(Credit: IMF) By Prasad Ananthakrishnan, Torsten Ehlers, Charlotte Gardes-Landolfini, and Fabio Natalucci Achieving the transition to net-zero emissions by 2050 requires substantial climate mitigation investment in emerging market and developing economies, which currently emit around two-thirds of greenhouse gases. These countries will need about $2 trillion annually by 2030 to reach that ambitious goal, according to the International Energy Agency, with the majority of that funding flowing into the energy industry. This is a fivefold increase from the current $400 billion of climate investments planned over the next seven years. We project that growth in public investment, however, will be limited, and that the private sector will therefore need to make a major contribution toward the large climate investment needs for emerging market and developing economies. The private sector will need to supply about 80 percent of the required investment, and this share rises to 90 percent when China is excluded, as shown in an analytical chapter of our latest Global Financial Stability Report.  While China and other larger emerging economies have the necessary domestic financial resources, many other countries are missing sufficiently developed financial markets that can deliver large amounts of private finance. Attracting international investors also faces hurdles, as most major emerging market economies and almost all developing countries lack the investment-grade credit ratings that institutional investors often require. And few investors have experience in these countries and are able to take the higher risk. Phasing out coal power plants, the single largest source of global greenhouse gas emissions (about 20 percent), is another major challenge. Most of power plants in emerging market and developing economies are still relatively young. Retiring or re-purposing them requires large amounts of private investment and public support. Some countries are highly dependent on coal and would need to develop alternative sources of energy relatively quickly. Beyond these challenges, climate policies and commitments at most major banks are still not aligned with net-zero climate targets, even when they do have policies intended to reduce emissions.  Meanwhile, though a growing number of investment funds prioritize sustainability, this isn’t having much effect on how much money is being provided for large climate needs. Only a small portion of such funds explicitly aim to create a positive climate impact. The much larger number of funds that make investment decisions based on environmental, social, and corporate governance factors don’t necessarily focus on climate issues. They typically consider ESG scores in their portfolio allocations, but these aren’t necessarily designed to reflect climate impact as we show in our latest Global Financial Stability Report. More impact-oriented investment portfolios could be quite different from the popular ESG-oriented ones.  Furthermore, lower-middle-income and low-income countries are generally not rewarded for good environmental and climate policies. Credit rating agencies' assessments of these economies fall short of fully reflecting these countries’ preparedness to a low-carbon transition or their exposure to stranded asset risks because of high level of hydrocarbons. The financial industry still lacks clarity on what constitutes good sovereign performance on environmental issues. A broad mix of policies is needed to create an attractive investment environment and unlock the necessary private climate finance in emerging markets and developing economies. Carbon pricing can provide an important pricing signal for investors, but it faces political hurdles of implementing it on a broad-enough scale. A number of additional financial sector policies are necessary. Structural policies aimed at strengthening macroeconomic fundamentals, deepening capital markets, and improving governance are a fundamental part of the policies mix. They can help improve credit ratings and lower the cost capital. And they can increase the domestic financial resources available in a given country. Investors require better climate-related data to make investment decisions. Innovative financing solutions such as blended finance and securitization instruments should be employed to initiate a managed phase out of coal power production. Policy focus Policies need to refocus on creating climate impact rather than supporting activities that are already “green” and should consider the specific needs of emerging market and developing economies. For example, transition taxonomies should consider activities with a potential for significant improvements in emissions over time and across sectors, including in the most carbon-intensive ones such as steel, cement, chemicals, and heavy transportation. The emission reduction targets and criteria in transition taxonomies can be connected to a country’s nationally determined contributions, long-term strategies, and decarbonization targets for specific industries. The use of sustainability labels is still lax, and regulators and supervisors should set clear rules and tighten enforcement. They should ensure that disclosures and labels for sustainable investment funds effectively enhance market transparency and market integrity, and should ensure a better alignment with climate objectives. Many of the policies we recommend here will take time to implement and achieve their intended effects. Meanwhile, more extensive public–private risk sharing is critical to foster climate private investments in emerging markets and developing economies. Multilateral development banks and donors can play an important role in supporting blended finance – including through a more extensive use of guarantees. The IMF Resilience and Sustainability Facility can help by bringing together governments, multilateral development banks, and the private sector to foster the financing of climate