Banking on Climate Finance for Latin America

Kevin Gallagher

Latin American and Caribbean (LAC) countries arrived in Paris with ambitious national commitments to combat climate change.  Mexico promises to reduce peak emissions even before China’s landmark commitment; Chile has said it will introduce a carbon tax; Brazil has put forth a strategic plan on reducing emissions and deforestation; and Caribbean nations have come with a dire message, reminding the world that their livelihoods are at stake if the world sticks with more business-as-usual, as the Caribbean continues to be subject to ever increasing sea-level rise, flooding, and extreme weather events.

But these promises and plans won’t come cheap. LAC governments will need to make significant financial investments to meet their climate change commitments.  According to the Inter-American Development Bank, the region faces a $100 billion annual gap in financing for climate change mitigation and adaptation.

At the same time, though, the region also faces a serious economic downturn, with growth projected to be 0.3-0.5 percent for 2015, and only slightly better for the foreseeable future.  National budgets are strained, and the private sector is reluctant to move into climate-friendly investments.

Low-carbon investments require high up-front costs, though they are among the cheapest to operate in the long term.  In a world where financial markets are still geared almost exclusively toward short-term profits, the private sector has been anemic when it comes to climate-friendly investment in the region.  This is not only due to the longer-term structure of cost and benefit flows, but also due to the fact that prices for green technologies are comparatively expensive, especially given the high amount of fossil fuel subsidies and the (ill) perceived risk of investing in new technology.

Development banks—national, sub-regional, and multilateral—are uniquely poised to play a catalytic role in spurring finance for low carbon transitions. Development banks, at their best, can structure finance to spur long term investment and bring the private sector into low carbon growth projects.  They do this by providing financing with longer maturities, tapping climate funds to measure and mitigate negative externalities such as the price of carbon emissions, and by providing a stamp of approval to ease credit risk of investors. Moreover, they can conduct rigorous social and environmental risk analyses that would help investors more accurately understand (and price) the risks associated with major projects.

Unfortunately the development banks operating in LAC countries are falling far short in transforming the region’s economies toward a low carbon future.  According to my new report with Fei Yuan titled Greening Development Finance in the Americas, the majority of development bank finance in LAC flows into projects that will lock Latin America onto to a high carbon growth path.  The majority of projects are in extractive industries, fossil fuels, and big infrastructure projects.

The State of Green Financing

In contrast, climate finance by the eleven major development banks in LAC countries has reached a combined $5.9 billion per year since 2007—far short of the necessary $100 billion needed in the region but a promising base to build on.  The Inter-American Development Bank is investing in solar power plants in Chile and off-grid solar power projects in rural Ecuador.  The KfW, Germany’s development bank, is investing in wind power in Brazil, and the Export-Import Bank of China is financing metro lines in Buenos Aires.

Many development banks, including the China Development Bank, the World Bank, the CAF-Development Bank of Latin America and others, are investing in large-scale hydropower projects. In many cases hydropower is a low carbon solution that can help expand energy access to the poor. However, in Latin America this is less often the case; hydropower projects in the Amazon oftencreate significant methane emissions when water is released from turbines and trigger the building of roads that cause deforestation and increase emissions.

To be truly sustainable, low-carbon investments, and all large-scale projects for that matter, need to be socially inclusive. Development banks have a trickier record here. Some development banks—such as the World Bank—have stringent environmental and social safeguards that attempt to conduct environmental impact assessments and engage with local communities. Others, such as the China Development Bank, defer to host-country rules and regulations.

Both approaches to social inclusion have been rife with concern and controversy. World Bank environmental safeguards are often seen as onerous and time consuming by host governments, while civil society organizations still point to countless breaches of human rights and environmental integrity by the World Bank. On the other end of the spectrum, simply deferring to host countries has proven to be risky as well. The controversial Belo Monte hydroelectric plant in Brazil, financed in part by Brazil’s national development bank and a big Chinese energy company, attracts frequent environmental and indigenous protesters and is proving costly: it may cost the project $1.4 million per day of protest and delay.

For Latin America to meet its climate change and sustainability goals it will need to scale up development bank finance for low carbon growth and safeguard all projects in a more socially inclusive manner. Development banks will need more capital, and to leverage the capital they do have in a manner that brings in significant private sector finance. In addition, they will need to re-evaluate the way they engage with local communities in order to strike a balance between inclusiveness and efficiency.

In so doing, the region will not only move closer to a more environmentally sustainable growth path, but it may help to get out of the immediate economic doldrums the region faces.

Originally published by Latin America Goes Global.

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