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How Pakistan can finance its greenhouse gas emissions reduction

Meeting targets for emissions reduction requires innovative strategy, especially in coal-dependent, emissions-heavy countries. This strategy also requires a comprehensive plan to finance the energy transition. The Government of Pakistan can leverage concessional climate finance from abroad through nature-based debt swaps, carbon-trading provisions, and more comprehensive green bonds among others.

The Government of Pakistan (GoP) has ambitious plans for reducing its 2030 greenhouse gas (GHG) emissions to 50% of the 2016 baseline projected levels. According to the GoP’s updated climate action plan, it aims to do so by shifting to 60% renewable energy and 30% electric vehicles by 2030, banning imported coal, and sequestering carbon through national capital restoration initiatives (such as the Ten Billion Tree Tsunami Programme and Protected Areas Initiative).

In the GoP’s view, this reduction in projected emissions should be financed from both domestic (15%) and international (35%) sources. The latter should be largely on a concessional basis (i.e., below market rate and on generous terms). Whether Pakistan reduces its emissions to meet its commitments by 2030 will thus hinge on the availability of concessional international climate finance, identifying qualifying projects, sharpening the focus of climate change initiatives, and improving the overall investment climate to attract international funds.

The availability of climate finance

Climate finance refers to local, national, or transnational financing that is targeted towards supporting mitigation and adaptation actions that address climate change. The United Nations Framework Convention on Climate Change (UNFCCC), the Kyoto Protocol, and the Paris Agreement call upon parties with more financial resources to assist those that are less endowed and more vulnerable. This is to ensure that progress towards the global objective of stabilising GHG concentrations in the atmosphere can be made.

Climate finance instruments and mechanisms include green bonds (for new investments in renewable energy), blue bonds (for example, sovereign debt restructuring for expanded maritime carbon sinks), brown bonds (for decommissioning of land-based carbon emitters), equity investment, construction-phase loans, grants, and guarantees (such as political risk and credit guarantees that can cover losses in the event of debt service default). Major climate finance providers include project sponsors, environment, social, and governance (ESG) funds, commercial banks, bilateral donors, multilateral development banks or institutions, and guarantee agencies.

Accessing international climate finance

Pakistan accounted for 0.6% of global CO2 emissions in 2018, ranking 27th from the top amongst the world’s CO2 emitters. Pakistan’s profile of relatively high emissions and relatively low GDP per capita may enable it to attract concessional mitigation-oriented climate finance based on its threat to the climate and relative poverty. However, accessing concessional international climate finance will require compliance with stringent qualifying criteria. Globally, the volume of concessionary finance has been modest. Of the total climate finance of US$ 65 billion was concessionary finance by multinationals to East Asian economies. Only US$20 billion comprised of grants to the poorest countries.

Furthermore, the majority of Pakistan’s planned mitigation spending is for renewable energy. The GoP’s current plans anticipate US$ 101 billion for the energy transition alone (the energy sector accounted for 41% of Pakistan’s 2018 GHG emissions). As the costs of renewable energy alternatives fall within the range for fossil fuel options, non-concessional financing for renewable energy investments has become the norm. Investors expect renewable energy investments to cover their costs and provide an adequate return on investment. They would not qualify for concessionary climate finance. Recent trends show the same; of about US$ 324 billion in recent worldwide annual funding for renewable energy, a large proportion was market-rate debt and private equity.

Exploring possibilities to expand climate finance 

Achieving GHG emissions reduction targets will require Pakistan to develop an innovative strategy which targets external climate finance for both renewable energy and other climate change investments. The GoP can explore the following options to do so:

1. Working with conservation financiers to organise nature-based debt swaps

In November 2021, the largest debt refinancing to date for ocean conservation was negotiated between The Nature Conservatory – an environmental organisation – and the Government of Belize (GoB). According to the terms agreed, GoB committed to protecting 30% of Belize’s ocean (as well as a range of other conservation initiatives) in exchange for a US$ 362 million debt-for-nature swap. This would reduce Belize’s debt by 12% of GDP. Pakistan can explore financing nature conservation projects, such as the Ten Billion Tree Tsunami Programme, through a similar settlement. In April 2021, GoP issued a 30-year bond for US$ 500 million. If GoP can borrow to redeem the outstanding April 2051 bond, it could generate debt servicing savings which could potentially fund 5.7 billion trees over the bonds’ remaining maturity period.

2. Working with multilateral and bilateral development financial institutions (DFIs) to use carbon-trading provisions in the 2015 Paris Agreement to finance the decommissioning of heavily polluting coal-fired plants

Coal consumption has tripled over the past five years to 21.5 million tons/year because of growing demand from industry (especially cement), and due to local coal power production starting in 2018.  Compared to coal-fired plants in the US, Russia, and Europe that have a higher average age of 30-40 years, Pakistan’s coal fleet is fairly young. The GoP could use this to its advantage when negotiating coal plant retirements – it would be rare for a new coal-fired plant to be decommissioned without some sort of concessional financing. Moreover, the emissions reductions accruing from decommissioning can be calculated by measuring the current annual emissions and assuming that these savings would continue for the remaining years of the expected life of the plant. Given reasonable expectations on investor returns, plant utilisation and emissions, decommissioning costs, and the future value of carbon credits, it should be possible to borrow enough from DFIs to (i) buy out the investors for major coal-fired plants and pay decommissioning costs, and (ii) rely on the revenue from future carbon credits to pay off this DFI borrowing.

