Transformation Towards Renewable Energy Systems: Evaluating the Role of Development Financing Institutions

By 2030, global emissions of greenhouse gasses (GHGs) must drop by 45 percent from 2010 levels to stay on a 1.5° path, while the cost of inaction could be as high as 4 percent of US growth domestic product. 

For the world to meet the decarbonization and climate mitigation goals set out in the Paris Agreement, renewable energy must be scaled up at least six times. According to the International Renewable Energy Association (IRENA), keeping the global temperature increase below 2 °C is feasible if the total share of renewable energy rises from around 18 percent of total final energy consumption (in 2015) to around two-thirds by 2050.

In a new journal article published in Studies in Comparative International Development, Jiajun Xu and Kevin P. Gallagher evaluate the role of development financing institutions (DFIs) in fostering renewable energy transformations. Going beyond the conventional approach of assessing the bankability of individual projects, they identify four constraints: the incumbent entrenchment of fossil fuels, unmet energy demand of energy-intensive industries, weak production capacity of renewable energies and lack of supporting infrastructure. Xu and Gallagher argue that DFIs can potentially address these constraints by setting a mission-driven vision, acting as honest brokers to overcome the incumbent entrenchment, scaling up renewable energy financing to make the cost of renewable energies more competitive, incubating nascent renewable energies and financing supporting infrastructure. 

Main findings: 

• Renewable energy transformation is key to achieving the Paris Agreement on climate change. DFIs must tackle system-level constraints to enable a rapid and substantial deployment of renewable energies in the national energy system.
• Most DFIs have recently prioritized financing renewable energy to align their strategies with the Paris Agreement. However, only a few DFIs can reach economies of scale to bring down the price of renewable energies.
• Using policy dialogues with national governments, multilateral development banks (MDBs) are better able to shape policy environments in favor of renewable energies.
• DFIs help to incubate nascent renewable energy technologies by making the first-of-the-kind investments to overcome the first-mover challenge.
• MDBs have tried to provide cheap loans denominated in local currencies to enable developing countries to import renewable energy technologies abroad, though limited in scale.
• DFIs have made investments in complementary infrastructure to facilitate the deployment of renewable energies in national grids.

In the future, Xu and Gallagher suggest DFIs will need to make more comprehensive investment plans to alter the energy mix toward cleaner energy. They say DFIs should take a system-level transformative approach to ensure that complementary infrastructure is in place and provide the local currency-denominated financing to help less developed countries tackle balance-of-payment problems.