Finance leaders must support the IMF on the climate despite multiple global crises

The International Monetary Fund has a critical role to play in closing the global climate finance gap which will help avoid further economic shocks.

Expert comment
Published 13 October 2022 Updated 14 October 2022 3 minute READ

Lilia Caiado Couto

Former Research Fellow, Global Economy and Finance Programme

The global climate finance gap is currently USD2-3 trillion per year. Estimates indicate additional investment needs to be around 2 per cent of global gross domestic product (GDP) for the energy transition to reach net-zero between 2026 and 2030. Despite the need to respond to multiple economic shocks, finance ministers and the governors of central banks should also make action on climate finance a top priority and give the International Monetary Fund (IMF) their full support.

The IMF’s role in tackling the climate crisis

The IMF has caught up quickly with the climate emergency over the past two years. Kristalina Georgieva, the IMF’s managing director, said in October 2022 that: ‘Climate change is a threat to humanity. We can survive inflation and we can survive recession but we cannot survive an unmitigated climate crisis. We simply cannot.’ The current impacts of the changing climate, and therefore the urgency to transition to net-zero, are forcing ministries of finance, central banks, financial regulators, private financial institutions as well as multilateral development banks (MDBs) and the IMF to reappraise their role in addressing the climate crisis. 

Beyond the official climate finance transfers traditionally discussed in climate diplomacy, and an important focus of MDBs, serious efforts are now under way both to green the entire financial system and to close the global climate finance gap by using public mechanisms to leverage private finance globally.

Since 2017, central banks have cooperated through the Network for Greening the Financial System (NGFS) which the IMF has joined as an observer. Then, in 2018, finance ministers formed the Coalition of Finance Ministers for Climate Action while, since COP26 in 2021, private financial institutions have been collaborating under the Glasgow Financial Alliance for Net-Zero (GFANZ).

We can survive inflation and we can survive recession but we cannot survive an unmitigated climate crisis.

Kristalina Georgieva, Managing Director, IMF

A key challenge is that, typically, the more vulnerable a country is to climate change, the greater is its relative financing gap. Developing economies account for most of the world’s potential for renewable energy generation and nature-based climate solutions, and yet, tend to be the most vulnerable to the impacts of climate change. They therefore have large needs for adaptation finance but can also contribute to global mitigation targets. However, their capacity to attract investment is often hindered by high political, regulatory and macroeconomic instability and indebtedness. The COVID-19 pandemic and the Russian invasion of Ukraine has deepend the latter with many such economies having fallen into debt distresss.

The IMF has a critical role to play as a mobilizer of climate economic policy strategies and mainstreaming climate-related economic policies particularly with respect to low-income countries and vulnerable middle-income economies. The IMF created a climate strategy in 2021 and has established five main areas to its climate action: policy research and analysis, country economic surveillance, financial sector analysis, data production for decision-making and capacity development.

Alongside this, the IMF has worked with the World Bank to provide support for countries to implement carbon pricing mechanisms and has contributed to the so-called ‘climate information’ architecture, bringing together climate, economic and finance data.

Most recently, in the spring 2022, the IMF launched the Resilience and Sustainability Trust (RST) which aims to support low-income and vulnerable middle-income economies with limited fiscal space in recovering from the COVID-19 pandemic while also building resilience to external shocks such as climate impacts.

The creation of the RST has followed a USD650 billion additional allocation of Special Drawing Rights (SDR) spread across all IMF members in 2021. It is designed to recycle SDRs allocated to advanced economies, and other countries that don’t need them, to countries that do. So far, the IMF has received USD40 billion in pledges to the RST while Barbados, Costa Rica and Rwanda have reached agreement to access its funds. There are another five programmes under consideration.

More action is needed

The IMF recognizes that the climate crisis is an existential threat and that the delays in action to date have been immensely damaging. But the reality is that more action is still needed to deliver the transformative change that is required.

Indeed, governments may eventually be faced with deploying all the economic tools they have at once to this end. The IMF, and other multilateral financial institutions, will need to catch up even faster than governments so that they can be a step ahead to provide adequate technical support and exercise their convening power to persuade and encourage countries to implement radical economic policies.

The USD40 billion made available by the IMF through the RST is a positive move but it is still a drop in the ocean when compared to the size of the current global climate finance gap. Greening the financial system and financing green investments should converge ultimately to create a single strategy designed to shift capital from fossil fuels and other emitting assets towards climate-consistent investments. The additional capital spending of around 2 per cent of global GDP will only be affordable if investment is transferred from the fossil fuel sectors. Therefore, a transformation of the whole financial system to become compatible with the net-zero transition is urgently required.

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Through its country economic surveillance and financial sector analysis for climate, the IMF should lead in establishing common global frameworks that do three things:

  • Determine what climate-consistent investment really means by creating consistency between the different climate investment taxonomies.
  • Create an internationally agreed data production and modelling framework to assess climate impacts and risks at the asset level.
  • Encourage and support finance ministries, central banks and financial regulators in implementing this framework at the country level.

The meeting of finance ministers and the governors of central banks at this week’s IMF and World Bank annual meeting need to give this agenda their full support.