3. Stressing climate change priorities in sectoral strategies to identify emissions, reducing opportunities such as mitigating crop burning by investment in better planting technologies

For three weeks in October-November, farmers in the Punjab province resort to stubble burning of the harvested rice crop to prepare the fields for wheat sowing. Due to this (and also because of low-grade fuel, industrial emissions, and dust particles), many cities in Punjab experience a sharp deterioration in air quality. Lahore, with a population of more than 10 million people, now ranks among the most polluted cities in the world while      Pakistan came third in the list of the most polluted countries in 2021. One known technology for eliminating stubble burning is the ‘happy seeder’ which breaks down rice stubble (mulching it to the ground), and plants wheat seeds simultaneously. Options to subsidise this technology to make it financially viable for the farmers, incorporate a premium price for farmers if they commit to non-burning, or approaching environmental organisations (such as The Nature Conservatory above) to fund crop stubble burning abatement can be explored.

4. Converting Pakistan’s NDCs 2021 into a comprehensive document for climate investors

Potential climate financiers might appreciate a more fully developed presentation of emissions reduction plans. It will be important to show which specific changes would be needed for Pakistan to reduce 2030 emissions to 50% below the baseline projection. For example, the GoP contemplates major increases in renewable energy but the goals for achieving renewable energy targets have not been laid out clearly. Specific projects, and the emissions cut contribution for each, should be identified and grouped by suitability for non-concessional versus concessional climate finance. It will also be important to generate credible investment costs projections. For example, the estimate for buying out new coal power plants and Thar coal mines is placed at US$ 18 billion, which is significantly greater than the investments in the five electricity generation public-private partnerships (PPPs) that reached financial close since 2016 and totalled only US$ 6.6 billion.

5. Refining domestic guidelines for green bonds to minimise burdens on investors, while assuring that green bond sale proceeds contribute to climate mitigation or adaptation

The International Capital Market Association (ICMA) is a non-profit association and is responsible for the development and monitoring of the Green Bond Principles that provide guidelines on transparency, disclosure and reporting on funding to projects that contribute to environmental sustainability. In September 2021, the Securities Exchange Commission of Pakistan (SECP) approved the national guidelines for green bonds. These guidelines recognise and go beyond the ICMA principles for green investment, requiring more work for the issuer and regulator. For example, SECP requires the issuer to map the project to the UN Sustainable Development Goals, describe the criteria for evaluation, selection and financing of projects in the asset pool of the green bond, and disclose external review report (undertaken before issuance of the green bond) on the issuer’s website. Consistent with its overall approach to securities regulation, the SECP may wish to bring green bond disclosures in line with ICMA requirements and simply ensure that any required disclosures are included in each green bond prospectus. This leaves it to potential investors to make their own assessments about a bond’s greenness.

6. Enhancing Pakistan’s competitiveness vis-à-vis other major claimants on private investment by improving its country risk rating, especially rule-of-law indicators

A country’s risk rating can affect the overall credit rating for a public-private partnership (PPP) project company, and hence the cost of its debt and the rate at which it can profitably sell an infrastructure service (such as electricity) within the country. To build on the proposed recommendations above, it will be important to simultaneously improve Pakistan’s risk rating. Although Pakistan’s overall PPP rating exceeds the average for South Asia (and is almost at par with the average for high-income countries), it currently ranks at about 25th percentile from the bottom on rule of law indicators, well below the averages for South Asia and other regions. To raise Pakistan’s attractiveness to potential foreign PPP sponsors, GoP could learn from other countries who have excelled in aspects of PPP (project preparation, procurement, contract management, treatment of unsolicited proposals), and work to improve the country’s rule of law rating. This will enhance investor confidence in contract enforcement, property rights, and physical security.

Leveraging opportunities in climate finance

Recent climate finance developments have major implications for Pakistan. The war in Ukraine further clouds prospects for a substantial increase in the overall volume of funds. Attracting climate finance would require Pakistan to pursue nature-based bonds, work with potential investors to decommission coal plants, encourage more domestic issuance of green bonds, invest in green technologies, and improve investor perceptions of country risk. Importantly, it will be critical to build capacity and technical expertise within the Ministry of Finance so it can identify and mobilise financing from the range of climate finance instruments and means available internationally.

LSE Environment Week will convene from 19-23 September to encourage economic research on environmental issues and influence policy change. This article is based on this IGC project and was published in collaboration with LSE’s International Development blog.

 

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