December 8, 2022


The conclusion of COP27 reflected persisting uncertainties around coordinated global action towards decarbonization. Major agreements—including the establishment of a loss and damage fund—were reached, but the burden of mounting debt among global South countries continued to limit climate ambition.

The second event convened by The Polycrisis begins with COP27 and tackles the larger constraints in the global financial system, the role of private finance and multilateral development banks, the possibilities of debt restructuring, and new avenues to rethink climate finance. The discussion featured Mona Ali, Rishikesh Ram Bhandary, Anna Gelpern, Avinash Persaud, and Brad Setser, and was moderated by Adam Tooze.

A recording of the event can be viewed here. This transcript has been lightly edited for length and clarity.

A conversation on climate and the global financial architecture

adam tooze: It seems to me that there are four key issues for us to discuss. The first is the question of sovereign debt restructuring. Looming over that is the role of private finance in addressing development issues, and climate finance issues in particular. Then there is the role of multinational financial institutions: the World Bank and the IMF. But the obvious place to start is with COP27, and where we’re at now.

Avinash, from your point of view, where do things stand, particularly with the Bridgetown Initiative? You and Barbados Prime Minister Mia Mottley have developed this clearly formulated program for a route out of the impasse we find ourselves in.

Avinash persaud: The Bridgetown Initiative is five very specific proposals, which can be achieved within the next twelve to eighteen months and would collectively have quite a meaningful impact on the global system. COP27 in Sharm-el Sheikh really was quite a historic event. We’re all justifiably cynical about international agreements and events—COP is a great place to launch ideas, but a lousy place to get anything agreed—but a lot was achieved. A historic decision was made to set up a loss and damage fund and its transitional committee. 

What was unusual and almost unprecedented about the Loss and Damage Fund was the degree of absolute unity that the G-77 plus China showed. They were completely unshakable despite their variety. They isolated Europe and the United States—Europe crossed the floor first, making the US deeply uncomfortable. In these events, the typical US strategy is to isolate China, but they instead found themselves completely isolated, so they moved along too. 

Also at COP, the UK launched a model for a natural disaster clause that countries can put in their sovereign debt agreements. That may not sound exciting, but it will have a huge impact if all debt instruments have natural disaster clauses that allow the suspension of interest on principal payments. If a disaster happens, we get 17 percent of our GDP over two years. That is huge—most multilateral developed banks will offer you 2 percent.

Finally, the discussion on the multilateral development banks in the COP text is really interesting. There is a focus on global public goods, tripling the expansion of multilateral development bank lending, and widening concessional funding for climate vulnerable countries. And finally, Emmanuel  Macron took note of the proposal Mia Mottley put down, agreeing to launch a global summit in June of next year focusing on a global climate mitigation trust, to drive the private sector into this transition—especially in developing countries where the cost of capital is so prohibitively high that we’re not really seeing much of a private sector transition.

aT: That is an extraordinarily upbeat view. Establishing the fund is the one thing, charging it with money is another. Who will be on the hook for this funding? 

aP: Two things were critical for the agreement to take place. The first was that developing countries had to shift their ask a bit. The initial ask was open ended—it was about all past historical responsibilities and all future ones. We shifted that to the specific and defined task of reconstruction after a climatic disaster. Secondly, in terms of who is on the hook, we’ve moved the debate away from the simple idea that developed countries must pay, to the idea that developed countries have the main responsibility to contribute, but there will also be new forms of financing. We’re talking about things like a global cross border carbon tax, things which the developed countries know will involve other countries too. Ultimately, widening the remit on finance contributed to the agreement.

aT: You can see how a compromise might emerge from that. Mona, you’ve thought a lot about the IMF and World Bank structures. How did the unfolding of COP27 strike you? Are we making as much progress as you would like to see, and where do you see further avenues?

