“Unlocking the trillions” will not suffice: a new Grand Bargain is needed between North and South

The 2022 Bridgetown Initiative – Barbados Ministry of Foreign Affairs and Foreign Trade, September 23 2022

The Barbadian Proposal Turning Heads at COP27 – Foreign Policy, November 11 2022

Without a grand bargain India to South Africa, to Indonesia, none of these large economies have the incentive to play ball and seriously narrow their development options, their energy options, et cetera, and focus entirely on renewable energy, which is much more capital intensive. And the one thing, these countries don’t have enough of is capital.

So there is a win-win opportunity to be had that can deliver large productive gains for the global economy if capital is deployed in the old fashioned capitalist sense towards where there’s a scarcity of capital. And the scarcity of capital is not in the Netherlands. It’s not in the United States, it’s in India, it’s in Nigeria.

Denise: Today we are excited to welcome back Sony Kapoor to the podcast, and we’re talking about the Bridgetown Initiative, a new plan – an exciting new plan – to overhaul the international financial system to unlock huge flows of finance to the global South for the energy transition.

Now disagreement between the North and the South on how to finance the latter’s exit from fossil fuels provides a useful lens on a wider problem about the geo-economics of today’s world of multiple, intersecting crises.
Sony outlines the nuts and bolts of this new plan – championed by the Prime Minister of Barbados, Mia Mottley, to “unlock the trillions” for the global South. But, more importantly, he explains why this approach is far from sufficient.

He questions whether headline-grabbing news that focuses on big numbers instead of the quality of the finance, is the answer.
And raises the issue of which economic model the new engines of global growth – India and Indonesia – can follow in a world where we no longer have the carbon budget to replicate China’s carbon-intensive trajectory.

Now Sony has a plan for a new “grand bargain” between the North and the South for a new development model led by services and virtual delivery of services that respects global environmental boundaries. This is arguably one of the most important policy conversation of our times, so stay tuned.

Sony: Uh, I’m Sony Kapoor. I’m a professor of climate, geoeconomics and finance at the European University Institute in Florence.

Denise: So, um, we are just, uh, a couple of days, uh, out recording after the COP 27 meeting concluded. And, um, today, you know, I’d love to talk to you a little bit about, uh, some of the more interesting outcomes, which concern climate finance and reform of the international financial system.

Uh, but first of all, I wonder if I could just get your take on, uh, COP 27.

Sony: Uh, what was encouraging was the, uh, that a number of small developing countries and and large emerging economies showed, uh, unity that hasn’t manifested itself properly before, and I think that is critical to any large scale success on being able to deliver on the climate agenda, and one direct outcome of that was the launch of the loss and damage fund. Which has been, you know, at, at the sidelines of every single COP summit that I remember, and particularly the small island states that face existential risks from climate change have been desperately trying for, you know, years and years to get, uh, universal agreement on that and have failed and, and the unity shown.

By developing economies in the face of opposition from the large, some of the larger developed states, uh, made sure that, that at least, you know, an agreement was reached to set up the fund. Uh, it is still a fund without any money. Um, and I think that’s where I’m skeptical.

So what was very disappointing about this COP was, uh, no new significant sources of, uh, finance were agreed, the ambition on 1.5 degrees, which, which frankly, you know, as, as someone who, who understands climate science and finance and economics, I know is, is no longer, uh, thermodynamically, you know, politically, financially, economically feasible. Uh, but at least, you know, we kept the facade of, you know, saying this is still a target.

And, and, and so, you know, everybody now recognized. So it’s just one of those things, you know, um, make me chaste Lord, but not yet.

So we once again promised and no resources, uh, were allocated to at least give a half a chance in hell to deliver on 1.5. So it was just empty words and moral grandstanding, particularly by the European Union, uh, with no real commitment.

So I think we’ve missed the bus on 1.5 for sure. Um, and you know, the, the proof of the pudding on whether the loss and damage funds ends up being something real, substantial and useful will not be known until the next COP when there’s a discussion on the mechanisms, the funding, et cetera.

Denise: Um, but one thing that many people seemed quite hopeful, uh, cautiously optimistic about was this, the Bridgetown Initiative.

And, um, I was very excited to actually talk to you about this because, uh, if you go online and you try to find details of the Bridgetown Initiative, there’s not a lot of stuff available. Um, so right now it seems very broad, um, but it does seem to suggest that what’s at stake is, um, a sort of a root and branch of reform of the international financial architecture, the IMF, the World Bank, the multilateral, uh, development banks.

