IEA (2021), Financing clean energy transitions in emerging and developing economies, IEA, Paris https://www.iea.org/reports/financing-clean-energy-transitions-in-emerging-and-developing-economies, Licence: CC BY 4.0
The cost and availability of capital for investing in clean energy transitions is a crucial aspect of the ability of EMDEs to meet sustainable development goals. Although EMDEs account for around 40% of energy investments and emissions reductions under IEA climate-driven scenarios, they currently hold only 10% of global financial wealth. Improving the domestic ecosystem for investing in clean energy, while addressing risks and barriers that shape access to foreign capital, will be critical.
Energy investments in EMDEs today rely heavily on public sources of finance. However, in IEA climate scenarios over 70% of clean-energy investments - mostly renewables and efficiency - are privately financed. Public actors, including SOEs, are key for grids and transitions for emissions-intensive sectors. The catalytic role of development finance institutions, through blended finance, will be critical to attract capital to markets and sectors at early stages of readiness, or with hard-to-mitigate risks.
While clean energy transitions rely on much higher levels of both equity and debt, the capital structure of investments is likely to move towards more debt. This stems from the shift from investment in fuels to the electricity and end-use sectors, as well as the higher fixed element in the cost and revenue structure of the underlying assets. While most energy investments are funded from company and consumer balance sheets, off-balance sheet financing structures, which typically involve higher degrees of leverage, play an increasingly important role in extending the capacity of developers to fund clean energy projects under IEA climate-driven scenarios.
Mobilising clean energy investment will depend on enhancing finance from local sources as well as international providers. Foreign capital is likely to increase the most in directly financing renewable power. While consumer-based investments, as in end-use and efficiency, and those more reliant on SOEs, as in fuel supply and electricity grids, rely heavily on domestic capital, the importance of foreign sources of capital in funding projects, companies and financial intermediaries rises in these areas as well.
While global capital is abundant, attracting finance hinges on addressing cross-cutting factors that hinder investments in EMDEs. The economy-wide cost of capital is higher in EMDEs than advanced economies. Economy-wide nominal financing costs in EMDEs range some 700 to 1 500 basis points - up to seven times - above values for the United States and Europe, with higher levels in riskier segments. This points to relatively high bar for investments in accessing debt finance and meeting equity return hurdle rates.
EMDEs face heightened macroeconomic risks and domestic capital constraints. Over 90% of EMDE investment needs are in countries with underdeveloped banking and capital markets. Debt burdens are on the rise in a number of economies, and EMDEs have not sufficiently mobilised resources for sustainable recovery. Domestic savings are unevenly distributed across regions, while currency risks and restrictions on direct investment can dissuade foreign investors, especially in developing economies.
Today’s policy settings in EMDEs do not provide a trajectory for emissions reductions or access to energy that achieves sustainable development goals. Actions to unlock higher levels of long-term local currency debt, and equity for riskier projects, develop and enhance learning for financial intermediaries, channel institutional capital – including through public funds – and develop international partnerships are critical.
Cross-cutting investment issues can be better addressed through policy predictability, setting clear and ambitious clean energy strategies and good governance. Getting price signals right and addressing contractual, licencing and land acquisition issues are key for jump-starting projects. Enhancing the financial performance of SOEs, empowering new businesses and SMEs, and aligning strategies with transition pathways is critical. EMDEs have an opportunity to integrate sustainability in financial systems with clear taxonomies and rules for disclosure and risk assessment.
Stronger international efforts are also needed. Realising the commitment by advanced economies to mobilise $100 billion per year in climate finance is a critical starting point. The COP26 is an opportunity to boost the catalytic role of public finance with stronger mandates and boosting and improved delivery of international climate finance. Aligning capital markets with net zero goals risks excluding EMDEs with higher-carbon footprints or sectors with more challenging transition pathways. Initiatives could better target EMDEs and sustainable development more widely.