The Problem With Climate Finance Targets

Goodhart’s Law tells us that “when a measure becomes a target, it ceases to be a good measure.” The disagreements climate diplomats were having last week highlight why.

Last week, climate negotiators sparred in Bonn, Germany, over a New Collective Quantified Goal on climate finance. The NCQG, as it’s labeled, is a new target for how much money governments must mobilize to meet global climate investment needs consistent with goals set down in the United Nations’ landmark 2015 Paris Agreement. Reaching a consensus on the NCQG is the biggest item on negotiators’ plates between Bonn and COP29, the annual United Nations-led conference on climate change, happening this fall in Baku, Azerbaijan. But, true to Goodhart, the global climate targets negotiators are deadlocked over are not good measurements of progress, let alone ones that developed countries measured up to.

In 2009, at COP15 in Copenhagen, developed countries set a goal of mobilizing $100 billion annually for climate investments in developing countries by 2020. In 2015, as part of the Paris Agreement, the world’s climate diplomats agreed to set an updated goal — the NCQG — before 2025. In the interim, developed countries achieved their original goal, although years later than planned and amidst allegations that some of their grants and loans were merely existing sources of development financing dressed up as climate finance. That there is no fixed definition of the term “climate finance” makes the $100 billion target doubly fuzzy: Upon closer inspection, some spending classified as climate finance doesn’t really seem like it should count, while other spending seems to have circled back to donor country governments, consultants, and nonprofits.

Despite these measurement issues, negotiators at Bonn pressed for an ambitious updated target. There was consensus that the NCQG could not be less than $100 billion annually — but that is where agreement ended. While negotiators from developing countries ― particularly those from African and Asian governments ― called for an NCQG as high as $1.4 trillion annually over the next five years, developed country negotiators refused to commit to a figure, choosing instead to argue over which countries should be expected to pay. Held up over this disagreement, Bonn ended without a resolution even on what a range of possible NCQGs could look like.

Whatever its size, this target means nothing without a plan to deliver it. What’s more, the back-and-forth over the size of the bill and who foots it took up so much time last week that two other long-standing debates were neglected: The first over what type of financing the NCQG should prioritize ― a measurement issue ― and the second about the obstacles (or “disenablers,” as negotiators called them) in the way of achieving that level of financing — a target issue.

As to the type of financing, the share of total official development assistance sent from G7 governments and the European Union to African countries is at its lowest in 50 years, making it possible to conclude, as did an EU negotiator at Bonn, that “public resources alone will not suffice” to meet the NCQG. The growing scale of the climate challenge, weighed against this apparent (if arguably self-imposed) inadequate public spending by developed countries, has prompted policymakers to advocate for greater private-sector involvement in meeting global climate finance targets. The United States in particular has placed heavy emphasis on the need to “mobilize private capital.” This agenda has prompted Global North governments and the World Bank to attract private investors to decarbonization projects in developing countries.

Developing country negotiators and civil society advocates, meanwhile, have long criticized the fact that the majority of the climate financing we know about has come in the form of loans and not grants, and that most of the loans ― some of the ones from the public sector and all of the private loans ― are issued on market-rate rather than “concessional” terms. In other words, all this so-called help places an undue burden on the balance sheets of developing countries, especially as global interest rates stay high.

Some negotiators are looking to incorporate these arguments into the NCQG as a measure of the quality of the financing developing countries receive. And this is where the conversation around the obstacles begins.

One can argue that loans of any kind are better than nothing at all; long-term investments require long-term debt financing. But market-rate loans in the Global South carry prohibitively high interest rates, reflecting the greater risks that private investors think they face when investing. The International Energy Agency confirms that “the cost of capital for a typical solar PV plant in 2021 was between two‐ and three‐times higher in emerging and developing economies than in advanced economies and China.” While policymakers, particularly at the World Bank, are developing tools to “derisk” these investments such that they can be profitable at market interest rates, it’s still not clear that private sector creditors will respond with enthusiasm. Under these conditions, many climate-vulnerable communities are liable to be locked out of capital markets.

Debt, after all, is not inherently bad. High debt-to-GDP ratios don’t mean anything in and of themselves — indeed, taking on debt to finance crucial investments can (and should!) be prosperity-enhancing and increase a country’s future borrowing capacity.

But today’s global economic system is structured in such a way that debt places a needlessly heavy burden on developing countries, contributing to a “crowding out of crucial development spending,” per findings of the UN Development Programme. Almost 40% of developing countries are setting aside over 10% of their governments’ total revenues to cover interest payments; 62% of developing countries’ external public debt is owed to private creditors (again, at market rates). And these figures don’t include the debt that individual firms take on to finance, say, energy infrastructure. Even that requires the governments of developing countries and development banks to derisk low-return projects across much of the Global South, a process which can plant “budgetary time bombs” on those governments’ balance sheets. Where decarbonization is concerned, private balance sheets are also public liabilities.

Developing country governments and firms also face interest rate and foreign exchange shocks, as higher U.S. interest rates and the concomitant threat of currency depreciation strain their abilities to service external debts. The perverse effect is to prioritize hoarding dollars earned through exports as potential shock absorbers rather than channel them toward domestic investment goals. Loans become a millstone around a government’s policy goals, rather than a measurement of its ambitions.

These liquidity risks loom over climate-vulnerable countries. Take Egypt, where this summer is expected to be brutally hot enough to force its government to import more grain and more gas ― putting increased pressure on the already-volatile Egyptian pound ― and to seriously threaten labor productivity. Egypt’s latest Nationally Determined Contribution, its national climate plan, states that it needs approximately $35 billion per year between now and 2030 to meet its climate targets. Yet the International Monetary Fund expects Egypt to spend $50 billion a year on interest payments in that same period, all while Egypt’s recent bailout agreement with the IMF commits to “put debt firmly on a downward path.”

This debt-climate nexus or climate risk doom loop, exemplifies why developing country negotiators and civil society advocates have hesitated to embrace loan-based climate finance. Debt today need not “crowd out” debt-financed climate spending tomorrow. But that’s exactly what’s happening.

So where does that leave us? For all diplomats’ focus on the NCQG target, how they measure it does matter. As it stands, $100 million of climate finance in the form of market-rate loans to developing countries might seriously threaten their debt sustainability. But developed countries, the multilateral development banks, and the International Monetary Fund can change the nature of debt finance. They can commit to making debt easier to bear by offering lower interest rates and extending loan terms. They can issue more of this concessional debt, of course, displacing the panoply of private lenders that currently play in sovereign bond markets. They can reform their lending standards such that they no longer penalize borrowers for carrying high debt-to-GDP ratios when huge debt-financed investment is precisely what staving off climate change requires. And they can set up dollar swap lines to provide developing countries with the resources to manage interest rate and currency value shocks.

These strategies, if fleshed out in practical detail, can sidestep fickle private investors, contribute to an investment-friendly reform of the global macroeconomic architecture, and kickstart a virtuous cycle of green development around the world. That’s the target. Can we measure up to it?