Climate: IMF conditionality could increase the speed and efficiency of climate financing

Last year, the members of the International Monetary Fund (IMF) approved an allocation of special drawing rights (SDRs) of USD 650 billion, the largest allocation in the history of the IMF. Since then, a new financing instrument at the IMF is being discussed, largely financed by these new SDRs. Now better known as the Resilience and Sustainability Trust (RST), financing through this new trust would tackle longer-term structural challenges, including climate risks and pandemic preparedness, differing in essence from regular IMF lending that focuses on solving more short-term economic imbalances.

The RST as a great opportunity to bring the IMF in a meaningful way to the table on climate financing. The economic effects of climate change have clearly been established as being within the mandate of the IMF and the focus of the RST should start here. It is, however, the case that  other multilateral institutions have already worked for some time in the area of climate financing, including the regional development banks, and particularly the World Bank. Therefore, we have to ensure that the RST delivers tangible value from the IMF’s unique expertise and access to data. The IMF has an opportunity to leverage its quantitative and policymaking expertise to help support IMF members in developing macroeconomic policies on climate mitigation, adaptation and transition.

Firstly, the IMF should further develop methods for quantifying risks from climate change through, for example, climate stress testing and quantifying risks to financial stability, and help countries build institutions that are able to bring in climate risks in their day-to-day operations and analysis. For this work to be successful, it requires cooperation with other actors at the forefront of climate analysis, such as the Network for Greening the Financial System (NGFS).

Secondly, the IMF has an important role in investigating the distributional effects of climate change, requiring e.g. appropriate social safety nets. It is also important that the RST be closely integrated with the IMF’s work on technical assistance and surveillance. Technical assistance is particularly important for fragile and low-income countries where strengthened institutional capacity is necessary for successful policy reform implementation. Regular countrywide climate assessments by the IMF should also be considered, similar to how the Financial Sector Assessment Program (FSAP) functions today.

Thirdly, the RST has to have a truly catalytic role. What does this mean? There is already significant climate financing available and, while it is not nearly enough, the difficulty is to ensure that funds are spent efficiently. One of the most important roles of the IMF is its role as a trusted advisor, and the policy conditionality it brings to the table when a country borrows money. A catalytic role means that the private sector and other green financing sources must view the IMF’s presence through the RST as a positive signal of the authorities’ commitment to sound economic policies, and thus of a favourable investment environment. This would make private climate financing available to countries that otherwise would not get it at a reasonable cost.

It is also critical that the IMF works closely with the World Bank and other financing institutions that have experience from working closely with the private sector, to ensure that the IMF efficiently incentivizes private sector participation in helping the country transition to a green economy. The World Bank Group has for example already adopted a plan to catalyse and mobilise investment for climate action by e.g. supporting the development of carbon credit markets, green bonds and loan markets in countries. The IMF must ensure that policies under the RST support such efforts and that countries’ programs contain concrete plans on how to catalyse green financing.

To summarize, it is critical to focus the RST on climate for now, and get the design right, in order for it to be truly complementary to the broader climate financing architecture.