How Africa can benefit from the private sector’s growing interest in climate finance
This post first appeared on the OECD Development Matters Blog on March 17, 2022.
While the private sector across the world is on a journey towards greening their activities, COP26 marked a milestone so significant that it was termed the Business and Finance COP. In other words, COP26 made ‘climate action mainstream business’. But what challenges and opportunities does this newfound interest present for Africa?
The first challenge, as I have pointed out before, is that almost all financing mobilised by the private sector is focused on mitigation. This bias was reinforced during COP26 where almost every initiative agreed to by the private sector was mitigation focused.
Source: OECD, 2020
While these commitments present opportunities for Africa, the priority remains climate adaptation and resilience, given that hundreds of millions of African livelihoods depend on sectors directly impacted by climate change:
Agriculture: More than 60% of Africa’s population are smallholder farmers, representing 23% of the continent’s GDP.
Water: One in three Africans face water insecurity and approximately 400 million people lack access to basic drinking water in sub-Saharan Africa. Climate change makes rainfall more erratic and increases the risks of floods and droughts. Given that 95% of farmed land in sub-Saharan Africa is rainfed, investing in better water management and infrastructure has never been more important.
Tourism: The sector accounts for about 8.5% of Africa’s GDP and employs around 24 million people. It is the second-fasting growing tourism sector in the world and is particularly natural-asset dependent.
Forestry: Exact estimates are tricky to find, but according to the African Development Bank, forestry contributes a great deal to Africa’s GDP and employment. In Cameroon, the Central African Republic and Liberia, forests contribute to between 30-40% of national exports. In Swaziland, Gabon, Equatorial Guinea and South Africa, the formal forestry sector accounts for around 1% or more of total formal employment.
In addition to prioritising mitigation over adaptation, the climate finance architecture is currently biased against Africa in three other ways. Formal, structured climate finance products do not effectively meet the needs of a private sector dominated by SMEs and informality; climate finance standards, compliance and reporting norms often have a global north bias; and there is a climate finance ‘premium’ due to the high-risk perception linked to climate/green finance solutions.
The second challenge is that companies today know they have to be visibly green and climate-aligned to survive, but how much of that is communications versus action? A company may not set out to ‘deceive’ consumers but may fall victim to jumping on a marketing hype train that oversells a well-intentioned initiative that is not yet viable. In February 2022, ESG funds representing more than USD1 trillion in assets were not delivering on their stated environmental, social or governance goals, resulting in the ESG tag being removed from more than 1 200 funds, or roughly one in five, according to Morningstar Inc.’s classification system. As Bloomberg points out, these findings, ‘feed into concerns that asset managers are still making misleading claims on the extent to which their allocations are doing the planet or its inhabitants any good’. Africa is particularly susceptible to this tendency because well intended strategies aimed at meeting the continent’s high investment needs are often not well informed by updated African priorities, realities and capabilities.
Despite these challenges, the entry of the private sector into the climate action space offers Africa numerous opportunities.
The first is that Africa does not have to pollute to prosper. As shown below, most countries threw Mother Nature under the bus to get out of poverty, but this is not a tenable path for Africa. Both investors and the African private sector now have an appreciation of the fundamental importance of being conscious, sustainable and responsible in how money is invested, spent and made.
Cumulative CO2 emissions across different regions between 1751 and 2019
Source: Triki and Said (2021), Tony Blair Institute for Global Change
Second, private sector interest in climate finance is surging at a time when the African private sector is entering new stages of development, innovation and growth. Despite COVID-19, in 2021 Africa’s start-up ecosystem raised USD 5.2 billion from venture capitalists — 3.6 times more than in 2020. With debt included, a total of USD 6 billion was raised in 2021 reflecting continued investor interest in the continent’s rapidly growing tech marketplace in particular.
Source: Onukwue (2022), Quartz Africa
Although 2021 was a recovery year for venture capital all over the world and the absolute amounts for Africa are small, FDI into Africa is diversifying away from traditional extractive industries with rapidly growing investment in the service sector (business services, telecoms, media and technology, financial services etc.) A dynamic African private sector combined with the mainstreaming of climate (and ESG) priorities into investment decisions creates the ideal environment for developing a responsible, sustainable and profitable African private sector. It is important that African governments continue to enhance transparency, diversify their economies, and institute reforms to attract FDI to support a dynamic private sector and create more employment opportunities for young Africans.
Finally, climate finance provides a new wave of liquidity to finance economic transformation in Africa. African governments have prioritised industrialisation as an engine of economic growth and development. It is clear shifting to green manufacturing powered by renewable energy (hydro, geothermal, battery storage solutions, and green hydrogen)and gas as a transition fuel, is feasible.
Shift to renewable energy to power manufacturing in Africa
Source: Jayaram, Kendall et al (2021), McKinsey & Co.
Moreover, climate smart and green transformation can also be implemented in other priority sectors such as agriculture, buildings, infrastructure, water and urban development. At the moment, rich countries have not only polluted their way to prosperity, but their economic model is also premised on the over-consumption of the world’s resources and high emissions per capita. Africa is the last frontier; it can be the continent that shows the world it is possible to develop and thrive in a green, sustainable and inclusive way.