How a Well-Designed Resilience and Sustainability Trust Could Foster Climate-Resilient Economies
The International Monetary Fund (IMF) recently approved a global allocation of $650 billion in Special Drawing Rights (SDRs) to support global liquidity, address the ongoing COVID-19 pandemic and foster resilience of the global economy.
While a substantial step in the right direction, the allocation falls short on two main fronts. First, due to the IMF’s quota structure, the allocation will primarily flow to high and some middle-income countries that do not face the immediate liquidity challenges for which SDRs would be most helpful. The G7 has since announced a reallocation of $100 billion in SDRs to support countries are facing these constraints, but this ignores the other main shortcoming: the amount pledged cannot meet the real cost of financing recoveries from COVID-19, building climate-resilient economies and more.
One of the proposed uses of the reallocation is a Resilience and Sustainability Trust (RST) at the IMF, through which sustained re-channeling of new SDR issuances could form an essential part of the climate and development finance landscape in emerging market and developing countries. A new policy brief by the newly established Task Force on Climate, Development and the International Monetary Fund identifies possible objectives and modalities to support climate change efforts through a well-designed RST.
Providing ample capacity for countries to respond to climate shocks
There is a gap in the international climate finance architecture when it comes to helping countries overcome the economic and financial impacts of climate change. Indeed, there is no multilaterally-backed institution to provide assistance to countries responding to immediate climate shocks. The RST housed at the IMF could fill this critical gap.
To be effective, the RST should be designed to address the entire range of climate shocks. Increasingly severe weather events, like hurricanes, threaten a country’s productive assets, ecosystems, health and human life. The economic ramifications of these climate impacts can be enormous, inducing short-term financial instability and damaging a country’s economic health more broadly.
Along with climate shocks, the RST must also address shocks induced by two other climate risks: cross-border spillovers and domestic transition risks. In implementing climate policies, countries may have unintended, cross-border impacts that can be a significant source of concern for economies that have long relied on fossil fuels and fossil fuel exports.
Likewise, countries will face economic challenges at home as they implement ambitious climate policies. For example, a government that has depended on revenue garnered by taxing fossil fuels may find itself under tight fiscal constraints once it implements a carbon tax and production and consumption is shifted to non-carbon intensive options.
An RST would help facilitate country transitions to green, resilient economies by providing the vast financial support needed to do it without leaving entire communities behind in the process.
Catalyzing low-cost financing, resilience and adaptation strategies
Vulnerable countries need access to finance to not only address the consequences of climate change but to build resilient, sustainable economies for the future. However, public finance for adaptation trails public finance for reducing greenhouse gas emissions by a ratio of four to one. While the Paris Agreement called for greater balance in the kind of finance provided, data continue to show a persistent lag in supporting adaptation measures compared to mitigation. Moreover, developed countries have still not met their standing commitment to help mobilize $100 billion in climate finance for developing countries by 2020.
Any substantial financing efforts through an RST must also be affordable. Recent research shows that climate vulnerability has, on average, increased the cost of debt by 0.63 percent over the course of 1991 to 2017. In other words, not only is there insufficient public finance flowing to these countries, funds available through non-concessional windows are also getting more expensive. Should an RST not build in these features, countries may not use it for fear of a growing debt overhang.
Mobilizing longer-term financing for just transitions
Without access to affordable, long-term finance, embarking on a just transition for vulnerable countries will be all the more challenging.
Emerging markets and developing countries face enormous investment needs and rising capital costs to make rapid and just transitions away from fossil fuel combustion and production dependence. Private capital markets are reluctant to make such a major investment in structural transformation. Development finance institutions and national governments are required to make massive public investments that crowd in the private sector to fill the gap. What is more, public finance is needed to cover the adjustment costs of a transition so that the communities, workers and contracts behind stranded fossil fuel assets are not left behind, but can instead benefit from new engines of green and inclusive growth.
An RST would be critical in assuring the market access or fiscal space is accessible and affordable in the scale necessary to jumpstart just, green transitions.
How to make an RST work
Reflecting on these objectives, the RST would need two modalities:
- Short-term financing for responding to climate shocks
- Longer-term financing for capacity-building, resilience, adaptation and just transitions
Short-term financing will help countries address climate risks that threaten economic and financial stability. Given the large financial protection gap faced by the most vulnerable countries, it is imperative that the RST’s modalities provide affordable and concessional rates to countries. Likewise, short-term financing through the RST could also be coupled with debt-for-climate swap agreements. Often, countries facing balance of payment issues will also have debt challenges. Therefore, the RST’s concessional finance could form an important part of an overall package that helps countries tide through short-term imbalances, while not saddling them with more unaffordable debt.
Countries also need access to longer-term financing instruments, and these instruments should have longer maturity periods, in the range of 15 to 20 years. These long-term loans would help to build capacity and mobilize finance for climate resilience and adaptation and enable countries to implement programs to help transition out of fossil fuel-based growth into the low carbon economy. Longer-term loans could take two forms:
- Policy loans for economy-wide green structural transformation and capacity building
- Project finance at affordable terms for specific resilience, adaptation and decarbonization projects
Policy loans would help to support the implementation of economy-wide efforts to build climate resilience and embark on a just transition. For example, building social safety nets to support the just transition process will be key. Project finance can help to increase the affordability for member-driven proposals and entice the private sector. The IMF could partner with multilateral development banks and other relevant entities to implement project finance loans.
Designing an inclusive and sustainable RST
The policy brief also highlights the importance of universal eligibility. The IMF’s income-based criteria needs to be broadened to recognize that many countries who are not eligible for concessional finance also need support. For example, Caribbean countries may have higher national income levels, but their immense exposure to the impacts of climate change make them vulnerable to severe economic crises. When Hurricane Maria hit Dominica, the country lost 226 percent of its annual GDP. Therefore, eligibility needs to reflect the principle of universal access.
Tackling the climate crisis requires resources an order of magnitude greater than what is currently being discussed. While the G7’s donated $100 billion in SDRs is a step forward, developing countries will require significantly higher resources to make the transition to a low carbon, climate resilient economy. Therefore, the RST will need to receive regular re-allocations and contributions from countries.
If designed to reflect the objectives outlined above and equipped with the appropriate modalities, the IMF’s RST has an opportunity make a step change in support of developing countries tackling the climate crisis.Read the Policy Brief
Visit the homepage of the Task Force on Climate Development and the IMF to learn more.