Why investors avoid developing countries, and how to change that: Moving Money
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Welcome to Xero. I am Akshat Rati. This week, how to unblock the private money taps. The world is pouring money into the clean energy transition at an unprecedented rate.

Last year, more than $2 trillion was invested in low-carbon technologies, according to Bloomberg NEF. Over half of that went into renewable energy and grid infrastructure. Another third went into electric cars. This year, those investments might slow down in the US, but the signs remain bullish in other parts of the world. In developed countries, the private sector is leading the charge, with hundreds of billions of dollars each year flowing to profitable clean tech opportunities and large-scale projects.

Meanwhile, only a tiny trickle of private capital goes to developing countries, with investors scared off by unfamiliarity, volatile exchange rates, and markets that at times seem too risky. At COP29 in November last year, all countries, even the US, agreed to triple the money that goes from rich countries to poor countries, reaching $300 billion annually by 2035.

But the United Nations experts have found that the finance gap is closer to $1.3 trillion each year. The upcoming COP 30 presidency is working on a roadmap that will hopefully fill that void. And while we don't have the specifics yet, we know that most of that gap will have to be filled by the private sector. So how do we unlock private capital for developing nations where clean energy investments are most needed?

For this episode of Moving Money, we're welcoming back Avinash Prasad, Special Advisor on Climate Risks to the President of the Inter-American Development Bank. In this episode, he shares his ideas on how to de-risk investments, attract private capital and accelerate the clean energy transition globally.

Avinash, welcome back to the show. Thank you, Akshat. When we typically talk about climate finance, we end up talking about rich countries versus poor countries. But there is a third group that we don't consider often, which is private industry. One of the things that you have suggested could be a solution for getting private investors to invest in developing countries.

is to get a currency exchange guarantee because rich investors with dollar or pound don't find it as attractive to invest in a rupee or rand which is fluctuating quite a lot.

But if you could provide a funding guarantee that would ensure that that exchange rate is fixed, then that could be a much more attractive proposition. Now, that was just an idea when we talked about it last time around on this podcast. You've actually put it into action. Tell me more about how it's working. So, yes, indeed, we launched with the government of Brazil, Ministry of Finance and the Central Bank.

a FX liquidity facility. It's just started. We're looking for investors, but the platform is established.

Now, let me just make one step backwards. I think you described this very well. We have a trillion dollar target. Maybe 600, 700 billion of that one trillion, so 60 or 70 percent, could come from the private sector investing in things that generates a revenue, most of which looks like mitigation. Solar farms make money. Hydroelectric power stations make money.

Now, actually, the private sector is doing this in rich countries. 81% of mitigation is funded by the private sector in rich countries. So it's not like this is something that can't be funded commercially and you've got to blend it with public money. It's being funded.

It's commercially viable stuff. But it's not happening in developing countries because the private investors feel that the country risk, the currency risk, not something they're experts in, is large. And they don't have an ability to absorb that risk very well. And so they stay away. At the moment, what happens is there's a bit of a market structure problem in finance where

So as your listeners will know, today, investors don't say they will find the best investments in the world. They've all been specialized. So you go to a global infrastructure fund or global energy fund or global renewables fund, and that fund sells to its investors that they're experts in this sector. They don't say, oh, we're experts in currencies.

We're experts in hedging. They say we're experts in infrastructure. And that's why they get the money. So then they say, all these other risks, we are going to farm out to somebody else. And so they go to the banks and the banks say currency risk in Brazil for 25 years for your solar farm. The problem is that's long term and the banks are short term.

The problem is Brazil is highly pro-cyclical. In the up cycle, many emerging markets are doing well. So are the banks. But in the down cycle, all of these risks collide together. The countries have a bad time. The banks have a bad time. So the banks know this. So they're saying, well, you know, when you need money is when I need money. So I'm going to charge you a lot for me providing you a guarantee on the currency side.

So we've come in, we being the Inter-American Development Bank and part of the multilateral development bank system and saying, well, we've got a triple A rating and we need to make sure we're using the benefits of that triple A rating. And one of the benefits of that is in the down cycle, when people are fleeing risk, they're flying into our instruments because they're looking for safety and we represent safety.

