Trillions in Climate Funds Could Sow Turmoil in Poor Nations

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PARIS—A tsunami of cash is headed for developing countries to address climate change—and with it growing worries that the money will overwhelm the poorer economies it is meant to help.

Wealthy nations are preparing a plan to send more than a trillion dollars each year to the developing world by 2030, a flood of foreign investment that would be unprecedented in modern history. Much of it would come from the rich world’s big institutional investors: pension funds, insurance companies, asset managers, private-equity firms and others. The goal is to provide financing on a massive scale for renewable-energy projects in developing countries and infrastructure to protect poor nations from rising seas, drought and other impacts of global warming.

But capital flows of that magnitude risk sowing economic instability, economists and global finance officials say, particularly for smaller, poor countries that lack the financial institutions to channel the money into productive investment. A string of financial crises in the developing world has shown that foreign investment surging into these countries often leaves a mess.

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United Nations climate negotiations are the driving force behind the climate finance plan. The financing offered by wealthy nations persuaded poorer countries to agree to Paris accord targets, even though the U.S., Europe and a handful of other nations are responsible for most of the greenhouse gases in the atmosphere that scientists say are causing the earth to warm.

Leaders gathered this week and last at the United Nations General Assembly in New York are negotiating policies to bring private capital into the developing world for climate projects. The ideas range from boosting the lending capacity of multilateral development institutions such as the World Bank to harnessing the IMF’s special currency for green energy.

The leaders of wealthy countries—which have failed to meet previous goals for providing climate finance—are trying to muster more of it from their government budgets that would be blended with private capital. Drawing in private investors is crucial for the Biden administration, because congressional Republicans are staunchly opposed to spending government funds for climate projects in the developing world.

The plan is gaining political momentum despite a growing body of research that casts doubt on some of the benefits of foreign investment. Prasad and other economists have found that developing economies that rely heavily on foreign capital haven’t grown faster than countries that used domestic capital—and faced more volatility from currency and capital flows.

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The list of financial meltdowns includes Latin American countries in the 1980s, Asian economies in 1997 and Russia in 1998. The eurozone crisis of the previous decade was preceded by a rush of capital flowing from the currency bloc’s core economies to its poorer, southern rim.

“Do we want these capital flows or not?” said Lesetja Kganyago, governor of the South African central bank, during a recent speech at the International Monetary Fund. “Twenty or 30 years ago, the mainstream view was that financial globalization was good…. Nowadays, the mainstream view has shifted.”

In the fight against climate change, officials say, developing countries probably have no choice but to rely on foreign capital. Big developing economies must accelerate their plans to shift away from fossil fuels if the world stands a chance of limiting warming in line with the Paris accord; the poorest nations are under pressure to develop without burning more coal, oil and natural gas. Those shifts will require investment in clean energy to grow exponentially in the coming years.

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The volatility of developing world currencies is a major problem. Renewable-energy projects in developing nations often have to raise debt denominated in dollars or euros to attract foreign investors. Foreign shareholders of these projects often negotiate deals with local utility companies to be paid in foreign currency.

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“We have seen many times that the sum of money is secondary to the quality of policies, the incentives they create and capacity of the institutions available to invest funds,” the South African central bank’s Kganyago said. “The capital flow skeptics and the climate justice activists should exchange notes.”

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