EMEs to absorb/manage climate finance flows from external sources other than capital and financial flows (net of current account balances) in a BAU scenario. This is the first study to examine the macroeconomic sustainability of climate finance projections.
The study focuses on assessing the climate finance needs that arise solely due to the need to mitigate climate change across four key carbon emission sectors (power, transport, steel and cement). These four sectors collectively contribute on average about 49% of carbon emissions across the nine economies, and are therefore critical to decarbonizing the global economy.
The study used two different methods for estimating climate finance across four sectors. For the electricity and road transport sectors, climate finance is estimated as the additional capital expenditure (ACE) required to switch from fossil fuel-based sources to renewable energy (electricity) and from internal combustion engine vehicles (ICEVs) to electric vehicles (road transport), which is higher than the planned capital expenditure (capex) in the BAU scenario. Investments in the BAU scenario for these regions are calculated assuming that there will be no efforts to mitigate climate change. For the steel and cement sectors, climate finance has been calculated as the total capital expenditure required to completely reduce carbon emissions in both these sectors, which would arise from existing capacity as well as capacity to be installed by 2030.
climate finance (2) The need for the nine economies for all four sectors is estimated to be $2.2 trillion ($255 billion annually), driven mainly by the steel sector ($1.2 trillion or 51% of the total), followed by road transport ($459 billion or 21%), cement ($453 billion or 21%), and power ($149 billion or 7%). The need for climate finance as a percentage of GDP averages 0.6%. Thus, contrary to the common narrative, transforming the power sector from fossil fuel-based sources to renewables does not require large climate finance. 60% of the estimated climate finance need is attributable to China. Excluding China, the climate finance need for eight other economies stands at $854 billion ($100 billion annually or 0.5% of their GDP).
Mitigation is difficult for the steel and cement sectors as these sectors have limited options other than carbon capture and storage (CCS) to reduce carbon dioxide (CO2) emissions released during the production process. This is expensive but is the only viable technology to implement at this stage. Therefore, the steel and cement sectors require the largest share of projected climate finance. The road transport sector also needs significant climate finance. However, most of the capital expenditure in the road transport sector is required to develop charging infrastructure rather than transition from ICEVs to EVs. The power sector needs the least climate finance compared to other sectors in the study because the unit capital cost for solar and wind power plants has fallen to such an extent that it is now less than the cost required to install fossil fuel-based sources of energy.
The study also assesses the potential carbon emissions reductions that could be achieved through the climate-related investments estimated in the study. Climate investment projections for nine EMEs for three regions (3) (Power, Steel and Cement) has the potential to reduce 33 billion tonnes of CO2. The average cost of reducing one ton of CO2 (tCO2) is estimated at $53. In terms of per unit cost, the power sector has been found to be the most expensive for decarbonizing at a cost of $66 per tCO2, followed by steel at $53 per tCO2 and cement at $49 per tCO2. These projections depend on current market technologies and any future technological advances have the potential to significantly reduce the climate finance requirement for the steel and cement sectors.
In 2022, climate finance provided by MDBs to all countries was 36% of their total annual loan book. The share of climate finance provided by MDBs to the nine EMEs included in this study in their total climate finance portfolio was 16% in 2022. The global climate finance portfolio of MDBs is projected to grow at a compound annual growth rate (CAGR) of 14%, from $74 billion in 2022 to $215 billion in 2030. Over the same period, climate finance for the nine EMEs included in the study is expected to grow by $. 12 billion to 34 billion dollars. At this stage, climate finance by the MDBs is estimated to cover only 7-9% of the estimated climate finance need of the nine economies. The situation improves somewhat when China is excluded, increasing the share of climate finance by MDBs to 15–25% of the total climate finance requirement of the eight other economies. MDBs finance a range of activities such as health, education, transport, agriculture, water and waste management and urban infrastructure. Since the cement and steel sectors in most economies are largely private sector, which MDBs do not typically finance, they need to treat decarbonization of the cement and steel sectors as a public good for financing purposes. The International Finance Corporation (IFC), part of the World Bank Group, finances the private sector in any case.
A macro-economic stability analysis suggests that both (i) managing external financial flows will be a challenge; and (ii) projected climate finance for most of the nine economies flows from external sources. External financial flows (capital and financial flows net of current account balance) to the nine economies are estimated to be $2.7 trillion ($1.1 trillion excluding China) during 2023–2030 in the BAU scenario. However, the monetary base (M0) for the nine economies is projected to expand by $3.1 trillion ($1.2 trillion excluding China) for the period 2023–2030. This leaves only a small scope of $423 billion ($37 billion excluding China) to absorb climate finance from external sources. At the economy level, while Turkey can easily absorb external financial flows and projected climate finance flows, three other economies (China, Mexico and Russia) have some room to manage climate finance flows in addition to external financial flows in the BAU. All other EMEs will need to efficiently manage both external financial flows and climate finance from external sources in a BAU scenario.
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This paper is written by Janak Raj, Senior Fellow and Rakesh Mohan, Chairman Emeritus and Distinguished Fellow, CSEP, New Delhi.
