Solar energy and wind power (symbolic image) © Jochen Tack/IMAGO
The G7 and experts are sounding the alarm: rising interest rates and capital flight are jeopardizing the urgently needed energy transition in developing countries.
This analysis is IPPEN. MEDIA as part of a cooperation with the Climate.Table Professional Briefing – it was first published by Climate.Table on 25 May 2023.
High capital costs are slowing down the expansion of renewables. In Germany, too, too little use has been made of low interest rates.
The G7 summit at the weekend in Hiroshima, Japan, pointed to a threat that has hardly been in the headlines so far: the debt crisis of many developing and emerging countries is also jeopardizing plans for the global energy transition. Tackling the climate crisis and debt vulnerability "are interrelated and mutually reinforcing," according to the summit's final document.
The tense financial situation and interest rate hikes in the industrialized countries are also having an impact on the urgently needed expansion of renewable energies in many emerging and developing countries. Due to rising interest rates and capital flight to industrialized countries, the expansion of solar and wind power has stalled.
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According to the International Renewable Energy Association (IRENA), the energy transition and the expansion of renewable energies will require investments of 2030 trillion US dollars worldwide by 44. But in order to combat inflation as a result of the Ukraine war and high energy costs, the central banks of the industrialized countries keep raising key interest rates. As a result, the cost of capital is skyrocketing in many developing and emerging countries. Development experts and economists warn that the expansion needed to achieve global climate targets could be slowed down considerably. In some emerging and developing countries, "unfortunately, there is a threat of considerable headwinds," Ottmar Edenhofer, director of the Berlin-based climate research institute MCC, told Table.Media.
While the rise in interest rates in the Global North is usually still quite moderate, financing costs have deteriorated sharply in many countries of the South. For Germany, the rise in interest rates is "a small headwind. But for Nigeria or Kenya, where U.S. dollar lending rates are now at 13 percent, this has significantly increased the cost of building renewable energy," says analyst Teal Emery.
IMF: Most acute situation in decades
The rise in interest rates is having a particular impact on the expansion of renewables. Solar and wind power plants require higher initial investment than coal-fired power plants of similar size, IRENA said in a recent report. Even "small changes in interest rates have an increasing impact on project costs over time," writes IRENA. And Edenhofer says: "If interest rates rise, investments in sustainable infrastructure projects will be cut back more than fossil fuel projects."
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Developing countries and emerging economies are hardly responsible for the steep rise in the cost of capital, as Abebe Aemro Selassie, director of the Africa department of the International Monetary Fund (IMF), writes. Many private and institutional investors have withdrawn from these countries in recent months. Inflation and a risky global economy are driving investors into safe havens, mostly in the Global North. As a result of this drying up of international financial flows, the cost of capital is rising much faster in the Global South than in the North. The result: "The global rise in interest rates is putting an end to renewables in Africa," concludes "Energy for Growth".
Selassie of the IMF calls the poor financing situation of developing and emerging countries "by far the most acute situation of its kind in decades". While "better-off economies may rely on their substantial foreign exchange reserves and deep capital markets," the cost of debt and access to fresh capital have deteriorated massively for countries in the Global South, Selassie said. This also has an impact on the energy transition.
Responsibility for the Global North
In order to reduce the costs of the energy transition in the Global South, experts propose some countermeasures:
- Countries of the Global North should reduce borrowing costs in developing countries and emerging economies and keep their 100 billion promise for climate finance. There should also be more "conditional transfers to governments," says Matthias Kalkuhl, head of the Economic Growth and Human Development Working Group at MCC Berlin. Selassie of the IMF is also proposing more budget support: "OECD countries are now providing only a fraction of the budget support they provided a decade ago, and the resulting gap is being filled by more expensive borrowing," said the IMF's Africa director.
- (Multilateral) Development banks such as the World Bank should use their good credit rating to grant more concessional loans to the countries of the Global South, says Teal. For Edenhofer, too, "development banks are of paramount importance for the financing of sustainable energy infrastructure".
- According to Edenhofer, "the Green Climate Fund could also guarantee the default risk of loans" in countries with a high cost of capital – this would reduce investment risks and make private investors more willing to provide funds.
- However, Edenhofer also considers it "crucial that CO₂ pricing is introduced, especially in emerging markets". This would "partially offset" the rise in interest rates, as fossil fuel investments would become more expensive.
Germany: "Dream constellation" not sufficiently used
In Germany, according to experts, the rise in interest rates will not have such serious consequences. Higher interest rates will increase the costs of the energy transition. But emissions trading would provide enough incentives to continue investing in renewables, Kalkuhl said. Foreseeable increases in CO₂ prices due to the expansion of European emissions trading would give many investors planning security.
According to Hans Ulrich Buhl, the last ten years of low interest rates have been a "dream constellation" that has been underutilized, according to the economics professor at the Core Competence Center for Finance and Information Management in Augsburg and Bayreuth. Before the Ukraine war, Germany was the country with the lowest financing costs for the expansion of renewables, as an IRENA study shows.
Federal policy should have "advanced the energy transition much faster" during this time, says Buhl. In a global comparison, Germany is still in a good position when it comes to financing the energy transition. However, the Federal Republic of Germany can "no longer afford" additional "high costs, for example due to long approval procedures", warns the economics professor to reduce bureaucracy and accelerate procedures. (By Nico Beckert)