So I wondered if, um, You could maybe briefly explain to us what is the intent of this Bridgetown initiative? Um, what is, what does it seek to do? And maybe get into a little bit of the, actually, you know, what is the IMF, what is the World Bank? What do they do? Why do they need to be reformed?

Sony: Uh, so the IMF and the World Bank were set up in the immediate aftermath of, uh, of the Second World War as Bretton Woods institutions to help, uh, the World Bank, in particular, to help the reconstruction of war devastated economies, particularly in Europe, but also beyond.

And the IMF as the arbiter of the international monetary system that would have oversight of things like current accounts, surpluses, deficits, exchange rates, et cetera, and the ability to offer, uh, support through liquidity and, uh, and hard currencies to countries that got into trouble. Clearly, you know, a lot of time has passed. We live in an almost entirely different world, and it would be unfair to say that these institutions have not changed because the IMF today, uh, is, you know, looks, looks very little like the IMF of, you know, the late 1940s.

And with the World Bank, the change has been even more dramatic. The World Bank does not lend into, you know, any rich northern European states. And its focus has shifted almost entirely to what we call the global south, to developing economies from, you know, middle income countries such as India, Indonesia, et cetera. And it is, it is very critical, particularly for low income countries, many of which are in sub-Saharan Africa, and provides long term, cheap loans for everything from infrastructure projects to, uh, occasional, um, you know, uh, things like new policy development initiatives, uh, et cetera. And also identifies itself as a knowledge bank. So it’s supposed to help uh, develop bureaucratic capacity, management capacity, get policy lessons from policies that have been successfully implemented in other countries and transfer them to a new country that is, for example, trying to set up a wireless network.

So these two institutions have been very influential in the economic management, industrial policy, uh, social policy, fiscal policy construction of many of the world’s, uh, developing economies today, including that of China. The World Bank played quite an interesting role, uh, in the remarkable opening of the Chinese economy, and both the IMF and the World Bank were again, critical in the big reforms that launched India’s liberalization in the 1990s.

So it’s not just small economies, but, but these institutions are powerful and central. And, and then last but not the least, to bring us to the Bridgetown agenda. Uh, but yes, the institutions have changed. But they have not changed, uh, at the rate and scale at which the world around them has changed.

So for example, you know, uh, the IMF has only recently, I think as of last year, started talking seriously about climate change. And as of today, climate change still doesn’t make it into the IMF core function of macroeconomic surveillance, of looking at the global financial system, et cetera. And that discussion is only just starting and you know, we are in 2022, and with the World Bank, it continues to prioritize old fashion, long term loans for infrastructure, et cetera.

It calls itself, you know, the world’s biggest climate finance lender, which is true, but that’s just because it is the world’s biggest lender. You know, the contribution, the share to tackling climate change remains rather small. And the World Bank, for example, still has nothing intelligent to say about development models.

That might be consistent with binding environmental constraints, you know? Uh, so China obviously followed a very carbon intensive, resource intensive development strategy, which is merely identical to what Korea did before, and what Japan did before. But given where we are in 2022, given we are about to breach the one and a half degree limit and the other environmental physical impacts that are manifesting themselves, uh, this development model is no longer available to a large country like Indonesia or India, uh, because we just don’t have the carbon budget and the resource budget available and you know, so what do these countries do instead? And the World Bank doesn’t have anything intelligent to say. So that’s why it is important to update these institutions for the times we are in and to look beyond at the broader reforms of the international financial system.

Denise: Okay. So, um, let’s get into the Bridgetown agenda then. And, and maybe you can kind of, um, as I, as I said, we, it’s hard to find any information about this. So, uh, what do you know, are you actually directly involved? And how effective do you think this is a proposal? Is it fit for purpose, for the, for the challenge at hand?

Sony: I’m extremely happy and delighted that Mia Mottley and her advisor Avinash Persaud, who’s a long standing friend, have taken this on, put this on the agenda, and that foundations from the European Climate Foundation to CIF to Rockefeller rallied around it together with other civil society organizations and put it firmly on the radar screen of not just global governments at COP and the G20, et cetera, but also in the public imagination, in the public discussion of civil society and beyond.