So that's a perfect time for us to lend to renewable energy projects the dollars they may need to pay their investors. So our commitment to lend dollars to good projects when they need in the down cycle means that they no longer need to go to the banks and ask for expensive hedging. They've got this pre-commitment.

And we are lending, you know, only in the down cycle when people are coming to us anyway. And we are picking the right projects. We're picking the right countries. And so we've limited our risk. So we've launched that with a backing of $5.2 billion. So this isn't a $5 million pilot. This is a serious, some serious monies behind this.

And we're working with some new investors on potentially coming in. Some of the investments are actually not things we expected as an interesting biodiversity type investment that is looking at the waste products of sugar cane processes. Those byproducts are currently poured into the rivers and the sea, creating all kinds of pollution. And they could be turned into something more useful. And we're working with one investor on that.

And they're a foreign investor and they are looking at the need to not have to hedge the foreign exchange of that investment. And then another idea that you are currently working on, haven't yet launched, is to figure out how foreign investors can go into developing countries, but perhaps not directly down to the project level, but perhaps through local banks. Yes.

Because you're right. Right now, most of the money that is going in the energy transition on reducing emissions is going in rich countries, whereas most of the money that we need needs to go in developing countries. And so we need to solve that problem. How exactly is it that going to banks will make that happen rather than going directly to projects?

One of the things I've enjoyed about getting older is a realization that what matters is listening rather than speaking. When I was 30 years younger, I used to think, you know, the triumph of a meeting was I spoke all the time. And now I realize you have to listen all the time. And so I'm listening to all these people who say, oh, I would love to invest in emerging markets. I'd love to invest in climate. I'd love to invest in biodiversity. But

the risks, so the risks of going here and the risks of will I get the permit? Will I be able to construct? Will I get all of these things? I'm listening to this and thinking, hmm, okay, how do we come up with ways of de-risking? And then I'm looking at some numbers and I realize, well, the banks in Latin America own around 30 to 40 billion dollars of assets today on their balance sheets. They've lent millions

$30 to $40 billion in projects that are actually producing revenue. So the best thing for foreign investors to do is to buy those things that are already there. They're already performing. They don't need to deal with permitting risk, construction risk. These are instruments already performing. Now,

It seems less sexy to be buying something that's already there. There's no origination pioneer. But so what we say is, OK, we're going to create a fund that will buy the performing assets in the banks today, but at a premium on condition that the banks reinvest the money that they've got from selling their loans.

into the same sector. So what this allows us to do is to double the investment very quickly. And the way to think about this is it's a little bit like, you know, I'm an economist, so I know no actual science. So it's always a marvel when I discover something like fluid mechanics. So, you know, you get the water going uphill by creating a vacuum. You get water going uphill in a pipe by creating a vacuum at the top. So what we'll be doing is creating a vacuum at the top

removing all of the loans, existing loans of performing renewable energy projects, creating this vacuum at the top, allowing the same banks that originated the first loan to go out looking for another. And the reason why this is important, Akshat, is the banks are saying in Latin America and in India, another place where the banks have a lot of these assets, we've done this, it's fine, but we're now running out of runway to do any more.

We've got concentration limits. We've got a limited amount of savings there is.

And so by coming in and creating that vacuum, we're giving them the space to do more as well as the need to do more. And so I think that's a way in which we can go from $30 billion invested in renewables in Latin America to $60 billion in a couple of years and then $120 billion in a couple of years' time and $240 billion in a few years after that. So I think that that is a way that we can really accelerate. Do you have...

All of these ideas about accelerating in brand new projects in brand new locations that investors have never been before. And the reality is they're too afraid to go. Trying to invest in performing assets is exactly what finance does. And so why is it that you have to come up with this idea and why isn't finance already doing it?

Well, you're quite right. 97% of finance is refinancing. It's a sad reality. And finance loves to refinance and refinance over and over again. So I actually think that when we get this fund up and running, people are going to come to it. Now, the reality is today, someone has to do this hard work because these loans are

They're not defined as renewable. So someone has to go around, go into these bank ballot sheets and say, here's the thing that I'm prepared to buy and filter them out.

