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Structurally different transitions
- The global transition to a low-carbon economy is one of five mega forces sweeping markets and economies. We see emerging markets (EM) playing a decisive role in this transition. Why? We estimate EM economies will account for over half of energy demand and carbon emissions by 2050. We believe this means the shape and speed of EM transitions will in large part define the speed and shape of the global transition.
- The consequences of a changing climate will be even more acute for EM than for developed markets (DM), in our view. We think several structural factors set EM countries apart from DM economies in the transition: stronger growth in energy demand, a higher cost of capital to finance the transition, a larger share of hard-to-abate emissions – or those that can’t be easily reduced by low-carbon technology – and greater exposure to physical climate damage.
- These factors, plus the greater investment risk perceived broadly in these economies, mean transition-related investment in EM will likely be notably lower than what they need across a range of scenarios, in our view. Recent trends back this up: aggregate low-carbon investment in EMs excluding China and Russia has held flat while it has accelerated in DM and China. We estimate annual EM investment needs could be between 17-24 times higher than recent public commitments from DMs for climate finance, or public or private investments aimed at decarbonizing the economy or funding adaptation and resilience to physical climate change.
- We think closing the gap would require significant public sector reforms and private sector innovation, resulting in greater "blending" of public and private capital – or blended capital. Reforms being discussed include evolving the mandates and toolkits of multilateral development banks and public financial institutions like the World Bank.
- As proposed reforms take shape, we see the potential for private capital to find new investment opportunities as part of filling the EM climate financing gap. For example, the drive for public reforms and private innovation could create new private market infrastructure opportunities or increase the pool of green bond issuance by EM countries.
- Progress on these fronts could accelerate the most-likely path of our BlackRock Investment Institute Transition Scenario (BIITS) – yet they remain a key source of uncertainty. We examine the sensitivity of our base case transition view through two hypothetical scenarios: an accelerated case where reforms are assumed to lower the EM cost of capital and indirectly increase EM climate policy ambition, and one with an assumed persistent economic drag in EMs due to ongoing sluggish financing flows.
- In our upside case, we find successful reforms could see low-carbon investment in EM increase, on average, by an additional U.S.$200 billion a year – or U.S.$4 trillion overall – above our base view of a major increase in investment between 2030-2050. We find this may result in faster decarbonization in EM. Yet if reform efforts prove less durable or effective than in our base case, we see investment levels reduced by roughly U.S.$50 billion a year, along with lower economic growth, lower energy demand and a more divergent global transition.
- We identify six challenges that could slow EM transitions through a macroeconomic drag: persistent macroeconomic risks, the economic ripple effects of shifting priorities of public financial institutions, risks to EM national climate commitments, the limited balance sheets of multilateral development banks (MDBs), a lack of available projects, and growing spreads between policy rates and rates of expected return on investments.
Authors:
- Benjamin Attia, BlackRock Investment Institute
- Chris Kaminker, Head of Sustainable Investment Research and Analytics – BlackRock Investment Institute
- Adrien Bouyssi, Aladdin Sustainability Analytics
- Nagore Sabio Arteaga, Aladdin Sustainability Analytics
- Anmay Dittman, Portfolio Manager, Climate Finance Partnership, BlackRock
- Chris Weber, Head of Climate Research – BlackRock Investment Institute
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