That is a very good, long overdue development because up until now most initiatives to do with, uh, moving forward on development or tackling climate challenges, both of which are inseparable from each other, have been quite piecemeal and specialized. I was, for example, involved in the multilateral debt cancellation initiative in 2005, which ended up canceling, uh, multilateral debts of 50 billion dollars for a number of countries, about 60 or so. Uh, but given the scale of challenges, you know, it was marginal. I was involved in tackling tax havens and helping reduce the leakage of corrupt money going from poor countries into offshore financial centers. But again, a relatively small niche. And I was involved in many of the discussions around the so-called Billions to Trillions agenda, which talks about, uh, offering some public subsidies as a means to attract private institutional capital into emerging economy investments, but again, relatively narrow and specialized.

So what’s new, interesting and useful about the Bridgetown agenda is that it takes a much broader systemic view and at least recognizes the scale and the scope of the challenges we face. Uh, I have been tangentially involved in some of the technical discussions, some of the political discussions, as well as some of the communication messages, and I’m supportive of all of the individual initiatives within that, and we’ll talk about some of those.

That having been said, I think the agenda doesn’t go far enough, is not ambitious enough. And would have been, and could still be much more effective and impactful were it not primarily being championed by a small Caribbean economy, uh, no matter how, you know, charismatic, the Prime Minister might be, uh, but we really need one of the, you know, one or more of the large G20 member states to put all of their political weight behind this sort of agenda to, to make it, uh, succeed.

Now on the content, there are three parts to the Bridgetown agenda. One is a short term ask, uh, with a timeframe of about six months, and that’s primarily aimed at alleviating the suffering and the financial crunch being faced by many developing economies from the, uh, aftermath of the corona crisis. The energy price and food price crunch triggered by Russia’s invasion of Ukraine and the general, uh, unfavorable financing conditions that always happen when the Federal Reserve in the United States starts increasing its interest rates.

And it almost always sucks capital out of developing emerging economies. So capital is being sucked out of these places. Their cost of financing is rising, even as the challenges on energy, price, on food price, on the need for investments for climate and fundamental developmental purposes have never been greater.

The short term six month horizon is focused around how to reduce the outflow of money, for example, by extending the suspension of debt repayments, uh, which was agreed on at the peak of the corona crisis. For example, by getting the IMF to increase its lending and support limits for developing economies back to the abnormal levels they were hiked up to at the peak of the corona crisis.

For example, by using some of the Special Drawing RIghts, which is like an international reserve currency that is issued by IMF members to use. And 650 billion dollars was emitted again, at the peak of the corona crisis, you know, led by the large member states of the IMF. And an agreement was reached back then that a hundred billion of this a hundred billion dollars worth of this would go towards supporting, emerging and developing economies.

And the IMF set up a special window called the Recovery and Resilience Trust to be able to channel these sources, and again, like the loss and damage fund, the structure of this trust exists. Uh, but not a single, uh, dollar has been dispersed, and the idea was to accelerate this. So in the short term, the ideas.

In the Bridgetown initiative, I think there’s five or six of them all focus narrowly on how to increase the liquidity, uh, and financial support available to developing economies to alleviate the immediate cash crunch brought on by the corona, the Ukraine, and the climate crisis.

Then there’s a medium term agenda. And that is about increasing the lending available, uh, from the World Bank in particular, but also the broader system of the regional development banks. That includes the Asian Development Bank the Inter-American Development Bank, the African Development Bank, and the new institutions of the Asia Infrastructure Development Bank and the New Development Bank.

And there the Bridgetown agenda has piggybacked on the reform process that was launched by the G20 last year. And I’ll try not to get us lost in the technical details, but the basic premise is that only a very small proportion of the capital of the World Bank has actually been paid in by the member states, uh, including, you know, the United States, Germany, Japan, et cetera.

90% of the promised support for the World Bank, uh, comes in the form of what is called callable capital, which a normal person would understand to be some sort of a guarantee that if the World Bank ever defaults, the United States, Japan, the UK, all the member states would cough up this callable capital to compensate the creditors, right?

So it’s, it’s a promise. Um, and all the multilateral development banks share this particular structure. So the way the World Bank works now, is it has a very high credit rating, AAA, and that means it is able to borrow at very low rates, uh, comparable with Germany and the United States in international financial markets, and it adds a small margin and lends this money to everybody from Indonesia and India to the likes of Senegal, Ghana, South Africa, et cetera.

And that means the benefit for these countries is they’re able to get access to concessional funding or subsidized funding that they otherwise would have to pay much more for, uh, together with the knowledge and the expertise the World Bank brings, um, and the benefit to, you know, the, the large, rich member states is that they haven’t actually had to put much money on the table. And the fact that, you know, the US and the UK and Japan have said we will pay if the World Bank goes into default, is taken to be a sign of strong credit worthiness.

