Date: 12/04/2023

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment; Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.

Key Phrases: World Bank, International Monetary Fund, G20, Pandemics, Inflation, Social Stability, Macroeconomic, Carbon-Reduction Timelines, Multilateral Development Banks, International Financial Institution.

Context:

• Numerous low-income countries worldwide continue to grapple with the economic aftermath of the pandemic, as well as consecutive inflation and interest-rate shocks.
• Their potential for growth is uncertain, with a pessimistic outlook in some cases. Their debt loads have not eased, and their currencies remain susceptible to further depreciation.

Key Highlights:

• The upcoming Spring Meetings of the International Monetary Fund (IMF) and the World Bank in Washington, DC, will bring together ministers and officials from around the world.
• The G20 nations will also hold their second Finance Ministers and Central Bank Governors meeting under the Indian Presidency during the same period.
• Low-income countries are feeling apprehensive about their macroeconomic and social stability, as well as anxious about their growth prospects.
• In the midst of these concerns, many are under pressure to shift to a future powered by renewable energy instead of fossil fuels.
  • As a result, they are seeking financial, technological, and material resources to facilitate this transition.

Private Financial Capital's Successfulness in the Developing World

• The idea of attracting private capital to foster global public goods could seem practically and conceptually attractive. Still, it becomes unrealistic upon scrutiny.
• The private financial world fails to finance socially and economically transformational projects in developing countries regularly.
  • Private financial capital has not proven itself efficient in allocating capital. It has frequently fomented asset bubbles, with monetary and fiscal authorities having to step in to mop up the debris afterwards.
• However, the price extractable from these nations may end up being unaffordable for their intended beneficiaries with the current low-interest rates. Therefore, for private capital flows to thrive, it has to be de-risked by the International financial institutions (IFIs).
• Nevertheless, both investors and their targets need de-risking as resources are limited, and de-risking could result in socialization of losses and privatization of gains, which creates a moral hazard.

De-Risking Investments

• Though some de-risking can benefit both investors and destination countries, some risks investments cannot be mitigated.
  • Currency risk, particularly exchanges leading to economic misery and investor's exit, is a concern, and nations need special arrangements to ease currency misalignment risk.
• Moreover, countries that want to attract private capital from abroad must indeed run current account deficits. The challenge revolves around the sustainable level of current-account-deficit in the face of an energy transition that contributes to the planet's sustainability.
• This is particularly because short-term currency and fixed-income traders and credit rating agencies have an intense focus on short-term incentives rather than global intergenerational imperatives.

Fixing the Broken Link

• The financial sector needs to understand how it can connect better with society. There must be an alignment between global intergenerational imperatives and achieving short-term goals.
• Investors should be investing in projects for the long term, and the host-country's assets should not be hollowed out to reward shareholders.
• About twelve years ago, more than 1,000 economists from 53 countries agreed that the link between finance and society was broken and called for efforts to fix this link by giving back to society. The global financial sector needs to take this seriously now.

The Role of MDBs and IFIs

• Multilateral Development Banks (MDBs) and International Financial Institutions (IFIs) have focused on de-risking investments by mitigating political and currency risks to attract private sector investments.
• MDBs and IFIs have to take up this role because they can de-risk but not eliminate risks, and governments in many low-income countries have constrained fiscal space. Moreover, the current investment flows are not enough to meet the climate objectives.
• To increase private investment, MDBs and IFIs have to work on improving the market conditions for private investments, but with the host country government playing a more aggressive role to fill critical gaps, especially around regulatory quality, legal frameworks, and reducing climate-technology risk.
• Governments should take a stronger and more active role in fostering and enabling investments in sustainable infrastructure projects, acting as intermediaries and partners between the private sector and development partners such as MDBs and IFIs.

Conclusion

• Attracting private capital remains crucial to leverage global public goods around the world.
  • Investors, policymakers, and destination countries must consider the best way to de-risk investments for the private sector, focus on long-term investments, consider sustainability, and align with global intergenerational imperatives.
• While the emphasis must be on sustainable investments, investors must also consider the moral obligations of setting fair investment terms that do not outsides the locals involved in these transition projects.
  • Policymakers must also ensure that they highlight the importance of this investment before, during and after these initiatives to the public.
• If these issues are handled properly and approached with the larger and long-term perspective, it could have a positive impact on the societal and economic growth of these nations.

Source: Live-Mint

Mains Question:

Q. How can International Financial Institutions, governments, and private investors work together to address the challenges in attracting private capital for financing energy transition projects in low-income countries? (150 words).