investments. Though this tool’s $40 billion total size is small relative to global climate investment needs, reforms supported by it can help attract more private climate finance. —This blog is based on Chapter 3 of the October 2023 Global Financial Stability Report. Chapter authors are Torsten Ehlers (co-lead), Charlotte Gardes-Landolfini (co-lead), Ekaterina Gratcheva, Shivani Singh, Hamid Tabarraei, and Yanzhe Xiao, with guidance from Prasad Ananthakrishnan and Fabio Natalucci. Markus Brunnermeier was an expert advisor. | (Credit: pidjoe/iStock by Getty Images) By Era Dabla-Norris, Ruud de Mooij, Raphael Lam, and Christine Richmond As the window of opportunity to contain global warming is closing rapidly, many countries are pursuing policies to reduce emissions. Several rely heavily on spending measures, such as increasing public investment and subsidies for renewable energy. These decarbonization efforts are welcome. Yet, in some cases these policies entail large fiscal costs. Climate action presents policymakers with difficult tradeoffs. Relying mostly on spending measures and scaling them up to deliver on climate ambitions will become increasingly costly, possibly raising debt by 45 percent to 50 percent of gross domestic product by midcentury. High debt, rising interest rates, and weaker growth prospects will further make public finances harder to balance. But prolonging “business-as-usual” leaves the world vulnerable to warming. Countries have the option to generate revenue to decrease their debt burden through carbon pricing, but relying on carbon pricing alone may cross a political red line.  Governments thus face a policy trilemma between achieving climate goals, fiscal sustainability, and political feasibility.In other words, pursuing any two of these objectives comes at the cost of partially sacrificing the third. Our latest Fiscal Monitor offers new insights on how to manage this trilemma. Governments must take bold, swift, and coordinated action, and find the optimal mix of both revenue- and spending-based mitigation measures. Smart policies needed While no single measure can fully deliver the climate goals, carbon pricing is necessary but not always sufficent to reduce emissions, as also noted by William Nordhaus and others. It should be an integral part of any policy package. Successful experiences from countries at various stages of development, such as Chile, Singapore, and Sweden, show that political hurdles associated with carbon pricing can be overcome. Insights from their experience stand to benefit not only the nearly 50 advanced and emerging market economies with carbon pricing schemes already in place but also the more than 20 countries contemplating their introduction. But carbon pricing alone is not sufficient and should be complemented by other mitigation instruments to address market failures and promote innovation and deployment of low-carbon technologies. A pragmatic and equitable proposal calls for an international carbon price floor, differentiated across countries at different levels of economic development. The associated carbon revenues could be partly shared across countries to facilitate the green transition. A just transition should also include robust fiscal transfers to vulnerable households, workers, and communities. Fiscal costs vary depending on the mix of revenue and spending policies. Our analysis shows that an appropriate mix and sequencing of revenue- and spending-based climate measures enacted now can limit the fiscal costs of emission reductions, while achieving climate goals. We find that public debt in advanced economies would rise by 10 percent to 15 percent of GDP by 2050 without additional revenue or spending measures, though such estimates are subject to large uncertainty, reflecting country differences in government budgets, size of investment and subsidies, compensation to households, and dependence on fossil fuels. Postponing carbon pricing would be costly, adding 0.8 percent to 2 percent of GDP to public debt for each year of delay.  While the expected rise in debt for emerging market economies from a climate policy package is estimated to be similar to that in advanced economies, the contribution from different revenue and spending measures is notably different. That’s because of larger carbon revenue potential but also higher investment needs and higher borrowing costs that are sensitive to the debt level. Economies with sufficient room in government budgets could accommodate such a policy mix. But such an increase in debt would be particularly challenging for most emerging market and developing countries in light of already high debt and rising interest costs, alongside sizable adaptation needs and aspirations to achieve the sustainable development goals. To navigate these challenges, governments must enhance spending efficiency and build greater capacity for raising tax revenues by broadening the tax base and improving fiscal institutions. Shared responsibility No single country can solve the climate threat alone. Nor can the public sector act by itself. The private sector has to fulfill the bulk of the climate financing needs. The Fiscal Monitor discusses the role of firms in the energy transition. Surveys in both Germany and the United States show that firms were resilient to the 2022 energy price spikes, with limited impact on firms’ production and employment, and in many cases, firms adjusted by reducing energy use and investing in energy efficiency. Policymakers must coordinate their efforts. Emerging market and developing countries face challenges that call for more concessional financing to support the green transition as well as transfers of knowledge and sharing of established low-carbon technologies. For example, the IMF’s Resilience and Sustainability Trust provides long-term financing to strengthen economic resilience and support reforms. Governments should harness the momentum of recent announcements such as the Nairobi