And so this whole discussion is about how to treat callable capital. So should it be that as someone who’s lending to the World Bank, when I’m looking at how risky this is, should I treat this $9 of callable capital as being the same quality as the $1 of capital that has already been paid in? Or should I say, actually, you know, what if the Republicans are in the Congress?

What if there is a congressional agreement needed and the US when it’s time to deliver the money it has guaranteed, uh, fails to do so. The US has a track record of being, uh, in arrears to everybody from the United Nations to many of the multilateral bodies, right? What if the German government, which has promised to pay this money, suddenly decides that the domestic energy crisis is so bad that it can’t afford to do so.

Right. And uh, so this G20 process that was launched last year said that this callable capital should be looked upon as more or less the same quality as capital that has already been paid in. And right now it is not. And that means without any country, uh, any rich economy having to put another dollar towards the capital of the World Bank and other multilateral development banks, if this reform were to come to pass, suddenly they could lend up to a trillion dollars more of cheap money to developing economies. And this is something that the Bridgetown agenda asks for in the medium term over the next three to four years.

And then there’s the longer term perspective. And that’s sort of more of a 10 year perspective.

And there is a call to reform the incentives within institutional investors and private finance and use creative instruments such as guarantees and blending, et cetera, to help attract three to $4 trillion more of financing towards developing and emerging economies within the next 10 years or so. So the immediate six month horizon, the sort of three to four year horizon and the long term horizon, those are the three constituent parts of the Bridgetown agenda.

Denise: So, um, I’m just gonna jump in there. I think, um, one thing that I’m struggling to grasp is, um, in all of these short, medium, and long term proposals, is there some fundamental transformation of the way that a developing country might access credit from these institutions in the event of a climate induced extreme weather event that amounts to kind of permanent access as opposed to emergency access.

Sony: Well, so one of the technical calls within the Bridgetown agenda is to standardize the use of climate contingency clauses in debt contracts. And let me explain.

So the basic premise comes from, uh, what used to be called catastrophe bonds.
Uh, which have been a fairly standard product for, you know, reinsurance companies like Swiss Re, et cetera, and the premise is that Swiss Re, uh, goes and borrows money from investors, pays a premium on the prevailing interest rate. Let’s say the interest rate for Swiss Re was 5% and Swiss Re says, okay, you know what, we’ll offer 8%, but over the next 10 years, if there is a catastrophe, which could be man made, it could be natural disaster that is so big that Swiss Re ends up as a reinsurer taking a big hit and it’s quantitatively defined how big it needs to be to its portfolio, then these creditors will not get all of their money back.

That same concept is now slowly being imported into sovereign debt clauses and into broader loan clauses, particularly for countries that are vulnerable to huge weather and natural risk disasters. The basic premise being that if such a disaster were to hit, this country would, would not be able to, right?

I mean, if, if there’s a disaster, you know, that kills 3% of your population, displaces 20%, let’s say in Bangladesh, uh, you know, where is it going to find the money? Will it have to be diverted from, you know, life saving, uh, interventions to repay creditors. So that’s one small part of it.

The issue with, with this, or the limitation of this approach is that if this clause is built into a contract, it increases, like I said with the Swiss Re example, the interest rate payable, right? So a bond with a climate catastrophe opt out for, let’s say, Barbados. Will have a higher interest rate than a bond where there is no such, um, you know, force majeure clause.

Denise: So, um, I guess, um, my question to you now is how, um, uh, when we spoke earlier, you mentioned that one of the, maybe the, the flaws of the Bridgetown initiative is that it doesn’t go far enough, it’s not ambitious enough, or perhaps the, the framing of it is more in terms of what we should do still rather than makes good economic sense to do.

Sony: Well, I mean, there’s three or four things there, right? So one thing to point out is that too many of the asks of the Bridgetown initiative are about increasing lending to, to developing economies. And that is a problem on a number of fronts. So in the world we are in today, a country like Italy that is aging, where the best days are behind it, where a good year would be a growth rate of 1%, is able to borrow 150% of its GDP at, you know, more or less zero interest rates. Right? I mean, and a country like Nigeria that has the youngest demographic in the world. Which has enormous catch up growth potential, uh, is, gets locked out of borrowing even when it reaches just 40% debt to GDP ratio.