MA: I’m going to step back and talk about this year, because the geopolitics of 2022 framed the tensions at COP27. About 60 percent of the foreign exchange reserves of nations, and about 40 percent of capital raising—equity and debt—is dollar denominated. After the Russian invasion of Ukraine, we’ve seen dollar appreciation at a twenty-year high. It’s come down to May 2020 levels now, but we’ve seen a destabilization of balance sheets across the globe. I do think that straining of the global macro financial environment is driving some of this realignment right across the G-77, and against Europe and the United States. 

We’ve seen ninety developing economies undergoing currency devaluation, which means that their dollar-denominated debt and all of the external debt of developing nations is about $11 trillion today, 40 percent being sovereign debt. Much of it is in dollars! We’re seeing a spiraling up of dollar liabilities, an increased cost of dollar debt servicing, and a sell-off of $70 billion earlier this year in emerging market bond funds. Altogether developing economies have lost about $370 billion in foreign exchange reserves this year. This drain in liquidity is occurring amidst a very troubling concatenation of commodity inflation, trade shocks, rising debt burdens, and climate vulnerability.

We know that the US is the largest contributor, in historical terms, to the cumulative carbon emissions that drive climate change, and that impacts GDP losses in developing countries. We now have developing countries contributing much less to cumulative carbon emissions but facing the brunt of the climate crisis. The excellent work of Stephen Paduano at LSE found that we have close to a trillion—$992 billion—of Special Drawing Rights (SDRs) sitting on the sidelines, underutilized. Andrés Arauz at CEPR has argued that if rich countries donate just a quarter of their SDRs to developing countries, the entirety of IMF debt to poor countries could be extinguished. 

Climate financing in developing economies, according to the recent Stern Songwe report, requires external funding of about a trillion dollars per year through 2030. 71 percent of climate financing right now is debt-financed. Given the debt and climate shock faced acutely by twenty-nine economies, I do think more debt financing is the wrong model going forward. Here’s a call for the necessity of regularly issued SDRs, and an extra issuance in the case of exogenous shocks. By the way, new financing made possible through regular and extra issuance was all part of the original intent of the 1944 Bretton Woods agreement. I think SDRs can be an important source of debt free liquidity to finance the clean energy transition. And of course, there are different issues with regard to who gets the SDRs, the unequal distribution based on IMF country quotas, and also technical hurdles to donating SDRs or re-channeling them from advanced economies to the global South. These technical reforms need to be sorted out quickly.

aT: The best use of SDRs is a key element of the Bridgetown Initiative as well, right? 

aP: Most definitely so. Mitigation is where we need to mobilize $4 to 5 trillion. I think the $1 trillion per year for developing countries is an optimistic number and assumes that there’ll be $1 trillion of domestic finance being mobilized. What’s really holding that back is the cost of capital. A recent study by the IEA found that the cost of capital for a solar photovoltaic project in Europe is 2 percent, the cost of capital for that project in Brazil is 15 percent, while for many African countries it’s nearly 20 percent. You can’t get any renewable energy project done where the cost of capital is 20 percent. So our plan is a global climate mitigation trust seeded with $500 billion of SDRs. 

Picking up on what Mona’s saying, we’ve got about $500 billion of unused SDRs today, because about half of them are owned by countries that issue their own reserve currencies. If you issue your own reserve currency, you don’t need an SDR. We could begin the Trust with those, and that would allow us to put equity into developing country projects—equity, not debt—and that will leverage something like $2 to 3 trillion of private sector finance. And if that works, we can issue another $500 billion of SDRs—we need that kind of scale to get the transition we need in transport, agriculture, and energy.

aT: Rishikesh, you’ve also been thinking about the role of climate finance, particularly the significance of the IMF. How did COP27 look from your point of view? 