Declaration and the participation of the African Union in the Group of Twenty to push forward a practical global deal on an international carbon price floor and support developing countries. | (Credit: Adobe Stock and IMF) By Jorge Alvarez, Mehdi Benatiya Andaloussi, and Martin Stuermer Watch the World Economic Outlook live here. Russia’s invasion of Ukraine in 2022 fragmented major commodity markets. Countries have since restricted trade in commodities, with a more than twofold increase in new policy measures relative to 2021. Commodities, particularly minerals critical for the green transition and some highly traded agricultural goods, are especially vulnerable in the event of more severe geoeconomic fragmentation, as we show in a chapter of our latest World Economic Outlook chapter. Further fragmentation could lead to turmoil in commodity markets, causing large price swings. While long-term global economic losses of about 0.3 percent would remain relatively modest due to offsetting effects in net producing and consuming countries, low-income and other vulnerable countries would bear the brunt. In our illustrative simulations, they could face long-term gross domestic product losses of 1.2. percent on average, largely stemming from disruptions in agricultural imports. For some countries, losses could exceed 2 percent. This would exacerbate food security concerns, as low-income countries are particularly reliant on food imports to feed their population.  These adverse effects are partly due to highly concentrated commodity production, largely a consequence of regional advantages in natural resource endowments. The three largest suppliers of minerals, for example, account for about 70 percent of global mined production on average. Scaling up mining and processing capacity can take years, resulting in slow responses to price signals. At the same time, some commodities like food and energy play a pivotal role in household consumption, while many minerals are key inputs for vital technologies and manufacturing. This combination of concentrated supply and widespread demand leads to extensive commodity trading, with many countries relying heavily on imports from only a handful of suppliers. This makes commodities more vulnerable in the event of trade restrictions.  Our research indicates that fragmentation of global commodity markets into two hypothetical geopolitical blocs, based on the March 2022 United Nations General Assembly vote demanding Russia end its war on Ukraine, could lead to significant price swings. It could also cause wide price differentials across blocs, particularly of minerals critical to the green transition and highly traded agricultural goods. Prices would also be more volatile in a fragmented world. Fragmented markets would offer fewer buffers to absorb future commodity shocks, such as poor harvests or extreme weather. Moreover, even a single commodity producer switching its geopolitical allegiance could trigger significant price fluctuations. Energy transition risk Commodities fragmentation could hinder the global energy transition. To achieve net-zero-carbon emission targets, demand for minerals is set to rise severalfold in the coming years. Meeting this demand requires a rapid scaling up of supply. Since economically viable deposits are concentrated in a few countries, trade becomes essential to guarantee access to these resources. Fragmented markets could complicate matters. In our hypothetical scenario where trade of critical minerals between blocs is disrupted, investment in renewable energy and electric vehicles could be lower by as much as 30 percent by 2030, compared to an unfragmented world. This could lead to slower mitigation of climate change.  Call for multilateral cooperation Our findings present yet another argument for multilateral cooperation on trade policies. If full cooperation remains elusive, pragmatic solutions must be explored to tackle the most pressing challenges: mitigating the risk of food insecurity and supporting the green energy transition. Urgent efforts are required to ensure the unhindered flow of food and minimize the threat of food insecurity in low-income countries, especially given the increasing frequency and intensity of weather events and natural disasters. Similarly, multilateral efforts should prioritize establishing a “green corridor,” consisting of a minimal agreement to maintain the flow of critical minerals. This would help avert climate change. As policymakers work to mitigate fragmentation risks, countries can take proactive steps to minimize the potential economic fallout. Strategies can include diversifying sources of commodities supply, greater investment in mining, exploration, and critical mineral recycling. Countries should also consider broader policies that strengthen resilience to shocks, including: - More robust macroeconomic, structural, and fiscal policy frameworks
- Ample fiscal and financial buffers
- Strengthened safety nets
- Preparation for sudden disruptions of commodity supplies
An international initiative to improve data-sharing and standardization in minerals markets could also reduce market uncertainty. Commodity market fragmentation could create a more unstable global environment, posting threats to food security, economic growth, and the cost of climate change mitigation efforts. Our findings present yet another argument for multilateral cooperation on trade policies to prevent such outcomes. —This blog is based on Chapter 3 of the October 2023 World Economic Outlook, “Fragmentation and Commodity Markets: Vulnerabilities and Risks.” The authors of the chapter are Jorge Alvarez, Mehdi Benatiya Andaloussi, Christopher Evans, Chiara Maggi, Marika Santoro, Alexandre Sollaci and Martin Stuermer, with contributions by Marijn Bolhuis, Jiaqian Chen, Benjamin Kett, Seung Mo Choi, Peter Nagle and Alessandra Sozzi, and under the guidance of Petia Topalova. |
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