Right? Uh, so. Even if willing lenders were ready to loan a lot more money, even at concessional terms or at, you know, market rates to countries ranging from Nigeria to India to Barbados. The way, uh, global financial markets and the IMF’s debt sustainability framework works today is that these countries would start flashing yellow and red on what markets and the IMF consider to be sustainable debt much, much before they were able to attract enough capital to be able to make investments for climate adaptation, climate mitigation and developmental needs. Right? So the supporting institutional infrastructure doesn’t exist to enable the resource transfer and investments to happen primarily through a debt channel.

And that is a fundamental problem.

The second related issue is, if as many of us have been arguing, uh, you know, climate risk is properly assessed and taken into account by financial markets and credit rating agencies many of these countries, particularly the small island states and you know, some of the poorest countries in sub-Saharan Africa would actually see a downgrade in their already, uh, you know, sub investment grade credit rating by two or three notches because the way the climate is changing, it’s the small island developing states and the tropical subtropical developing economies that will face many more physical risks climate than the temperate economies such as, you know, let’s say the UK or the Netherlands, et cetera.

And so it further skews. So if you’re already unable to borrow at reasonable terms when your credit rating is single B, uh, you will be completely locked out when it falls to, you know, double, double C minus or something.

Um, and number three, uh, is the fact that, you know, if I asked you, you know, would you like . a hundred billion of very restricted low interest loan, but there are serious limitations on what you can do with it. Or would you like, you know $10 billion of equity, right? Uh, or would you like a $1 billion of grant? Right? Uh, the answer is non-trivial. Because it’s not just the quantity of money, but it’s the quality that really, really makes a difference. You know, the fact that I cannot answer that question in a straightforward way despite, you know, the orders of magnitude difference, highlights the issue.

So the Bridgetown initiative as it’s currently devised has focused as with, you know, most of the discussions about climate finance and billions or trillions about coming up with the largest headline number with very little regard for whether that is, you know, a market based loan, a concessional loan, is it equity or is it a grant?

And I think, uh, we really, really need much more grants. We need much more in the form of equity investments than contingent debt instruments of the kind we spoke about with, you know, exception clauses for climate disasters and then concessional debt. And then, and only then, uh, market based lending. And the Bridgetown initiative doesn’t make that hierarchy of financing quality needs, uh, clear.

And then the last point, which is a broader point, is that it is as of now being, you know, championed primarily by a small island state, which is not macro significant, and the framing remains a moralistic one about, you know, developmental needs, you know, climate disaster. We are gonna sink and we know that, you know, in the larger developed economies, uh, we have a track record, uh, that is not very good of being persuaded by moral arguments.

So my suggestion, Is for a systemically significant, large developing economy such as India, which has just started this G 20 presidency to play hardball and not use moral arguments, but make it clear to the rich world that the developing world is environmentally and demographically systemic. The rich world may still have, you know, be technologically and financially systemic, but without a grand bargain.

India to South Africa, to Indonesia, none of these large economies have the incentive to. play ball and seriously narrow their development options, their energy options, et cetera, and focus entirely on renewable energy, which is much more capital intensive. And the one thing, these countries don’t have enough of is capital.

And if India played hardball and convinced the other G20 members that it was in their self-interest because they are facing a demographic decline and for every country like Italy or Germany or Japan, which is, which is seeing a shrinking number of workers. There are at least two countries in Asia and Africa that have the opposite problem.

Too many young people, not enough capital for productive employment. So there is a win-win opportunity to be had that can deliver large productive gains for the global economy if capital is deployed in the old fashioned capitalist sense towards where there’s a scarcity of capital. And the scarcity of capital is not in the Netherlands.

It’s not in the United States, it’s in India, it’s in Nigeria. And if such a grand bargain is agreed, it’ll have four elements. Large scale financial transfers and investments into emerging economies from rich OECD countries, technology transfer, particularly for green economies. Uh, reform of the trading system that opens up the trade of high value added services, which can deliver the same catch up growth for India as China saw with an environmental footprint, that is one 10th of what China used and is able to boost global growth to four to 5% annually from the present sclerotic levels because the productive gains for these aspirational workers in Nigeria to India when they first get a chance to be the best version of themselves are so large, the benefits from this form of globalization are so large that if we got better at more equitably sharing them within countries, which was the big failure in the last bout of globalization, there is a win-win opportunity that can deliver global growth and keep us under, let’s say 1.7, 1.8 degrees.

It’s too late for one and a half, is able to offer a new development model led by services and virtual delivery of services that is consistent with, uh, limited global environmental boundaries and is geopolitically feasible in the sense there is something there for both the rich economies and the developing economies.

And I think that’s the path India should take.