Rishikesh ram bhandary: One of the reasons why the Bridgetown Initiative has been so compelling is that COP as a collective has finally realized that unless you reform the global financial architecture, you’re really not going to move the needle on climate and development. You see this really clearly in COP27’s decision text where they’re calling for reforms of multilateral banks, they’re calling for a much greater utilization of tools outside of the formal process. So I think we truly are at an inflection point. Unless there is a wholesale reform, we’re really not going to decarbonize as fast as we need, precisely to guard against the losses and damages that we are already starting to witness. Of course, the creation of the Loss and Damage Fund is extremely important. If you read the entire decision, it also calls on the heads of international financial institutions to think about loss and damage. It’s not just one fund, it’s the larger architecture that is able to respond to the needs of climate vulnerable countries. 

We also have to remember that the goal of this COP was to raise ambition. In Glasgow, countries were asked to come back with stronger pledges. What I think is particularly compelling is that Egypt, the host country of this COP, stated very clearly in their pledge that they are unable to make a stronger pledge because of the fiscal constraints. They are in so much debt that they are not actually able to enhance their ambition. The link between indebtedness and climate ambition has been made very clear by this COP presidency. 

Multilateral development banks (MDBs) were also a very big part of the discussion. The G20 capital adequacy framework report was mentioned in quite a few places at COP, and I think very rightly so. There’s a lot of frustration around the role of MDBs, and there’s a great demand on them to really step up. If you look at the joint MDB report on climate finance that was released, the MDBs themselves are saying, “We said we would do $50 billion by 2025. We are at $51 billion this year. So in a sense, we can declare victory because we have already surpassed our targets three years ahead of time, right?” But we clearly know the scale of investment needed is orders of magnitude greater. I think we are now finally realizing that the target-setting approach within the context of COP isn’t working. If you don’t increase the balance sheets in a much more meaningful way, the scale of finance that needs to be mobilized is simply not going to happen. 

aT: The conversation converges around the adequacy of multilateral banks and financial institutions in our current environment. One comes out of the corporate climate finance discussion, but that converges, for example in the case of Pakistan or the case of Egypt, with longer standing issues of their ability to manage both short term macroeconomic crises and long-run debt sustainability issues. Brad and Anna, how do you assess conversations around sovereign debt restructuring mechanisms and the role of the IMF in COP27? One could think of various instruments and perhaps almost cynical strategies of a country like Egypt where it basically says, “Look, you’ve got to do something about our debt, so that we can do something about climate.” 

brad seTser: The overarching challenge right now facing low-income countries is that financing writ large has dried up. Over the past ten years, many countries were able to draw on Chinese project financing, which grew at an incredible pace between 2010 and 2020 but has basically come to an end, and borrow at a high cost from the global bond market. With the Fed rate hikes, that source of financing has also dried up. It does strike me that various mechanisms for expanding the lending of the MDBs – through an IMF sustainability and resilience trust as part of that – have to play a role, because the cost of private finance right now is largely prohibitive. Creativity is called for. China showed that you could generate enormous influence and build a lot of infrastructure by mobilizing roughly $500 billion over ten years. Given that the World Bank now has a balance sheet of about $400 billion, some kind of strategy for doubling its effective capacity over the next ten years strikes me as a realistic ambition that we should be aiming for. Setting aside whether that can be financed without increasing the capital of the bank or not, capital is basically cheap, and if it takes more capital, it should be provided. 

I completely agree with the view that there’s an awful lot of unused SDRs sitting around, and we should be more creative with how we try to mobilize them. But I would also note that SDRs are technically a perpetual liability, and they do carry a non-trivial interest rate now that the US and Euro area are off zero rates. The easiest use of the SDR is not to provide equity capital or as a sort of donation, but rather as a perpetual loan to various institutions, which then can lend at the SDR interest rate. Thinking of it as cheap debt financing strikes me as the easier approach to achieving results quickly. Pure donation means that you would have to absorb the interest rate costs, because it would be treated as a grant. 

