There is no turning back now, the ministries of economy and finance are at the heart of climate action. These ministries are crucial in the fight against climate change, as both the goals of decarbonization and those of resilience and biodiversity protection demand strategic actions that require their unique management, leadership, and coordination abilities.
What are finance ministries doing and discussing to advance green fiscal management? In this blog we summarize the main advancements on this agenda, which is being driven by the Regional Climate Change Platform of the Ministries of Finance, Economy and Finance of Latin America, a collaborative network composed of the 26 IDB borrowing member countries. This green fiscal agenda was subject of discussions during the Platform’s technical dialogues and meetings since the Platform’s launching in August 2022.
1- Countries need to strengthen their climate finance strategies
These instruments are commonly used by countries to guide public and private finance towards the financing of Nationally Determined Contributions (NDCs) and Long-Term Strategies (LTS), identifying actions and targets to be achieved. In recent years there has been an enormous increase in the development of these strategies, with around e 40 worldwide. During the first half of 2023, the Platform analyzed cases from 16 countries within and outside the region to identify best practices in the design and implementation of these strategies. Among the main recommendations are:
- Conduct robust diagnostics and consultations with financial system stakeholders.
- Consider a mix of general strategic lines and specific measures, prioritizing those with the greatest impact.
- Consider combining economic stability and competitiveness approaches with decarbonization objectives.
- Identify which interventions generate the greatest net social, economic and outcome benefits with LTS and NDC objectives.
- Mitigate risks related to stranded assets, energy transition and subsidy policy changes.
Having a financial strategy to address climate change can also lead to strengthening the legal framework, as well as institutionalizing instruments and processes related to public finance.
2- Sovereign thematic issuances are increasingly relevant
Sustainable debt instruments are becoming increasingly relevant in the capital markets. According to figures from the Climate Bonds Initiative, by the end of 2022, green, social, sustainable, sustainability-linked and transition bonds (GSS+) reached almost 900 billion dollars, 5% of the global bond market. In Latin America, thematic bonds issuance has increased significantly in recent years and represents 25% of regional debt from all issuers, with sovereign issuers accounting for a third of total issuance.
To support countries in entering the sustainable debt market, the Platform has developed a practical guide describing the issuance process for two types of bonds: (i) those structured on the basis of the use of proceeds (UoP), including green, blue, social and sustainable bonds; and (ii) sustainability-linked bonds (SLB). The guide summarizes key concepts and details the step-by-step structuring of these instruments, as well as present three case studies of thematic bonds issued by Mexico, Chile and Uruguay. Among the main advantages of thematic bonds issuance, the document points out:
- Alignment of policies with contributions to sustainable objectives.
- Prioritization of strategic environmental and social initiatives for sustainable and inclusive development
- Diversification of the investor base
- Access to financing under favorable cost, term and demand conditions.
- Capital market development
- Leverage private capital
The guide is being published by the IDB and will be useful for treasuries and public debt offices in the region. The Platform has also facilitated the exchange of experiences among countries, strengthening the capacities of the region’s ministries in this area.
3- New impetus for debt-for-nature swaps
Another sustainable financial instrument generating high interest in the ministries is the debt-for-nature swap. This allows sovereign debtors to obtain partial relief on the balance or service of their public debt in exchange for redirecting part of these fiscal savings to investments in environmental conservation. In addition to the environmental benefits, these swaps allow countries to improve the profile of their external debt, holders obtain returns from the sale of the debt, and environmental organizations strengthen their actions in the sector. A 2018 report by the U.S. Congressional Research Service reported more than 140 such transactions in developing countries since its inception in 1984.
Recently this instrument has been successfully applied in Belize (2021), Barbados (2022) and Ecuador (2023), with active IDB participation in the last two cases. These transactions reduced the cost of debt, resulting in significant savings for the countries, allowing them to redirect resources and invest in the protection of their natural assets, resilience of marine ecosystems and biodiversity conservation, among others. For example, in the case of Ecuador, there are savings of US$ 1.1 billion, which will be used to invest US$ 323 million for the protection of the Galapagos Islands.
4- Sustainable taxonomies are essential for access to timely and quality information.
Green or sustainable taxonomies are a classification system for identifying whether and to what extent an asset or economic activity, project or investment contributes to meeting the environmental objectives prioritized by a country or region. At the same time, they contribute to the standardization of criteria and definitions for sustainable finance through a common language, facilitating access to timely information and avoiding the risk of governments and companies exaggerating the impact of their actions to combat climate change (greenwashing) or on key social issues (socialwashing).
Recently, the United Nations Development Programme (UNDP), in coordination with several institutions, including the IDB, published the document Common Framework of Sustainable Finance Taxonomies for Latin America and the Caribbean, which aims to be a voluntary reference for stakeholders in the region who wish to align themselves with the best international practices such as those of the European Union, whose taxonomy is the basis for the construction of taxonomies adapted to the local context.
In 2022, Colombia was the first country in the region to publish its Green Taxonomy, followed by Mexico with its Sustainable Taxonomy, launched in 2023. Both cases have similar characteristics as they use the European Union’s taxonomy as a reference, but also particularities such as the incorporation of other environmental elements in the case of Colombia and, in the case of Mexico, the inclusion of a gender equality index. Currently, other regional blocs (Central America) and countries in the region, such as Brazil, Costa Rica, Chile, Peru, and the Dominican Republic, have expressed interest or are in the process of developing their own green taxonomies. The Platform will be supporting countries in the application of this tool through the exchange of experiences with pioneering countries both within and outside the region, as well as by advancing the production of knowledge and training in this area.
