Columbia SIPA Policy Note | Scaling Clean Energy through Climate Finance Innovation
Transitioning to a low-carbon energy future consistent with the goals of the Paris Agreement requires trillions of dollars of additional investment in the Global South. Most of this investment will need to be in domestic-oriented projects, generating local currencies and creating domestic development opportunities. However, local capital alone will not be enough, and significant amounts of foreign investments in the form of debt or equity will play a critical role. Exchange rate risk—the possibility that a local currency (LC) loses value relative to the foreign currency (FC) in which a loan is denominated—is a major impediment to large foreign capital flows for clean energy projects, increasing the cost of capital and at times hindering investments altogether while creating financial exposure issues for domestic sponsors. While currency hedging and other options exist, they can be expensive and are lacking for many developing country currencies, particularly at the long tenors, low cost, and large scale required to support the needed clean energy investments.
Addressing exchange rate risk should therefore be a priority for climate- and development-focused policy makers, financial executives, clean energy investors, and civil society advocates. While this issue is important regardless of economic cycles, it is vital in times of rising interest rates and cost of capital—particularly in many emerging and developing markets, which are often seen as riskier by investors in times of global economic uncertainty.
This policy note published by Columbia SIPA Center on Global Energy Policy sets out a possible structure that could alleviate exchange rate risk for clean energy projects. It outlines a facility, supported by a combination of domestic and international resources (including carbon credits, official development assistance, and international private capital), that could issue currency exchange risk protection to international lenders to catalyze financing for clean energy projects in developing countries.