The other observation may not be completely consistent with the views of everyone on this panel. Countries like Pakistan and Egypt haven’t yet concluded that they themselves want debt relief. They have insisted on structuring their IMF programs around payment. Egypt doesn’t want to default on its bonds. Pakistan has celebrated the fact that they are going to be able to pay their bonds thanks to the IMF’s lending, and both have opted to draw on bilateral sources of financing, notably in the Gulf, to augment the IMF lending as part of an approach where they maintain relatively high levels of debt.

One of the classic problems of the international financial architecture is that countries are very reluctant to restructure their debts, even when those debts are high, and even when those debts constrain their ability to make future investments. That problem clearly has not gone away, and it has been a constraint on the international response.

At: Anna, why are countries like Pakistan and Egypt unwilling to restructure? On the face of it, this would be a “Get Out of Jail Free” card. You can write down debt, so this would be a first move, but it seems that there are dysfunctionally few incentives to default and restructure. 

anna gelpern: I think that it’s a bit of a misconception. We’ve treated sovereigns as sort of defective corporates who just can’t behave. If you look at NITSA or review the recent literature, countries actually pay shockingly much more than you would expect them to pay. They also borrow shockingly more than you would expect them to borrow. Looking at sovereignty as a sort of a commitment defect and nothing else is perhaps a bit off. This actually suggests to me that even though corporations are no more eager to restructure than sovereigns, it’s a complicated domestic and international political economy problem. It’s vital to remember that most creditors are also debtors. If you look at the 1980s crisis, it could have been a US and European banking meltdown but it ended up being a Third World debt crisis.

One of these crises is not like the others. “Drowning in debt” is a metaphor, drowning in water is not a metaphor. It is critical to remember that debt is a social institution, social construct, an accounting concept. The genuine lack of resources—be it for climate adaptation, loss and damage, hunger, war—is not a metaphor. I do think that being creative on the finance side is where our focus should be, but we have to recognize that it’s not just a lot of debt.

This panel, I think, is right to focus primarily on mobilizing resources for critical needs. There’s a lot of opportunistic merging of debt and climate, and in some circles, debt relief is free money. Nobody wants to talk about what happens the day after you drop the debt, and five years after you drop the debt, because more than half of countries with debt relief are back in debt distress. I think that it’s important to separate out real problems, financial engineering, and institutional challenges. 

aP: Our framework arrives from the problem that there’s too little finance for the needs. Loss and damage, climate adaptation, and climate mitigation are three very different things requiring very different instruments. Loss and damage is actually the smallest of the three—probably $100 to $200 billion dollars a year, but it requires grants, and grants are very scarce. Still, every storm can’t leave nations with even more debt. We need additional sources of revenues, like tax revenues, to go towards loss and damage. Then there’s private sector optimism around climate adaptation finance. But the private sector won’t be able to fund it, there aren’t enough revenue streams for that. Governments and MDBs must play a role. 

How do we avoid countries sinking into that debt? Well, in two ways. Firstly, make the money as concessional as possible when it’s about climate resilience, as concessional money is also scarce. You can also limit concessional money to adaptation and not mitigation, because mitigation includes the whole transition of energy, agricultural transport, which may have other revenue streams involving the private sector. But then there are issues in the financial architecture—the high cost of capital in climate vulnerable countries, high risks, and so on. 

Most finance people have approached high costs of capital in developing countries through selling insurance or risk mitigation, but it’s the fundamental system that creates the risk. When you hold the international reserve currency during a global crisis, your currency goes in a high demand which allows you to have an activist fiscal and monetary policy. When you don’t have an international reserve currency and you’re in crisis, your currency is collapsing, and you’re forced to tighten monetary and fiscal policy. That’s why we need to employ the SDRs which are a proxy of this international reserve currency to help us reduce that cost of capital. 

at: This three-way division is incredibly compelling. Grants cover loss and damage, but at the same moment, loss and damage is redefined not as historic climate injustice but rather narrowly as the latest inundation of Pakistan, the latest crisis which must be addressed by grants. Then, climate adaptation becomes the zone for scarce concessional public finance because there are no revenue streams. And then we move up the chain to mitigation, which is the economic development project. 

