Using new SDRs to finance the global green energy transition

June 28, 2023|Written by Matthias Kroll|International Monetary Fund
A man crouches on top of a bank of solar panels. Behind him are low brown hills reflecting the sunlight and clouds in a blue sky.
Solar panels in northern India. Renewable energy development in the global south is slow and expensive. © Harikrishna Katragadda / Greenpeace

To achieve the Paris climate goals, huge investments will have to be made in the coming decades. The Intergovernmental Panel on Climate Change estimates that investments of US$2.3tn per year are needed just for the global transition to renewable energies by 2050.

Especially in the global south, however, the development of renewable energies (RE) is still far too slow. This is because in most cases the technical equipment must be imported and paid for in reserve currencies such as US dollars, euros or yen through high-interest loans. This makes RE investments in the global south so expensive they are hardly profitable.

Even if investments are made the exchange rate risk remains, since global south countries have to repay the loans in the respective reserve currencies, but they generate income, from electricity sales or their tax revenues, in domestic currency. This problem is only somewhat alleviated because the development of domestic RE gradually eliminates imports of fossil raw materials and thus saves foreign currency.

Using special drawing rights as a new finance tool

One economic tool that can help to solve the problem of foreign exchange shortages is the creation and allocation of special drawing rights (SDRs) by the International Monetary Fund (IMF), because countries from the global south can exchange their newly received SDRs into reserve currency and finance additional imports from RE equipment.

However, since the distribution of the new SDRs is done according to IMF quotas, the main part goes to the rich countries of the global north, while poorer countries only receive a small part. Since this unequal allocation of SDRs hardly addresses the problem of foreign exchange shortages, voluntary forwarding of SDRs that are not needed has been brought into the discussion. So far, three different mechanisms have been proposed.

The new Resilience and Sustainability Trust

For this purpose, the IMF has created the Resilience and Sustainability Trust (RST), into which the global north has transferred SDRs amounting to US$76bn (as of the end of April 2023). The US has also pledged US$23bn, but this has not yet been approved by Congress.

Loans to be allocated through the trust have long maturities and bear interest at the SDR rate. This makes them relatively affordable and could be of interest to the global south. However, the IMF imposes the condition that states can only access these loans if they are already participating in existing IMF support programmes. This means RST borrowers are automatically included in the IMF’s usual austerity and structural reforms, and are controlled accordingly by the IMF. RST loans will therefore have little appeal for many countries, despite their favourable conditions.

The African Development Bank proposal

One way to provide affordable credit without going through the RST is for countries to forward their SDRs directly to multilateral development banks (MDB). A plan of the African Development Bank (AfDB) envisages that MDBs use the SDRs forwarded to them in the form of hybrid capital in order to achieve a leverage effect of two to four times.

Forwarded SDRs worth, say, US$20bn could then be used to facilitate new lending of US$40-80bn. The path proposed by the AfDB could provide significantly more loans to finance the global energy transition than the RST, which has no leverage. In addition, the loans should only be slightly more expensive than those processed via the RST. The AfDB has designed its proposal in such a way that IMF staff have confirmed that SDRs routed in this way retain their reserve asset characteristic, as required by G20 countries.

The Bridgetown initiative

A third possibility to use SDRs to finance the global energy transition is the Bridgetown initiative of Barbados. It envisages a new global climate mitigation trust to be filled with new or unneeded SDRs to the amount of US$500bn. These are to serve as collateral for new, low-interest loans for the global south. Significantly, this would increase the number of “bankable” or calculable investment opportunities in renewable energies for private investors. Here, too, there would be a clear leverage effect.

These three options could significantly increase the number of profitable, and therefore bankable, investments in renewable energies in the global south. However, the SDRs committed so far are insufficient to achieve the necessary RE investments of several trillion dollars annually. Moreover, even loans with relatively low interest rates would further increase the already unsustainable foreign debt of the global south, and all three proposals suffer from this flaw.

A more radical SDR finance tool is needed

To close this investment gap and avoid further increases in external debt, a new mechanism is needed whereby countries in the global north pass on their unused SDRs in the form of grants. This would require countries to forego maintaining the reserve asset characteristic of their SDRs.

In this process, the MDBs (especially the so-called “prescribed holders” who are allowed to hold SDRs themselves) would play an important mediating role by developing RE roadmaps together with global south countries. The MDBs can use their expertise on how best to use the donated SDRs – as either grants or guarantees – to finance maximum investment.

As soon as SDRs are used to pay for imported RE equipment, they returned to the balance sheets of the central banks in the global north. However, the associated money creation is not a problem from an economic point of view because real values (the RE equipment) have been produced with the new money.

Similarly, the new financing procedure should involve a further, and in the best case continuous, allocation of SDRs.

A person and four horse are silouhetted against a blue sky with smal clouds. Behoind them stand two wind power turbines.
Wind power in Sulawesi, Indonesia. Various proposals have been made as to how special drawing rights can be used to enable the transition to net zero in the global south. © Muchtamir / Greenpeace

However, forwarding SDRs to finance the global energy transition goals will be hampered by global north states as soon as it results in them losing their reserve asset characteristic.

In view of the looming climate catastrophe, it is the duty of all G7 and G20 countries and their central banks to do everything they can to support the global energy transition. At the moment, however, they are putting on the brakes and not using the great economic potential of SDRs. The argument put forward by central banks to combat inflation is meaningless if the main cause of inflation is fossilflation and not exuberant demand.

In the end, the question of using SDRs for global climate finance and other sustainable development is a question of political will in the global north, or more precisely in the “global west” which consists of the G7 countries along with South Korea, Australia and New Zealand. If this will exists, all supposed legal problems can be solved.

These nations have good reason to repair the reputation lost through lack of economic aid during the Covid crisis and the price increases in the global south for energy, fertiliser and food. They must finally take the next step and use SDRs as the effective financing tool they were always meant to be.

If global west nations miss what is perhaps a final opportunity, it will not only be a major failure in the fight against climate change, but also a loss of ground against their new geopolitical competitors.

This page was last updated January 8, 2024

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