And one fund that needs to do this. At the moment, there is no capital market in which this is happening in these countries. But I'm going to take it to a capital market in which would want that, an international capital market. I'm not going to have a portfolio of performing loans in a wide variety of countries in renewable energies. I believe we'd be able to package that internationally.

into an instrument that the investors in the capital markets internationally will want. And if I can then sell on the loans that I have bought, having packaged them into nice packages that investors are looking for with the right degree of diversification and the right degree of spread of credit, I will then have money that I could go and reinvest by buying some new loans. And so we do think that this has scalability because

I think my first point of departure in this space a few years ago with the Bridgetown Initiative was about how do we move the needle? There's no shortage of clever, small ideas. How do we come up with a small number of big ideas that moves the needle? After the break, can carbon markets become the big idea to move the needle or are they forever stuck in the doldrums?

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So we've talked so far about currency exchange guarantees as an idea, trying to get loan portfolios in developing countries sold to international investors and freeing up capital in developing countries to do more green stuff.

But there are other private sector instruments that do exist, and they exist at pretty large scale. So green bonds are one where basically an investor...

buys into the bond, which is targeted for use in green stuff. So it could be building a renewable energy project. It could be building even adaptation projects sometimes are funded by green bonds. And that's hundreds of billions of dollars on an annual basis. Calling it green doesn't make it green. And I think that to me, the impact of that market is

the force of that market is a function of how lower is the interest rate on that money. So I've called something green. I'm going to use it for green purposes. And as a result, I can get money in the marketplace at 50 basis points less, 100 basis points less. And that's important because that means I could do more stuff, more of this stuff, right? Right.

The reality is the green premium, sometimes awkwardly called the greenium, is a few basis points. And I look at that and I think that's really two possible reasons why. Firstly, maybe people don't trust my definition of green.

And we need better definitions of green. In economics, we're always saying that things are caused by lack of information, transparency. And so an economist hearing this will say, ah, you have an information problem. No one really believes that it's green.

The other alternative is there isn't a market for someone to accept a lower return for doing something green. And I fear that that is even more important. And that certainly seems to have been the case in the last few years when interest rates shot up and

At the same time, there have been two things that happened simultaneously. There's been backlash against ESG, environmental social governance on a political level in places like the US. But outside the US where there isn't a political backlash,

Investors have been moving away from ESG investments because they can make money in just normal interest-linked derivatives like a treasury bond. That's exactly right. And it suggests that this issue is cyclical rather than linear, so that there will be a time in the future that interest rates come down again, and we should probably issue some more green bonds then. Because, as you say, when interest rates were very low, remember the zero interest rate policy, ZERP,

It seems such a long time ago, but actually only a few years ago. Then people began thinking, well, I'm not getting much cash from my bond. I might as well get something else as well. Right. And so there was a whole explosion of social impact investing and these other instruments.

It has, as you say, really declined. And I think that decline is because people can now get decent rates of return and they're not bothered about getting something extra. I think that we're in that environment for the next few years. I don't think rates are going back down to zero, but they will go back down low at some point in the future and we should issue those instruments again. But it's not, therefore, a reliable or, at the moment, scalable solution. Why is there a lack of demand for green bonds?

Isn't it clear now with these global climate goals that we have to be investing in these places and smart investors try and get to the place where the trends are, where future money is to be made and the earlier you get in, the more money you can make? But remember, the equation here is not someone saying, I'm going to do some smart investing. I'm thinking about the fact that in the future, this thing I'm doing is going to be valued better. It's going to be seen as important.

and therefore I will get a higher rate of return. This equation is different. This is like saying accept a lower rate of return because you're doing something good. And unfortunately, for whatever reason, that market does not seem to be there. There are not people lining up to accept a lower rate of return for doing good. And indeed, in some places, some pension fund trustees are being taken to court

saying that their job is to maximize rates of return for their members. The other idea that has been floated by clever financial people is that green bonds, as they had been defined, because they are restricted for that money to be spent on green activities, are perhaps a too restrictive instrument and perhaps that lower interest rate is not good enough.

