1. The scope of financing by advanced economies must be broadened to support growth in emerging markets.

Emerging economies, especially in Asia, are expected to experience strong economic growth in the coming decades. They also aspire to raise their living standards, which will certainly drive a significant increase in energy demand. While these countries will be promoting renewable energy, they still need to expand their gas-fired power plants to meet growing energy demand. Improving energy efficiency—even in the use of fossil fuels—will be necessary. Moreover, they will need to continue operating their young fleet of coal-fired power plants to ensure a sufficient power supply and to avoid major write-offs.  

However, Multilateral Developments Banks (MDBs) and international private financial institutions, under the Glasgow Financial Alliance for Net Zero (GFANZ), are reluctant to finance fossil fuel-related projects.

Financing from advanced economies, including MDBs, should be broader and more flexible to support growth and rising living standards in emerging economies. To contain CO2 emission growth, projects that facilitate the transition from coal to gas and enhance energy efficiency should be supported. While this may not reduce CO2 emission to zero immediately, it can significantly reduce them. We should not let the perfect be the enemy of the good.

2. Bankability of many projects in the developing markets must be enhanced        

The fundamental premise of financing is that the money lent must be repaid within a predetermined fixed timeframe, with interest. There must be sufficient cash flow to ensure repayment, yet many projects in developing markets do not meet this test.

In many developing markets, the tariff for electricity is lowered due to political reasons. In such cases, it will be hard to expect sufficient cash flow generation from the investment in power plants. Governments in the developing markets must understand this reality and change the way they determine the electricity rate.

To minimize increases in electricity costs, carbon credits could be used. By generating carbon credits through projects that help reduce CO2 emissions, these credits can improve project bankability.  

3. Cost of capital must be lowered

The high cost of capital in the developing markets must be addressed in four fronts.

First, we must deal with the perception problem: lenders from advanced economies tend to believe that financing in developing markets carries a higher default rate. However, the actual default rate in the Global South may not be higher than that in advanced economies. It would be beneficial for MDBs to provide data comparing actual default rates in developing markets with those in other regions. Perception can only change by providing facts.

Second, predictability in the application of policies and rules must be strengthened. Technical assistance and capacity building can help enhance policy and regulatory predictability. Most advanced economies have dedicated government agencies to provide technical assistance, and MDBs offer similar functions. It is unfortunate that the Trump Administration announced the closure of USAID, which had long been a global leader in providing technical assistance to developing markets. It is time for other advanced economies and MDBs to step in to fill in this gap.

Third, local currency risk must be addressed. Financial institutions from advanced economies, including MDBs, generally resist providing finance in local currencies in developing markets. Because they raise capital in dollars and other major currencies, they do not want to be exposed to local currency risk when lending in the local currency. On the other hand, borrowers in developing markets are exposed to local currency risk because their cash flows are in local currency while their repayments are in dollars and euros. This currency mismatch can lead to more defaults as borrowers may be squeezed by fluctuating exchange rates.

To mitigate this risk, MDBs could raise funds in local currencies by tapping into local savings in developing markets, then lend to local borrowers in their own currencies. Since there is no currency mismatch, neither MDBs nor local borrowers would be exposed to this risk. Given their high credit ratings, MDBs should have little difficulty raising funds from local markets. In addition to MDBs, international private financial institutions can play this role.

Fourth, blended finance should play a larger role. If public sector institutions, such as MDBs or government-affiliated financial organizations, assume the riskier portion of financing by providing guarantees, commercial banks might be more willing to extend credit to projects.

Although blended finance has achieved some meaningful successes, its overall impact may not be meeting the high expectation of many. While MDBs and government-affiliated financial organizations are willing to assume more risk than the private sector, they do have limits on how much risk they can absorb. They need to protect their balance sheets, which allow them to raise funds at low cost. If they must maintain their AAA credit rating, the risk they can assume through blended finance will be limited.

To overcome this bottleneck, some allowance should be set aside to cover potential losses incurred through risk assumption in blended finance. To enable this loss-taking while preserving their AAA credit ratings, member countries should consider providing grants in addition to equity investments to these financial institutions. This might represent a departure from the traditional financial arrangements of these organizations, but such grants could leverage a significant amount of funds for developing markets. If successful, these grants would be a well-spent investment.

The pledge of $300 billion annual transfer from advanced economies and others to EMDM made at COP 29 is important. But it is time to start seriously considering the necessary actions to make it happen.

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