How Blended Finance Can Support Climate Transition in Emerging and Developing Economies

IMF Blog, November 15, 2022

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Emerging market and developing economies account for two-thirds of global greenhouse gas emissions.
Many are highly vulnerable to climate hazards and will need significant financing in coming years to reduce emissions and adapt to the physical effects of climate change.
Many have high debt and constrained budgets because of the pandemic and face higher government borrowing costs amid rising interest rates around the world, making it especially difficult for public finance to meet pressing climate financing needs.
Private climate finance faces multiple constraints, including:
- future policy uncertainty;
- technological costs that raise the cost of capital;
- data limitations; and
- unattractive risk-return profiles.

Mobilizing private capital on a large scale will be key to achieving climate objectives in emerging and developing economies.
Financial markets alone can’t do the job, but combining public and private capital offers unique advantages by reducing investment risk and attracting greater funding.
Multilateral development banks (MDBs) and international financial institutions (IFIs) can create blended financing structures to alter the risk-return profile for the climate transition.
Public backing can increase expected risk-adjusted returns for private investors by agreeing to be first to endure losses in green funding vehicles and securitizations, while appropriate governance can help avoid moral hazard associated with guarantees.
Advanced economies could back public equity as a way of delivering on their annual $100 billion commitment to emerging and developing economies.

Innovative financing instruments can attract investors with different risk profiles and investment horizons.
In larger emerging markets with functioning bond markets, investment vehicles such as green bond funds can help broaden the investor base by drawing in institutional participants like insurance companies and pension funds.
Equity investment can effectively leverage public money:
- Commitments by development banks are matched by less than a third of the amount from private sources, for emerging and developing economies, on average.
- The IFC-Amundi structured fund attracted 16 times as much private investment.
For less-developed economies, green infrastructure projects will remain a key instrument, and development banks will play a central and enduring role.
Public money can launch green or climate structured funds where risk is distributed among lower tranches to attract much more private capital to take the senior tranches.
If green or climate funds invest in the equity of climate projects, development banks and commercial lenders may be more willing to lend—public money thus provides incentives at both the fund and project levels.

It’s important to start by establishing an attractive investment climate and policies to incentivize private participation.
Climate policies and finance are complementary: better policies attract private investment, in turn helping meet policy objectives.
Carbon pricing is described as the most effective tool to make high emitters pay for the climate costs they impose and thereby channel private investment toward projects that emit less.
Climate policies and commitments like the Paris Agreement’s Nationally Determined Contributions can signal to investors to direct investment to a low-carbon economy.
Establishing a strong climate information architecture for data, taxonomies, and disclosures also will help.
The IMF will continue to promote carbon pricing, along with alternatives that can achieve equivalent outcomes, such as feebates and regulations.

MDBs and IFIs can provide technical assistance, help develop projects, improve governments’ institutional capacity, and build local currency bond markets to broaden domestic investors.
Development banks can increase their capital base and form partnerships with the private sector to channel more climate financing to green infrastructure projects.
The IMF can play an important role through surveillance, capacity development, risk assessments, and climate diagnostic tools.
The IMF’s first ever long-term financing tool, the Resilience and Sustainability Trust, now has more than $40 billion in funding pledges, and staff-level agreements with Barbados, Costa Rica, and Rwanda.
Under the RST, lending by the Resilience and Sustainability Facility can help boost private financing.
IMF staff will work with governments, development banks and investors to identify financing constraints and further explore how to scale up private financing, and will continue to strengthen the climate information architecture and help emerging economies promote private climate finance.

Source: How Blended Finance Can Support Climate Transition in Emerging and Developing Economies (IMF blog, November 15, 2022).