So they created another instrument called a sustainability linked bond, where the bond's money can be used for whatever a corporation or a country wants it to use, except the interest rate would be tied to the goals that the company or the country has. And now bond investors...

get to essentially drive whether the country or the company actually meets those goals. Because if it doesn't, then the interest rate that the bond investors get paid rises and the company or the country has to pay more. And that instrument took off like a rocket over the past few years. It's about a hundred billion dollar market. We did an investigation looking at how some of those goals were not strong enough and that

kind of halted the growth of the market, but it's still a pretty robust market. All the people I've spoken to have said fundamentally, it is an interesting instrument, but there is an information problem that once sorted, it will rise again. What do you think about sustainability-linked bonds? I think that as with green bonds, there are some people out there who are prepared to

accept a lower or changed interest rate based around sustainability. Government donors can be part of that. Philanthropists can be part of that. And I believe that we need these instruments to tap that interest. Is there a mass marketplace for that?

I'm not sure. I don't think I've seen evidence to say it is. And in my current job at the Inter-American Development Bank, we're finding lots of opportunities to tap into a particular donor's interest and create a bond around that. So, for example, the current thing we're looking at is a loan to adapt all schools in Latin America and the Caribbean to enable them to deal with extreme heat.

There's lots of donors concerned about that. I mean, kids are not going to be able to learn in 40 degrees centigrade. It's going to have a huge impact on their future, their potential. The American government and the British government and the French and German and the Qataris and others are concerned enough about that to say, oh, I will back an instrument.

that funds the change of these schools. And once you've certified, because certification is important in all these processes, that the school is now adapted, I will pay some interest and therefore can reduce the cost for the country. So I think that those things, it's great that if I can tap into a particular demand, I can do more. But I think that is there a mass market of ordinary retail investors? Yes.

who want to do that. I'm not sure. I think you're also going to have some issues, and we're seeing this with debt swaps, is the more bespoke they are, interesting, sophisticated, the less liquid they are. And so that can mean that they're not as helpful. And what I mean by that is that liquidity is partly about people understanding that, right? So I've got a marketplace and my coupon has

Every single coupon in this marketplace has got some different link based on something else, some other metric. That's hard for investors to understand. And so that reduces the potential marketplace who are buying and selling these instruments. And if those markets are small, they're going to have less liquidity and be more costly. Yeah. And that sort of makes sense to me from an equity perspective, which is a much simpler market because

You're looking at a company like Apple and you're seeing, oh, they're going to produce a new iPhone. And that's about the information you need because people love a new iPhone. And so you're going to bet that Apple is going to make more money and you buy the stock and the price rises and you're happy. But in these sustainability linked instruments, you're going to have to think, oh, I'm

This Indian electric company is going to be reducing its emissions by 250 million tons by 2030. And that is going to be its goal. And that just already, that is too much information for any normal person to think about. And deciding whether to sell that bond to buy another bond because there's a Korean company who's got a similar target, but for a different year and a different...

It's hard for investors to really understand are they getting the best deal to use the power of the market to drive good deals and good investments. There's another private sector instrument that has got a lot of backing. At COP29, Article 6 rules were agreed. This Article 6 sits under the Paris Agreement. It's supposed to be a way for countries to trade constantly.

carbon credits. So Norway could be buying carbon credits from Indonesia and reducing its own emissions from its balance sheet, while Indonesia, which has many forests even now, gets to make money and perhaps put it to an energy transition investment fund. But companies could do it too. Microsoft that wants to reach carbon negative by 2030 could be buying the same forest credits from Indonesia. We've had, at least from a corporate level,

a voluntary market that has existed and we've covered that plenty on Bloomberg Green but also this podcast about how there are problems with that market. But this new UN-backed market was thought to be one that will bring better rules and higher integrity and then allow investment flows to happen, the thing that we want trillions of dollars going to developing countries. How do you feel about carbon markets? In thinking about

