What does Climate Risk really mean for African economies?
This article first appeared in the OECD Development Matters Blog on July 7, 2023.
Discussions on green and climate finance in Africa often dwell on two issues. The first is why it’s so difficult to scale-up this type of financing on the continent. The second is the issue of layered risk: some are not keen to layer ‘ESG’ risk on top of ‘Africa’ risk in investments.
How the ‘Risk Mindset’ limits Green and Climate Finance in Africa
The first concern on scaling green and climate finance in Africa is understandable. From a demand perspective, the Africa Development Bank estimates that the continent will require an average of USD 1.4 trillion between 2020-30, yet in terms of supply, climate finance committed and mobilised for Africa is falling short. As it stands, there will be an estimated annual climate financing gap of USD 99.9–127.2 billion between 2020–30. It follows that meeting climate financing commitments already made is likely to be a challenge.
Compounding this dilemma, is the continent’s seeming inability to absorb green and climate investors already interested in Africa. For climate financiers, risks associated with informality and the dominance of SMEs on the continent mean that investments originate and are implemented in an environment dominated by small ticket sizes, data holes, information asymmetry, lack of standardisation, limited line of sight to impact, and concerns about verification and compliance.
For them, failing to ‘manage and price’ informality heightens risk and exposure to legal and reputational issues later on.
Yet the informal economy in Africa is not disappearing, and African firms and governments can do a better job of organising and presenting climate deals. Concurrently, climate finance providers could adopt more collaborative approaches, partnering with African players to support local growth and to challenge perceptions that there are few bankable projects on the continent. Focusing on the financial architecture of green-climate deals from origination to disclosure to compliance, while managing the risks therein, will also help address the concerns of the risk averse. Grant capital and CSR funds offer opportunities to finance the financial architecture of deal flows:
How to develop a green project pipeline in Africa
Source: Were. A., How to develop a green project pipeline in Africa, BII, 2022
Layered Risk and the Debt-Climate Nexus
On the issue of layered risk, climate risks are to an extent being artificially siloed from broader fiscal and debt risks faced by African governments. To be clear, there are many issues in fiscal management that negatively affect African governments that have nothing to do with climate change. However, it is also undeniable that there are many ways that climate change is compromising the fiscal and repayment capabilities of governments.
Countries most at risk from climate change
Climate risk refers to climate change risk assessments that involve formal analysis of the consequences, likelihoods and responses to the impacts of climate change and the options for addressing these under societal constraints. (Adger, N. et al, ‘Advances in risk assessment for climate change adaptation policy’, 2018)
Examples of the macro effects of climate change being borne by African governments:
Lost and lowered economic growth and activity: The combined macroeconomic effects of climate change could lower the continent’s GDP by up to 3% by 2050.
Effects of climate change on fiscal and monetary policy in Africa
Source: Were, A., How climate finance can address the layered economic impacts of climate change in Africa, BII, 2023
What will become clearer over time is that climate risks are already integrated into lending and investments related to any country bearing the costs of climate change. As such, there is an urgent need to:
More deeply consider the integration of climate considerations in debt sustainability analysis (DSA) and other analytics around Africa and EM sovereign issuances; and
Integrate a climate-resilience lens when using proceeds, particularly in instruments like infrastructure bonds. 8 of the 20 countries with the highest expected annual damages to road and rail assets, relative to the country’s GDP due to climate change, are in Africa. Infrastructure investment in particular ought to be designed to ensure that projects can withstand the effects of climate change. This will ensure that projected revenues, debt productivity, and multiplier effects of the investment can materialise and positively inform the country’s repayment position.
Responsible climate assessments and investment optics
While it is crucial to get a much better handle on climate risk in Africa, the real work is in ensuring this does not have a penalising effect.
A key concern in Africa is that if governments encourage the integration of climate risks into the assessment of their fiscal and debt sustainability analysis, the market will penalise them by deeming them as even higher risk. This makes it even more difficult for African governments to access affordable finance. It is crucial that African and other affected governments are not subjected to a triple injustice of:
Shouldering the impacts of climate change on economic resilience – having contributed almost nothing to the problem;
Bearing the fiscal and monetary policy effects of climate – that limit their ability to respond to the crisis;
Being penalised by the market– should climate risks be more deeply integrated into fiscal and debt sustainability assessments.
Let this be an opportunity for the momentum behind the reform of global architecture to direct climate finance in a manner that speaks to the climate opportunities and priorities of the continent – in a just manner.