5- Carbon pricing mechanisms can help increase fiscal incomes.
Since their implementation under the Kyoto Protocol, carbon pricing has gained popularity. To date, 73 carbon pricing initiatives have been implemented globally, covering approximately 12 gigatons of CO2 equivalent and representing 23% of global greenhouse gas emissions, according to World Bank data.
There are various carbon pricing instruments and among the three most common are: carbon taxes (or green taxes), emissions trading systems and emissions credit markets. In Latin America and the Caribbean (LAC), five countries are already implementing some form of carbon pricing mechanism – Argentina, Chile, Colombia, Mexico, and Uruguay – covering 17% of the region’s greenhouse gas emissions.
Over the last year, the Platform has developed a framework study that seeks to improve understanding of these carbon pricing instruments and expectations about them in LAC. The research analyzes the perceived barriers to their implementation and the experience of two countries with active mechanisms: Chile and Colombia.
The analysis, to be published soon, concludes that carbon taxes can be a useful vehicle to capture additional fiscal resources that are then channeled through the budget to support environmental policy. While there is evidence that carbon pricing reduces emissions in certain sectors, no evidence was found that they are an effective instrument to incentivize the technological changes required to transition to net zero emissions. This is partly a consequence of the low levels of carbon prices currently in place. In this light and considering the low effective carbon tax rates in LAC countries, a good pricing policy to help meet decarbonization goals should first look at reviewing fossil fuel subsidies.
6- Green public financial management is incipient and countries need to establish pathways for action
Green public financial management (PFM) is emerging as a trend and a great opportunity for all LAC countries. Green PFM refers to promoting better integration of climate action throughout the public expenditure cycle, from fiscal and budgetary planning to monitoring and evaluation of expenditure efficiency.
Green PFM practices include, for example, green medium-term frameworks, green budgeting tools such as climate classifiers or climate budget tagging, and green accounting statements, among others. To understand how countries are adopting these practices, one of the main diagnostic methodologies used is known as the Public Expenditure and Financial Accountability Program (PEFA) and, in this particular case, its climate module (PEFA-Climate), which examines the extent to which a country is prepared to support the implementation of climate change policies.
Since PEFA-Climate is a relatively recent tool, only two countries in the region have applied it so far: Paraguay and Costa Rica. The Platform analyzed these two cases, and beyond the results obtained by each country, it is concluded that the integration of climate action into PFM policies, norms, procedures, processes, and systems is a complex and long-term task. Therefore, the main recommendation is that countries establish routes of action or work plans that, according to their capacities, allow them to advance gradually and systematically in the adoption of the best international practices of green PFM. As a recommendation, it also highlights the importance of establishing an order of priority in the implementation of these tools, focusing efforts, and promoting complementarity between tools.
7- It is necessary to green public investment management systems.
Green public investment is a tool to boost sustainable growth, as it contributes to both climate change mitigation and adaptation. This includes investing in infrastructure that is low or zero carbon, resilient to the impacts of a changing climate, and has positive impacts on the environment.
The IDB estimates that building the infrastructure needed to meet climate goals requires annual investments of about 5% of GDP through 2030. This represents an opportunity, as it not only minimizes risks from stranded assets, but can also generate savings from remediation of future damages, not to mention the social benefits that these actions entail.
Over the last year, the Platform evaluated how climate change criteria are currently being incorporated into the national public investment systems (SNIP) of three countries: Argentina, Costa Rica, and Colombia. To do so, it used the Climate Public Investment Management Assessment (C-PIMA) methodology developed by the International Monetary Fund (IMF).
Based on the cases studied, some guidelines were derived to incorporate climate action into the SNIPs progressively according to the maturity of each system. In general terms, the importance of planning investments based on the country’s most pressing priorities and needs, and the improvement of institutional coordination mechanisms, especially in countries with greater decentralization, was highlighted.
The IDB is working on a cross-cutting diagnosis on the inclusion of climate change criteria in national public investment systems in Latin America and the Caribbean and will publish a series of knowledge products to support countries in greening their public investment systems.
The Platform’s work agenda demonstrates that Latin American and Caribbean countries are committed to transforming the ministries of economy and finance into key players in achieving carbon neutrality and halting the loss of nature in our economies. At their most recent high-level meeting in September 2023 in Santiago, Chile (watch video below), the Platform’s finance ministries issued for the first time a joint declaration ratifying their commitment to climate action and biodiversity.
During the same meeting, Chile’s Ministry of Finance assumed the pro tempore presidency of the Platform for the 2023-2024 period, with an ambitious work plan to boost the institutional strengthening of its members and promote the development of innovative solutions and green fiscal policies based on international best practices but adapted to the regional context. Inaction is no longer an option.
Other related blogs
- Regional Platform of Finance Ministries Drives Climate Action in Latin America and the Caribbean
- Latin America and the Caribbean needs to increase carbon tax rates to mitigate climate change
- Six opportunities to promote resilience and decarbonization through fiscal policy
- How governments can do green public financial management
- What can carbon pricing achieve in Latin America and the Caribbean?