A lot about the issue. I've come to believe that there are really two things we need to think about. One is the border and the other one is the voluntary nature. So within the same tax border, like the EU,

or within the same tax jurisdiction, either UK, US, Canada, you can have some very substantial carbon markets which operate with very high prices for carbon. The European market is worth probably about $800 billion.

the US cap and trade, Canada, those are significant markets. Yeah, these are called compliance carbon markets. Compliance carbon markets. And I think the border is important. Now, the problem is we don't have a compliance system that operates cross-border. And so we created sophisticated voluntary systems. So the reason why we have a voluntary market is because of the border problem. Well, but there are compliance markets like Canada,

In Canada and the US, for example, like British Columbia with California and with Oregon and Washington across borders. Yes. And it's a compliance. Very limited and subject to a specific treaty. It's not that it's impossible, but it is that...

It's easy for national tax jurisdictions to basically price carbon through their tax system. And basically, it's a political problem. It's not a technical problem. So the fundamental issue is, is a taxpayer in America prepared to pay for emission reduction activity in Canada or vice versa? And the fact that the taxpayer...

You know, there may be a voluntary agreement to do that, but not a taxpayer enforced agreement. And that's the fundamental problem with this market.

So it's not about the integrity of the credits and how the carbon accounting is done and whether the promises are met or not. To me, the line works this way. So people think the line works and it's a lack of integrity. These knaves are out there, these bad people doing bad things. And as a result, there's no integrity. And because there's no integrity, the price is low. No, it's because it's voluntary.

And no one's required to do it. So what is this marketplace? There's someone who's saying, oh, I wouldn't mind buying some credits to offset my activity. And it's voluntary. I'm looking around. I don't have to do it. I'm not required to do it. And so I will buy the cheapest credit I can find. So the price of this voluntary market is very, very low. It's about 2% of the price of the compliant markets.

When the price is so low, there's no money in there to do integrity properly. Because to do integrity properly, you need monitoring, evaluation. You need to consider also what happens when the thing was reducing emissions, stops reducing emissions. So you need a bunch of stuff that costs some money. And if there's no money in this credit because it's so, it's volatile and low priced, then

You're not investing in integrity. In that case, this will never work. No, it will never work as long as it's voluntary. Now, you can make something non-voluntary in a multiple way. So it could be there isn't a specific tax around the carbon, but it could be that carbon is highly priced.

Any scheme in which it's got a high price is part of what's called an approved scheme. And approved schemes count for something. They get some kind of tax benefit, again, some benefit, which allows people to pay up for a high-priced amount. Right. So you could think of an approved scheme, say, in the UK, where there's an industry-wide approved scheme that says,

You have to reduce the emissions by this much because we have our climate targets to meet. If you don't reduce those emissions, we will create this approved scheme that is in Indonesia that us, the UK government, is working with the Indonesian government to monitor and verify that those carbon emissions are being reduced. You can buy credits from that approved scheme and they will cost just about the same as perhaps the money you will have to put in reducing your emissions at home. And that would be workable.

Yeah. So the issue is enforcement across the border. How do you enforce it across the border? How do you enforce your taxpayers sending money abroad for activities? Taxpayers don't want to do that. Governments don't want to do that. That's the problem to solve. And until we solve that, those markets are going to remain low priced and integrity is going to be always low. Thank you, Avinash. Thank you.

Thank you for listening to Xero. If you've not done it already, please check out the other episodes in the Moving Money series. If you have, we hope you've enjoyed the series. Please write to us with any feedback at xeropod at bloomberg.net. Let us know if you have any more questions about climate finance that you'd like us to answer in a future episode of Moving Money. And now for the sound of the week. That's not the sound of a gun, but the sound of a cash counting machine used in banks.

If you liked this episode, please take a moment to rate and review the show on Apple Podcasts or Spotify. Share this episode with a friend or with someone who still believes in carbon credits. This episode was produced by Oscar Boyd. Bloomberg's head of podcast is Sage Bauman and head of talk is Brendan Newnham. Our theme music is composed by Wonderly. Special thanks to Maithili Rao, Somer Sadi, Moses Andam, Blake Maples and Siobhan Wagner. I'm Akshat Rati, back soon.