How the IMF Can Help Facilitate Green, Just Transitions Around the World

By Rishikesh Ram Bhandary

In July of 2021, the International Monetary Fund (IMF) released a draft of its climate change strategy, a substantial step towards incorporating and preparing for the inevitable impacts of climate change. As the Fund bears the mandate to safeguard the international monetary and financial system, it has a central role to play in ushering in just transitions to climate-resilient economies around the world.

As such, the newly launched Task Force on Climate, Development and the International Monetary Fund – a consortium of experts from eight institutions around the world – released a strategy report outlining three key elements and five principles to guide the integration of climate change into the IMF’s work.

The Context

Climate risks already shape the IMF’s operating environment. As the Intergovernmental Panel on Climate Change (IPCC)’s most recent report underscored, the world has locked in 1.5°C of warming, and the consequences are already severe. Climate impacts will also disproportionately affect emerging market and developing countries, though their contribution to climate change has been minimal in comparison to major economies. Their high vulnerability is further compounded by the major shortfall in finance available for adapting to climate impacts. Public finance to reduce greenhouse gas emissions has outpaced finance to tackle climate impacts by a ratio of four to one.

Furthermore, as countries implement policies to steer investments away from carbon-intensive sectors into low-carbon ones, they risk leaving entire sectors, workers and communities behind, unless the transition is done in a fiscally sound way. Countries have long depended on a fossil-fuel based economy, leaving public investments and people deeply tied to the health of that industry. These transition risks can also emanate across borders, as countries implement their own policies to tackle climate change – with ramifications for other economies. For example, planes leave a massive carbon footprint with each flight, and a resultant tax on aviation fuels would increase the cost of flights. If people stop flying as frequently, countries that depend on tourism may see impacts to their economies.

As the only multilateral organization charged with maintaining the international financial and monetary system, the IMF is uniquely suited to both identify and address the physical, transition and cross-border spillover risks that climate change poses – insight made even more important in the absence of strong global coordination on climate policy.

While there has been a flurry of activity involving national-level actors, such as the Network for Greening the Financial System which brings together central bankers, or others that have developed taxonomies of green investments, no multilateral body has the mandate, nor the in-house capabilities to help countries mobilize the investments necessary to tackle climate change while addressing climate risks. As such the Task Force’s strategy report proposes three key elements for a climate strategy at the IMF:

• Multilateral surveillance and global leadership
• Bilateral surveillance and capacity building
• A climate-aligned finance toolkit

Multilateral surveillance and global leadership

One of the most important roles that the IMF can play in helping address climate change is in the identification and monitoring climate risks. Through its multilateral surveillance activities, the IMF already focuses on major and emerging macro-critical risks. It is imperative for the Fund’s surveillance activities to include the entire spectrum of risks identified above – transition, cross-border spillover and physical. Countries need to understand how their inaction on climate change may affect their economies, with their policy choices having ripple effects around the globe. For example, the European Union is actively considering using a carbon border adjustment measure. This carbon tax will impact the exports of countries that produce carbon-intensive products, thereby affecting the health of their balance of payments. The IMF’s core surveillance functions will need granularity to equip countries to collectively anticipate, mitigate and adjust to these global spillovers in a just manner.

The IMF could also play a strong role in global policy coordination, most especially in urging developed countries to follow-through on climate finance promises and providing key analytic input in international forums, like the G-20.

Bilateral surveillance and capacity building

Beyond the multilateral stage, the IMF will need to incorporate climate risks into its work directly with member states. These bilateral surveillance activities, most notably Article IV and Financial Sector Assessment Programs (FSAPs), are the most suitable entry points. The IMF can play a major role in helping countries understand the alignment of their public expenditure with their climate goals. Likewise, identifying and addressing the most relevant physical risks will be important. Surveillance will have to take into account the unique circumstances of IMF members, understanding that the needs of countries in the Caribbean, for example, are far different from those in Central Africa.

Identifying these risks and devising response strategies will require high-quality data, and as such, capacity development for well-trained staff to work on climate change will be critical. The IMF’s draft climate strategy proposes adding 95 full-time equivalents; this staff should both reflect the diversity of the IMF’s membership, as well as help build national-level capacity in governments that need it.

Climate-aligned finance toolkit

The IMF’s lending programs will need to be refreshed to meaningfully address climate change and its multitude of impacts. This notably includes identifying and mobilizing the necessary resources for adaptation and climate resilience efforts, so countries can focus on building capacity instead of exclusively responding to extreme weather.

Critically, the IMF has an opportunity to learn from past experiences, including rethinking its default approach of prescribing onerous conditionalities. Investments in nationally driven, social safety needs will be critical to ensure that both the costs of transitioning to a greener economy are covered and vulnerable communities are supported. Furthermore, the IMF’s lending instruments need to reflect the short-term and longer-term needs of member states.

The strategy report also identifies five principles to guide and underpin the previously mentioned elements of the IMF’s climate strategy:

• Adopt the global role in addressing the macroeconomic implications of climate risk, climate action and asymmetries.
• Align short-term stability concerns with longer-term sustainable and resilient growth pathways.
• Tailor policy advice to national circumstances.
• Empower national and stakeholder ownership of policy.
• Reconcile shared climate goals with equity and appropriate burden sharing.

In sum, the authors emphasize that the IMF’s climate strategy must be balanced in addressing the asymmetries of the principal climate change contributors and those bearing the consequences. The IMF’s current decision-making structure, based on quotas, currently reinforces these imbalances. Any climate policy at the IMF will need equity as a cornerstone of its strategy.

This inaugural strategy report of the Task Force on Climate, Development and the IMF, sets the framework within which the Task Force will be working over the next 18 months. It will engage in rigorous, empirical research and policy discussions to further the international community’s collective understanding of the role of the IMF in addressing climate change in a manner that is inclusive and just.

To learn more, visit the homepage of the Task Force on Climate, Development and the International Monetary Fund.