This op-ed was originally published in The Business Times.
Written in collaboration with Deepali Khanna, Head of Asia, The Rockefeller Foundation.
The climate crisis is intensifying and compounding an already challenging economic environment of high inflation and pressure on national budgets. With an estimated financing gap of over USD 800 billion per year in developing countries in Asia for climate mitigation and adaptation, there is a critical need to mobilize private sector capital towards climate action at scale. For this to happen, we need to strengthen and grow domestic capital markets in Asia.
ASEAN and India account for approximately 50% of the financing gap mentioned above. Both have shown strong GDP growth over the last decade, with good savings and investment rates, and sound banking and financial sectors. The domestic capital pool of money from bank deposits, sovereign wealth funds, and public pension funds is estimated to be at USD 7 trillion. There is a massive opportunity to mobilize these local sources of capital towards achieving the region’s climate finance needs.
Local capital participation has distinctive advantages. It has a deeper and more nuanced understanding of local investment landscapes and provides confidence to foreign investors, thus reducing risk perceptions and risk premiums. Moreover, the foreign investors often invest using local currency, thus avoiding currency hedging costs which impact returns on investments for international investors, especially in adverse macroeconomic conditions. Finally, local capital participation stimulates private sector development and builds capacity among local financial institutions into impactful sectors, such as climate finance.
Despite the clear benefits, participation from local capital remains below what’s needed. There are a few reasons for this: investors’ commitment to domestic development projects has been constrained by regulatory limits, their unfamiliarity with alternative asset classes and how to assess and mitigate risk, low levels of capitalization, and, for pension funds, a fiduciary responsibility to preserve capital.
So how do we mobilize domestic capital? Blended finance, the use of public and philanthropic capital to attract private capital into transactions aligned with sustainable development, is one way to mobilize new sources of capital from local private investors and scale up climate finance.
Historically, blended finance has primarily attracted cross-border flows. This is largely due to the dominant presence of multilateral development banks, development finance institutions, and donors based in developed countries. On average, only 6% of all blended finance flows per annum in Southeast Asia have originated in the target investment country.
To scale up local capital mobilization with blended finance, there is a need to build the capacity of local stakeholders, develop an investible pipeline of transactions and reduce time to market by focusing on standardization of deals which meet international standards, and create an enabling environment for blended finance that can attract cross-border and local private capital to flow into climate action and other areas where it currently is not.
Initiatives are underway to address these needs. For example, the Green Climate Fund (GCF) and Nationally Determined Contributions partnership has developed the Climate Investment Planning and Mobilization Framework, which aims to assist country governments with a step-by-step guide for supporting upstream investment planning, such as identifying climate goals, as well as downstream activities, such as identifying project pipeline and financing partners from both local and global investors. The Framework is designed to identify the gaps in capacity or information that are preventing climate finance mobilization and to facilitate the successful implementation of climate change projects and programs with the best financial partner.
Another example is The Rockefeller Foundation’s support of two blended finance initiatives in Asia: Convergence’s Asia Climate Solutions Design Grant Window (ACS) and the Catalytic Climate Finance Facility Learning Hub, a joint initiative by Convergence and the Climate Policy Initiative.
ACS is a pioneering design funding program that supports the development and launch of innovative blended finance solutions that mobilize private capital for the climate transition in Asia. The funding from The Rockefeller Foundation for ACS will support solutions with innovative models of mobilizing local capital in key markets like Indonesia, the Philippines, and Vietnam. Meanwhile, the Learning Hub aims to gather key data trends, policy initiatives, and draw on critical insights from the ACS portfolio to offer best practices for mobilizing domestic capital. This includes highlighting successful and replicable blended finance structures that have attracted domestic investment to climate finance projects, as well as enabling policies and regulations.
Ultimately, attracting higher levels of domestic sources of commercial capital into climate transactions will depend on both domestic donors (e.g., national and state governments, local philanthropies and foundations, and national development banks) and international donors (e.g., the Development Assistance Committee of the Organization for Economic Co-operation and Development (OECD), international philanthropies, and climate funds like the Green Climate Fund) deploying concessional resources in a manner that is more interconnected and more explicitly focused on blended finance and private sector mobilization. With just five years until the deadline for meeting the Sustainable Development Goals, there is no time to lose.