There are macroeconomic risks in the dollar system globally. There, the Fed is essentially a de-risking agent and we need a variety of de-risking strategies to stabilize those private flows. It’s a tiered stack of grants, concessional finance, and derisking private flows, which is, after all, what we do with the US Treasury market or the European sovereign bond market any day of the week. 

The question that many folks are asking is: why are we pursuing a gigantic, trillion dollar, publicly de-risked private debt machine to drive this energy transition? As Anna so nicely put it, every lender is also a borrower. There are both sides to the balance sheet. How do we stabilize this structure in a way which isn’t essentially exploitative of public balance sheets for the purposes of derisking private capital?

aP: We need what I call a third balance sheet. We need a balance sheet that stands outside of governments, and that’s what the global climate mitigation trust is. It hangs there, off the developing and developed country balance sheets. It’s a third balance sheet, to fund projects not governments. My developing country friends tend not to like that because they don’t like the private sector, but if you’re funding projects and not government, you can be a third balance sheet. People have been talking about a third balance sheet for global public goods, and now we really need it.

ag: I think the Bridgetown Initiative as a framework is really the way that we should think about this more broadly.

It’s not about, “Oh my God, are we going to end up subsidizing the private sector?” Guess what? We are. They’re good at this. When a chief economist of a major financial institution says “I would love to invest, just so long as you take out the transfer risk, the exchange risk, and the political risk, and I can get a free return.” Are we okay with that? Is this a good use of subsidy capital? One possibility is letting the creditors who are also debtors take a bunch of losses. We’ll recapitalize some and let the others float away into the sunset. I think it’s actually a fairly complicated calculus at any given point. 

Most importantly, there’s a mismatch between existing international institutions and domestic institutions in many of the countries that are providing capital. What is public and what is private? Does that even matter? We have international institutions that are configured around these mid-to-late twentieth-century concepts. That creates enormous incentives to arbitrage and get the subsidy while nobody’s looking. I think we have to be vigilant and imaginative here.

bs: In a complicated world, it’s hard to know what is public and private—the obvious example is the China Development Bank. It is one of the biggest global financial institutions, and it thinks of itself as a private lender, but the rest of the world thinks of it as a public lender. It is clearly a policy bank, but sometimes it’s a state commercial bank.

When you merge public and private, it’s helpful to decide if the public sector should put in equity or debt. The basic model of a policy bank is when the public sector puts in some equity and then you raise debt, which is a safe bond, so you’re tapping into the private demand for safety, and you’re increasing the supply of safe assets in the system by having a public equity buffer. It gets complicated if that equity buffer is not big enough, and there are questions about how much you should lever that equity buffer up. There’s another model, which a lot of private investors like, where the private investor—looking for super returns—puts up equity, and the public sector puts up debt. This can work, but that debt financing does carry some risk. It is still a way of mobilizing by providing cheap debt for more projects. I do think it is important to delineate what role the public sector is taking, whether that role is loss-absorbing capital, or cheap funding. 

at: Just Energy Transition Partnership (JETP) is a phrase du jour, which came out of COP26 with the combined Europe and US initiative centered on South Africa and Eskom, and is now being pursued in Indonesia and Vietnam. This takes us to a different dimension, which is the construction of partnerships where the public-private line is blurred transnationally. Is the JETP framework aligned with Bridgetown? 

ap: I think that one of our objectives is to make them aligned, but there’s an underlying conceit to the JETP: “If only the developing countries get their act together, the private sector will come. If only you had a proper investment plan, the private sector will come.” 

