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Our November monthly round-up focuses on all things climate finance following COP27 in Egypt earlier this month.
Taking place against a backdrop of multiple crises, COP27 left no stone unturned, addressing finance for just energy transitions, urban transitions, adaptation and even the highly divisive issue of high-income countries ‘compensating’ climate-vulnerable countries for climate-induced loss and damage. For most finance ministries, one or more of these topics is increasingly on their radar given that impacts and responses to climate change are already having implications for public finances at a time when many countries are experiencing significant budgeting pressures.
The BBC has a useful round-up of the results of the negotiations, covering loss and damage, the phasing out of fossil fuels, the fate of the 1.5⁰C target and the large presence of the oil and gas industry. This article in Climate Home provides a more detailed update, including on the ‘Bridgetown agenda’ for reforms to the international financial system proposed by the Prime Minister of Barbados, Mia Mottley. Our colleague Sarah Colenbrander provides a pithy summary of the successes and failures.
We start off with an overview of climate finance, including the steps forward on ‘loss and damage’ financing seen at COP27. We will then focus on how this can be managed through domestic PFM systems.
Providing and mobilising climate finance for developing countries
The Copenhagen Accord in 2009 and its successors commit developed countries to collectively deliver $100 billion of climate finance each year between 2020 and 2025 to help developing countries meet their climate change commitments. Given the symbolic importance of this goal as a means of recognising unequal historic responsibilities for rising global temperatures, there is growing anger towards developed countries, particularly the US, Australia and Canada, for not paying their fair share.
Several major reports were published just ahead of COP27 in November, taking stock of the opportunities and challenges for scaling up climate finance. The Independent High-Level Expert Group on Climate Finance, convened at the request of the Egyptian Presidency of COP27 and the UK Presidency of COP26 and co-chaired by Dr Vera Songwe and Professor Lord Nicholas Stern, surveys the field of finance for climate action. They estimate that meeting the Paris Agreement target of capping global warming at 1.5⁰C will require $1 trillion per year of external finance by 2030 for emerging markets and developing countries (EMDCs) other than China. The report sets out how international action can move forward based on four key pillars: strategy for investment; the rapid scale-up of MDBs and DFIs; new partnerships between the private sector, countries, and IFIs; and concessional and innovative forms of finance.
A core theme of this report is the need to make the most of different financial instruments (debt, equity investments, guarantees and insurance). This IMF paper provides a useful summary of the opportunities and challenges associated with these instruments for sub-Saharan Africa. A new ODI paper emphasises the need to understand the context and constraints that these instruments operate in, focusing on the extent to which each instrument can be designed to uphold the principles of equity and climate justice.
Although equity is articulated in the UNFCCC and the Paris Agreement, its implementation is fraught with difficulties. For example, many developing countries cannot efficiently access UNFCCC multilateral climate funds despite improving the ease of access being a longstanding objective. As well as highlighting challenges in the provision of and access to climate finance, this ODI report identifies several good practices pioneered by the Adaptation Fund (AF), the Green Climate Fund (GCF) and the Global Environment Facility (GEF). One such practice includes climate finance readiness programmes, which support countries in planning for, accessing, delivering and monitoring climate finance. At a time when trust in international climate finance is eroded, improving access to UNFCCC funds is essential to making the system more equitable and just.
Agreement on a Loss and Damage fund is a massive breakthrough at COP27
Numerous climate-vulnerable countries, especially small island development states and least developed countries, have stressed the need to address climate-induced loss and damage since the first UN agreement on climate change was drafted at Rio de Janeiro thirty years ago. Despite this concern being sidelined for decades, it finally earned a place in the formal agenda of COP27 negotiations. With leadership from the EU, the agreement by developed countries to establish a Loss and Damage fund (LDF) is testament to the consistency and persistence of developing countries.
However, the fund comes with many unknowns. A ‘transitional committee’ was established to work out the details of the modalities to operationalise the LDF and identify where funds will come from. The committee will report at COP28 next year. Fortunately, it will not need to start from scratch with several existing proposals identifying practical ways forward.
