How the IMF Can Foster Inclusive Growth and Development in a Global Climate Transition

By Marilou Uy and Rishikesh Ram Bhandary

The global transformation to achieve low-carbon and climate-resilient development poses macro-critical challenges for countries around the world.

Countries need to accelerate the shift to low-carbon investments, build resilience to climate shocks, contend with loss and damage and navigate the cross-border impacts of the climate transition. Developing countries alone require an estimated $2.4 trillion each year by 2030 to undertake this transition while creating pathways to sustainable growth and development. With limited fiscal spaces and enormous development needs, public financing of these investments will strain fiscal and debt sustainability. International cooperation – which has so far fallen short – is therefore essential for mobilizing the resources for a just, global transition.

The International Monetary Fund (IMF) is crucial to promoting macroeconomic and financial stability that is aligned with robust long-term sustainable and resilient growth pathways. In recognizing the macro-criticality of climate change and rapidly working to implement its 2021 Climate Change Strategy, the IMF has taken important steps to enhance the analytical work underpinning its surveillance activities and policy advice at the country and global levels, expand its lending toolkit and provide global leadership to facilitate multilateral cooperation. For example, the IMF expanded its lending toolkit by creating a new instrument, the Resilience and Sustainability Facility (RSF), to provide medium-term financing to support ‘policy reforms that reduce macro-critical risks associated with climate change.’

Going forward, the key question – posed particularly by developing countries, which make up more than two-thirds of its membership – is how can the IMF promote a just climate transition that will support the investment push necessary to foster resilient and sustainable growth over the medium-term?

A new report from the Task Force for Climate, Development, and the IMF provides a preliminary assessment of the strengths and shortcomings of the IMF’s approach to climate change, with a development lens that focuses on the achievement of development and climate change goals.

The Task Force is composed of think tanks and intergovernmental groups of countries primarily from the Global South with the core mission of advancing a development-centered approach to climate change at the IMF. It has conducted research to better understand the nature and impacts of climate risks on developing countries and regions, as well as the channels through which these risks affect inclusive growth, fiscal and debt trajectories.

Three areas for greater IMF leadership

The report takes stock of the efforts by the IMF to integrate climate change into its operations and draws from the research and policy papers by the Task Force that examine, among many other topics, the possible cross-border spillovers of climate policies, the Carbon Border Adjustment Mechanism, International Carbon Price Floors and faster climate transitions.

The report identifies three major areas where the IMF should show greater leadership to consider a development-centered approach in its climate strategy:

1. Multilateral surveillance activities have so far adopted a “one-size-fits-all” approach with carbon pricing as a panacea for climate action.
2. Bilateral surveillance activities are underestimating the macroeconomic implications of financing climate transitions in a financially stable manner.
3. The IMF lending toolkit lacks appropriate scale and overemphasizes short-term fiscal consolidation over long-run resource mobilization.

Multilateral surveillance and global leadership

The IMF has increased the pace of mainstreaming climate change in its surveillance instruments. The IMF’s economic health checks – Article IV consultations – have intensified coverage of climate mitigation policies in the 20 countries with the highest greenhouse gas emissions. The effectiveness of these policies hinges on international policy coordination and is thus, central to multilateral surveillance. The IMF stresses the urgency of more ambitious and coordinated climate actions globally and charts feasible progressive pathways to achieve net-zero emissions. Delays will only raise the cost of the climate transition. IMF Staff Climate Notes advocate for international carbon pricing among the largest emitters as the core instrument for climate mitigation in a policy mix that also includes public expenditure reforms, enhanced social protection and support for technology research.

There is, nevertheless, more scope for the IMF to foster an investment-led approach to a just global transition. While carbon pricing is regarded as an ideal solution to provide incentives and revenues to support climate mitigation, the reality is that many countries are opting for non-price measures that are more feasible to implement, both technically and politically. Going forward, it is essential for the IMF to develop a robust framework, reflecting the diversity of climate policies, that can be systematically applied by countries to understand how diverse price and non-price instruments contribute to climate change mitigation. In addition, the IMF needs to play a key role in catalyzing multilateral cooperation to scale up climate financing for investments in mitigation, adaptation and recovery from loss and damage. More analytical work is needed to better estimate the aggregate impacts of cross-border spillovers and the cost of climate transition in countries with diverse national circumstances such as climate vulnerability, carbon intensity, income levels and beyond.

Bilateral surveillance

The integration of climate risks in Article IV consultations and Debt Sustainability Analyses (DSAs) has gained momentum, but developing models that capture the scope of climate-related risks and their macroeconomic impacts face significant challenges. The Task Force encourages the IMF to build on state-of-the-art tools and research approaches to assess compounding climate risks for sovereign fiscal and financial stability. In short, DSAs should explicitly account for climate risks and its implications on fiscal policy, investment needs, debt burdens and the income distribution.

Research by the Task Force shows that the transition to net zero will lead to significant revenue losses, particularly for countries that are reliant on fossil fuel-generated revenues. The fall in revenues, if not offset by revenues from carbon pricing, constitutes a major hurdle to mobilizing resources to scale up low-carbon investments and manage transition costs. The pursuit of net-zero pathways is projected to lead to higher levels of public debt, which highlights the importance of mobilizing new sources of revenues. Bilateral surveillance should therefore cover mitigation and adaptation needs, model the effect of transition management policies and increase attention to the fiscal impacts of the climate transition.

Lending programs for climate and development 

The Task Force commends the IMF for creating the Resilience and Sustainability Trust that re-channels some Special Drawing Rights (SDRs) – the IMF’s unit of account in which member-states hold reserves with the Fund – to support climate resilience and sustainability. The IMF has also taken important steps to incorporate climate policy in its lending programs and expand the Catastrophe Containment and Relief Trust (CCRT) to provide debt relief to climate-vulnerable countries in need. The Fund should build on these achievements by bringing the necessary scale to its lending capacity, allowing it to mitigate climate shocks and mobilize the resources needed for low-carbon, resilient and inclusive growth paths of developing countries. Additionally, its lending programs should be consistent with development-led approaches to address the macro-critical challenges of climate change.

Against this background, the Task Force proposes the following steps: the IMF should incorporate climate-related financing needs to determine the “Adequacy of Fund Resources,” which will inform the extent of the increase of the IMF’s lending capacity. This expansion can be financed by either quota increases or new SDR issuances, or both. The CCRT should be expanded and the RSF scaled up with more concessional terms and design features to support country-led strategies to address their balance of payments risks over the medium-term. Using RSF funding as collateral and credit enhancement for restructured sovereign bonds could be considered to support debt sustainability. Green fiscal consolidation measures need to be replaced by investment-led programs for low-carbon and resilient growth and development.

As the IMF Managing Director Kristalina Georgieva and staff noted, there is a growing risk of geo-economic fragmentation. The need for a globally coordinated transition to a low-carbon, climate resilient pathway is more important than ever. The IMF has a central role in helping to foster this transition in an orderly manner. It has taken important steps forward, but the Task Force’s report shows that the IMF needs to do more, faster and bolder.

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