We were always a bit skeptical, but the process of developing the plan was a good, collaborative one. Still, now they’re finding that the 1 percent of grants they’ve put up is not making any difference —the private sector is not queuing up. In order to build a coalition, they also need to come to the global climate mitigation trust and put in public sector funding. 

at: JETP becomes a sort of preparatory exercise which then feeds into these large funding mechanisms.

ap: The politics of it is that the rich countries are desperate to make JETP work, because they’ve hung this conceit around it. So we come in and rescue them, and then convince them to put money into the larger streams of funding and equity. 

at: The other thing I like about the Bridgetown agenda is that it’s genuinely political. It’s easy to smirk at that, but it’s precisely what is needed. We do need to bail each other out, at least politically, and sometimes force people into a corner like G-77 and China did with the Europeans and the Americans.

RRb: JETP carries a pretty big assumption, that the domestic politics have already fallen in line, and JETP will lead. More generally speaking, I think JETP seems to be an interesting band-aid, when the international financial architecture doesn’t work the way it needs to. What does this mean in terms of a broader based legitimacy and support from developing countries that really want fundamental reform? JETP is an extremely important step, but we really need a larger reform.

At: We’ve discussed these cycles of debt, cancellation, and a repeat of the same. Where do we stand on debt restructuring?

ma: Let’s get political with the global mitigation trust, but let’s also politicize the IMF and the World Bank. Let’s really look behind the veil and think about how we’re seeing a hoarding of capital. There’s $700 billion unused at the IMF, and the World Bank is hanging on to their AAA rating. How about letting that go a notch that they can lend more. How about removing the surcharges that countries have to pay, not when they’re late in payments, but when they need large, timely liquidity? 

Avinash, I wanted to ask you: how can we harness the existing structures for climate objectives, and rethink what I consider extractive opaque practices at the IMF and the World Bank? 

ap: Back in 2016, before her election in 2018, Mia Motley asked me to help look at our debt. I spent two years trying my best to do every possible thing to avoid a debt restructuring, because that would signify the admission of failure for a country. Barbados had never restructured its debt ever before. I presented my plan of a very delicate, acrobatic form of getting around debt restructuring to my friend Brian Wynter of the Bank of Jamaica. He looked at me and said, “My experience was we didn’t restructure enough. If you’re going to go, go big.” I presented the idea to Mia, thinking she would dismiss it because it’s so un-Barbadian, but she gave the go-ahead. We had one of the largest debt restructurings as a percentage of GDP, and that put us on the right footing. You can’t do it often. We used the Greek legislation and reversed collective action clauses in retroactively. You need that for disaster clauses to make sure that liquidity crises don’t become solvency crises, but you also need to make it easier for them to default.

ag: I agree that new debt financing is not where we should be going. But we cannot stop cleaning the slate and hoping the next day will be brighter. Frankly, the biggest risk for the World Bank and the IMF is irrelevance. If they can’t set the terms of Zambia and Chad, what can they do? I actually don’t think the World Bank would lose anything in their credit ratings—if anything, ratings agencies think they’re being too conservative. 

I think that the only big problem is that we do not account for domestic politics, and for politics more broadly. These projects can be inflicted on a polity that may not want them, and may want to do something entirely different. The problem in some ways is that you have big debt relief but that comes with a big cost to agency—and with perhaps underwhelming results. I think aid should focus on cultivating agency in the right places. Don’t just vociferate about the IMF. Talk to Argentina! They know how to play the IMF. Sri Lanka needs to figure out what it wants to do, and how it wants to use the IMF and the World Bank. Like Avinash says, these guys are desperate to be useful. Just give them a deliverable, and they’ll hug you. We need to be more muscular about agency.

ap: When we arrived after two years of coming up with our plan—a shared plan, with both capital and labor involved—they looked at us and they said, “We think you’re doing too much.” But our plan was completely bought in by the public, because we recognized what the public could deal with. Because it was a shared plan, Barbados will probably be able to do more than if it were a top-down plan imposed on labor. Most countries go to the IMF when they have no time, in the midst of an emergency. I learned that actually having the time to develop your plan makes a huge difference. 

The Polycrisis is a publication focusing on macro-economics, energy security & geopolitics.

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