Brazil was paying attention
One of the foundational reasons for Economy Zero Group continues to be the disparity in climate finance dedicated to the Global North vs. the Global South. Similarly, it is also one of the foundational reasons for “the Bridgetown Initiative,” named after the capital of the nation that led its formation—Barbados; a country experiencing the plight of the Global South when it comes to the disproportionate effects of climate change, compounded by the lack of finance available to address these issues.
Generally speaking, the ‘Global North' refers to places in the world that have undergone industrialization to more developed economies, and ‘Global South' refers to countries in the world that are still undergoing development and can be considered low-, to middle-income economies. A practical rule of thumb is that if a country has a GDP per capita less than US$15,000, then it can be considered part of the Global South—effectively placing about 85% of the world’s population and 40% of the world’s economic output under that category.
Even though the Global South encompasses so much of the world, some of the latest analysis on climate finance from 2022, shows that less than 3% of global climate finance flows are to or within Least Developed Countries (LDCs)—those with GDPs per capita less than US$1,270. Similarly, only 15% of global climate finance flows is to or within Emerging Markets and Developing Economies (EMDE), excluding China—referring to markets in transition to industrialized modern economies, but not quite there yet.
One of the main reasons why there is so much less climate finance flowing to developing nations has to do with associated perceptions of risk. Less developed countries are typically seen as having higher levels of corruption and overall crime, are less macroeconomically stable, and more politically volatile. All of which translate to unpredictably variable currency and exchange rates for these countries. A big red flag for private capital seeking predictable constant returns that it can take to the bank (pun intended).
A crash course on FX risk
Let’s put you into the shoes of a private foreign investor. Let's further say that you came across an opportunity to buy a corporate bond from a solar farm developer in Brazil back in June of 2019. It seemed like a good way to invest into a socially-positive project that would be associated with reduced emissions (a cause close to your heart if you have made it this far), and a good way to diversify what you invest into.
So you put US$10,000 (R$39,000 Brazilian Reals) down into “Brazil Sun” (not real), with a guaranteed coupon of 10% paid out biannually, with the condition that you hold the bond for at least two years. This means that the investment will pay 5% twice a year, but you will receive the payment in Reals. So essentially a guaranteed R$1,950 twice a year. By the time year one is over in June of 2020, the Brazilian Real has depreciated to 5.3 BRL/USD, instead of the 3.9 BRL/USD that you were originally making plans with. This effectively means that into the second year of the investment you are only receiving US$369 twice a year instead of the US$500 that you had signed up for, which is effectively a 26.4% decrease in the returns that you were expecting. Without properly having prepared for this with a financial instrument that guarantees a specific FX rate of BRL/USD, this investment won’t be too reliable. And this would be the exact same situation that an international developer would find themselves if they were the ones developing this project.
The Bridgetown Initiative
This problem of the gap in climate finance when considering the developing world is not new, and some really smart people have been trying to crack it for some time. The most prolific being the Prime Minister of Barbados, Mia Mottley; and her ex-climate envoy, Avinash Persaud. They put together a group that came up with something called the Bridgetown Initiative, which they first presented at COP27 in Sharm El-Sheikh, Egypt. The Initiative is essentially a prescriptive roadmap on how to redesign the global finance architecture, so that the inequality in access to climate finance can be addressed, and we can all transition to a net-zero global economy. The first version of the Initiative concentrated on three steps:
Providing access to emergency liquidity for countries that are struck with climate catastrophe and are already debt burdened—utilizing Special Drawing Rights (SDRs) at the International Monetary Fund (IMF). You can read all about these in our previous coverage of last summer's “Summit For A New Global Financing Pact,” and how this measure of the Bridgetown Initiative was actually implemented!
More (concessional) lending to governments from Multilateral Development Banks (MDBs). Since MDBs don’t have the mandate to make above average returns as does private capital, they are able to offer lending at concessional rates. The Bridgetown Initiative calls for MDBs to step up into this privilege and increase their lending by US$1 trillion dollars.
Activate Private Sector Savings For Climate Mitigation and Fund Reconstruction After A Climate Disaster Through New Multilateral Mechanisms. In an echo of the first step, this one refers to creating mechanisms that countries can tap into when struck by climate disaster in a way that is immediate without having to wait for a decision on what disasters to prioritize. Also something that was partly introduced last year just before the summer’s climate finance summit when the World Bank’s president, Ajay Banga made an announcement of pauses to debt repayments for poor countries struck by climate disasters.
It is no coincidence that last summer’s climate finance summit in Paris seemed to have paid heed to the Bridgetown Initiative, seeing as April 2023 saw the reveal of Bridgetown Initiative 2.0. Barbados’ Mia Motley, and the UN Secretary General, António Guterres, convened a group of experts to work on the follow-up agenda, which now includes the need to address the FX risk that private capital faces when investing in developing countries. The thesis for the initiative is that often developing nations will find themselves already straddled with debt that they have taken on to address development needs, they will face higher interest rates when trying to access new capital, and are often also at higher risks of the effects of climate change. Creating a real need to redesign the global financial architecture for a global net-zero economy. So further tapping into the roots of this issue, Bridgetown 2.0 focuses on the following priorities:
Provide immediate liquidity support including rechanneling at least $100 billion of unused Special Drawing Rights through the IMF and multilateral development banks.
Restore debt sustainability today and in the long-term and support countries in restructuring their debt with long-term low interest rates.
Mobilize more than $1.5 trillion per year of private sector investment in the green transformation, including through providing $100B in FX guarantees for just green transition investments through the IMF and the WB.
Dramatically increase official sector development lending to reach $500 billion annual stimulus for investment in the SDGs (SDG Stimulus).
Transform the governance of international financial institutions to make them more representative, equitable, and inclusive.
Create an international trade system that supports global green and just transformations.
Brazil’s new Bridgetown-inspired FX-hedging program
On February 26th, 2024, the government of Brazil, along with the Inter-American Development Bank (IDB), unveiled a new program to support the mobilization of foreign capital into sustainable investments within the country. The “External Private Capital Mobilization and Exchange Rate Protection Program – Eco Invest Brasil,” will include new credit lines for foreign investments under the National Climate Change Fund, as well as new Foreign Exchange (FX) derivative products offered by the Central Bank to protect green and sustainable foreign investments. What has been key in making this program a reality, is the fact that the IDB is providing technical support, as well as US$5.4 billion support, $2 billion into the credit lines, and $3.4 billion for FX derivatives. The IDB brings its AAA credit rating, and Treasury services, to secure the confidence of private capital from the developed world.
Think of this program as being made up of one part additional funding, that will serve to decrease the total costs of sustainable investments (and thereby reducing overall exposure and providing a trusted partner to private capital), and the other part being made up of what can be thought of as insurance, against the uncertainty of investment returns. This last part is novel in practice (with regards to the unique combination of sustainable investments and FX hedging facilitated by a major multinational institution), but it is not necessarily a novel idea. For some time this has been recognized as one of the main levers in moving more climate finance to the Global South.
But when looking back at the full Bridgetown Initiative, Brazil’s Eco Invest Brasil with a $5.4 billion contribution from the IDB, is a step in the right direction but forms part of a much larger laundry list. A list of action items that the world needs to take in order to enable the transition to a net-zero future in a just and sustainable way for everyone. With a little bit of help, developing nations can lift many out of poverty, while implementing decarbonization and climate adaptation; all while proving to be a good investment for private capital in the developed world. The new growth potential is in these countries where people are still in dire need for better living conditions, and they can improve their livelihoods now without all of the fossil fuels that were used in the developed world to make the same transition.