Drawing on lessons from the provision of climate finance, aid effectiveness and humanitarian assistance, ODI researchers contributed to a publication that outlines how finance for loss and damage can be operationalised. A key finding is that loss and damage finance should be provided in a phased manner that places the needs and priorities of vulnerable communities at the centre. This includes giving those communities significant autonomy and decision-making power over how finance is utilised in line with their needs. Small grants and unconditional cash transfers, as opposed to loans or project-based finance, are also likely to be more accessible for recipients and more successful in reaching affected communities.
Making just energy transitions a reality
While international finance is of course necessary to support mitigation and adaptation to climate change, domestic decisions will ultimately influence a country’s trajectory. We first cover the programmes that support large middle-income countries transition away from fossil fuels, and then move on to more general guidance for ‘climate-proofing’ PFM systems.
At last year’s COP26 in Glasgow, South Africa’s Just Energy Transition Partnership (JETP) was one of the most significant achievements. The logic behind the JETP is that developed countries will provide programmatic support to middle-income countries to pursue low-carbon, climate-resilient development. In South Africa’s case, this amounted to $8.5 billion to help it decarbonise its failing power sector, which has been a drain on both the economy and the national budget while producing some of the most carbon-intensive electricity in the world due to its reliance on coal. President Ramaphosa of South Africa unveiled the new JET Investment Plan at COP27. The plan covers three priority sectors: energy, electric vehicles and green hydrogen. The fact that grants account for roughly 4% of the total financing package has been a source of contention, though it should not be a deal-breaker.
The Financial Times has published an excellent long read on how South Africa’s JET can get off the ground, emphasising the political challenges of transitioning from a large coal industry focused in one part of the country (Mpumalanga in the north-east) to renewable energy sources that are likely to be located elsewhere. Related to this, a recent AFD paper looks at the role that social protection policy can play in achieving a just transition in South Africa.
Similarly, if Nigeria is to transition from its reliance on the production of fossil fuels and high levels of government subsidies for their consumption, a credible programme to rebuild the broken social contract is needed whereby the government can meet its promises to deliver on social and development priorities while in parallel carefully removing fuel subsidies.
Despite expectations that new JETPs for other emerging economies would be announced at COP27, only Indonesia announced a similar $20 billion partnership at the G20 Summit happening in parallel in Bali. Instead, COP27 created a Just Transition Work Programme and annual ministerial roundtable as part of this process. A new ODI working paper draws out the lessons for JETPs from development cooperation.
The World Bank has launched a new diagnostic tool, the Country Climate and Development Report (CCDR), to help countries align their development and climate objectives. Based on its application in 24 countries, the Bank concludes that in most countries, low-carbon development pathways require challenging policy reforms, the reallocation of scarce public resources, increased mobilisation of private capital and greater financial support from the international community.
Towards climate-ready PFM systems
OECD authors provide useful guidance on how climate and environmental objectives can be incorporated into budgeting in Green budgeting: a way forward. The paper outlines seven areas where budget offices should develop green budgeting practices, and usefully sets out how climate and environmental issues can be incorporated across four building blocks of the budgeting process: institutional frameworks (e.g. laws, policies and governance), budgetary tools (e.g. macro-fiscal projections, budget classifications and appraisal), transparency and accountability arrangements, and the enabling environment for budgeting in the public sector.
For many low- and middle-income countries that already have low carbon emissions, adapting to climate change is as much of a priority as mitigating it. Unfortunately, adapting to climate change will mean being better prepared for an increasing number of natural disasters. Responding to these disasters places extreme pressure on PFM systems and will worsen existing fiscal challenges: the UNDP’s debt report that we covered last month pointed out that the 54 low- and middle-income countries with the most severe debt problems include 28 of the world’s 50 most climate-vulnerable countries.
We have learnt lessons about responding to disasters from the Covid-19 pandemic. When countries do not have adequate disaster financing and crisis-ready PFM systems in place, they are forced to make hasty reallocation decisions, threatening the achievement of national development goals. Accountability is also likely to suffer if countries respond outside the PFM system by using tools such as extrabudgetary funds. The World Bank’s recently updated Disaster Resilient and Responsive PFM assessment tool can provide countries with invaluable insight into which elements of their PFM systems need to be strengthened now to respond effectively to future crises. The PEFA Secretariat’s 2022 Global Report on Public Financial Management provides a comprehensive discussion on how countries can best respond to crises from a PFM perspective.