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The 27th Conference of Parties (CoP-27) held in Egypt under the aegis of the United Nation ended last month in an expectedly disappointing way. Nearly 34,000 people registered for the event. Eloquent words were spoken. Action remained well short of rhetoric. The silver lining of the cloud was an agreement on a Loss and Damage Fund. This fund aims to provide compensation and financial assistance to vulnerable nations most impacted by the effects of climate change.

Climate finance lies at the heart of climate action. The incentive for countries to procrastinate on climate action is high, given other urgent priorities. The only way to tilt them towards climate action is to tie down the usage of funds directly. In rich countries, this must be done by legislation and market forces. In vulnerable countries, like small island nations, this takes the form of technology and financial assistance that is earmarked for climate action. In developing countries, it has to be a bit of both.

There are three main uses of climate finance: 1) mitigation; 2) adaptation and 3) Loss and damage (L&D) compensation. Reducing emissions and stabilizing the levels of greenhouse gases (GHGs) in the atmosphere is mitigation. Preparing for climate change that is already inevitable, on the other hand, is adaptation.

Loss and damage: Until now, there has been no consensus on the obligation of industrial countries to compensate vulnerable countries for L&D. Even though the CoP-27 agreement had little detail on who will pay, how much they will pay, and who will be the fund’s beneficiaries, it was an accomplishment of this year’s conference that the moral obligation of addressing past pollution was accepted in principle.

A group of 24 countries will work out the details of the L&D fund over the next year. Among the ideas that have surfaced are the use of windfall taxes on fossil fuel companies and debt swaps for climate action. Such swaps would incentivize climate action by placing green usage ahead of other debt obligations. In 2015, Seychelles used private philanthropic funds and loan capital to buy back a loan from Paris Club creditors. In return, Seychelles agreed to protect 30% of its waters, 15% of its biodiversity areas and adopt a marine spatial plan. Similarly, in 2021, Belize issued a ‘blue bond’ to retire its existing debt of about $550 million. The proceeds of the debt relief were used to fund an endowment for marine conservation and expand its protected oceans from 16% to 30% in five years. With a US agency providing risk guarantees, Belize received a sovereign-credit upgrade from Standard & Poor’s as a consequence.

Mitigation and adaptation: At CoP-15 in 2009, the world’s rich countries agreed to give developing countries a sum of $100 billion a year to mitigate and adapt to climate change by 2020. This year has come and gone and the pledge of over $1 trillion in the dozen years since has not even remotely been met. Meanwhile, estimates suggest that about $200 billion a year is needed now and that will rise to about $300 billion a year by 2030. Even though calculations are difficult, given the complexity of how each country estimates this, the actual amount contributed in 2019 was about $20 billion, far short of the $100 billion pledge. The OECD estimates this number at about $83 billion in 2020, by including multi-lateral credits, export credits and private funding. There needs to be a clearer understanding of what the category entails and what ‘cash’ actually flows to climate action. Only directly tied use of funds is likely to work towards climate change adaptation and mitigation.

In the context of climate change, there are four categories of countries. Developed countries, developing countries, small island developing states (SIDS) and Least Developed Countries (LDCs). The latter two categories require external support in some form, since they are very vulnerable to the externality of a global phenomenon to which they have contributed the least. Developed countries have an obligation to decarbonize faster and contribute towards cushioning SIDS and LDCs. The position of developing countries like India is decidedly trickier. They are both victims and perpetrators and separating those roles, particularly in the context of financing, is complicated. For instance, many SIDS have suggested that India should be part of the contributing list of nations to the L&D fund.

Rather than seeking grants of any type, India’s best bet is to combine technology transfers, soft loans from multi-lateral institutions, adoption of market solutions for climate actions (bit.ly/3uqqyiu), and carefully designed cess schemes to discourage GHG emissions. We can capture the moral high ground by contributing to the L&D fund in a gradually increasing manner. Of course, the killer app for climate action is to increase the use of green energy and mitigate demand that increases GHG pollution. India has taken aggressive action to add about 60GW of solar power to its electricity grid, short of its 100GW goal, but still quite creditable. India’s target of 450GW from renewable sources by 2030 is ambitious but reachable. On the demand side, India has not made equivalent progress. An ambitious agenda to improve the domestic fuel economy, accelerate the adoption of electric vehicles, levy a carbon tax at the point of emission, and raise the economy’s overall energy efficiency is the need of the hour.

P.S: “Money is a horrid thing to follow, but a charming thing to meet," said Henry James.

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