Moderator:

• Uli Volz, Founding Director, SOAS Centre of Sustainable Finance, SOAS University of London & Senior Research Fellow, German Development Institute

Panellists:

• Signe Krogstrup, Assistant Governor and Head of Economics and Monetary Policy, Danmarks Nationalbank
• Paolo Mauro, Deputy Director, Fiscal Affairs Department, IMF
• Irene Monasterolo, Assistant Professor of Climate Economics and Finance, Vienna University of Economics and Business and Visiting Fellow, Boston University
• Heron Belfon, Programme Coordinator, Jubilee Caribbean

Uli Volz: The IMF identified climate change as an emerging issue in 2015, and Christine Lagarde clearly tried to put a greater emphasis on this. If you look at what the Fund released just this year, it’s quite impressive, including an IMF staff paper, “Fiscal Policies for Paris Climate Strategies” (May 2019) and an IMF policy paper on “Building Resilience in Developing Countries Vulnerable to Large Natural Disasters” (June 2019).

In August, Signe – who also on today’s panel – co-authored an IMF working paper on macroeconomic policy and climate change mitigation, reviewing the evidence on the issue to date.

The recently released Global Financial Stability Report (GFSR) has a chapter on sustainable finance, while the new Fiscal Monitor, which Paolo who is on the panel today co-authored, focuses on climate mitigation policies.

At a panel on Wednesday entitled ‘Can central banks fight climate change?’, new IMF managing director Kristalina Georgieva was very clear that the IMF will now be treating climate change as a macro-critical issue. “The IMF is gearing up very rapidly to integrate climate risks in our surveillance work,” she said, according to Bloomberg. “When we are working in countries that are either big emitters of carbon, and therefore need to transition, or are at high risk of carbon shocks, there is no way to address the fundamentals of their economies without looking at these climate risks.”

Signe Krogstrup: I am new to my role at the Dansmark Nationalbank, and I was at the Fund until June. It’s incredible to see the change in tone over just four months.

But I think that there is still a discussion about what should the IMF be doing on climate change. The IMF is an organisation with quite a clear mandate and goal – which works on a clear set of issues. And in the past it has quite jealously defended what it wants to go into. There’s always a danger that we give organisations too much to do, and then they do not operate as effectively.

Macro-stability is the clear focus of IMF. So the question is: Is climate macro-critical for the Fund, and should it be doing more?

Climate is potentially macro-critical in at least two ways: disaster risks, where countries’ macroeconomic prospects are negatively affected by climate impacts; and transition risks, where the shift to a low-carbon economy may cause a change in asset valuations.

These risks require policies that the IMF is dealing with. It’s part of the baseline of macroeconomic stability.

What is really needed is a comprehensive policy framework to address climate change that fits into the IMF’s overall framework for ensuring stability. That includes stress-testing of economies for climate risks, as part of its approach to the GFSR.

There is a lot of stuff coming out on the issue of tackling climate risk, but we don’t really get the sense of how the policies fit together. In the IMF working paper we produced on macroeconomic policy and climate mitigation, our reading of the literature is that a carbon tax is really desirable – but actually it needs to be combined with a range of other policies. The literature points to some of these.

That’s another reason why we need a ‘second-best’ argument. Yes, a global carbon pricing floor is an important part of climate mitigation, but if we can’t get there, may we need to consider other policies that are more feasible. A whole policy framework is needed, not just carbon pricing.

Another question is: Is climate change mitigation a goal or constraint of macro-policy. I would be happy to talk about how we see some of these things as central banks in the question and answer discussion later. The Fund works around externalities – and is working with a lot of countries that are working with this with respect to climate issues, and this creates the need for new policies.

Uli Volz: Climate risk has to be front and centre of macroeconomic policy going forward. Irene, can you tell us how Fund can address this?

Irene Monasterolo: As Signe mentioned, there are both physical & transition risks related to climate change. The governor of Banque de France, François Villeroy de Galhau, has noted that physical risks are occurring earlier than anticipated.

The way in which in we introduce climate policy will have a big effective on financial markets. This means that there could be a big effect on different sectors. There also could be impacts for sovereign bond issues of aligned and non-aligned countries [with the Paris Agreement], as these are the main market for pension funds, which have fiduciary responsibility to not invest in risky areas.

Research on investors’ exposure to climate risk: One good message is that we don’t need to re-invent the wheel. There are existing methodologies. But, we can’t just include climate as an additional risk in models. We need to consider all the factors of climate risk, and non-linearity of risks means we can’t rely only on past models.

What can the IMF (and central banks) do? As independent institutions they have a lot of power to preserve financial stability. It will be critical for IMF to lead the way on analysing the risks to countries’ sovereign bonds. They can also provide analysis, in order for countries to identify what are the potential drivers of financial instability at the country level. This involves looking at what is the structure of the fiscal revenues and risks, country by country.

Uli Volz: At an event hosted by the Green Climate Fund last week, Jamaican prime minister Andrew Holness commented that, “Climate change is making us fiscally vulnerable. We have to treat climate change as a major macro-financial risk.” Heron, can you tell us about the experience of Caribbean countries in terms of physical risks of climate change?

Heron Belfon: Presently almost every island in the Caribbean has debt sustainability issues. In Grenada, in 2016 we had economic reforms, which dropped the debt-to-GDP ratio from 109 per cent to 62 per cent.

Our macro-economic stability is affected by climate change, which also affects our livelihoods. In Dominica, they are using the opportunity of losing over 95 per cent of the structures on the island to try to build back better, and make things more resilience to storms.

After storms, we still have debts to pay, and private loans come easier. We borrow the money, and our debt increases. One of our main campaigns is to have the IMF support a debt moratorium in the event of Caribbean countries experiencing a natural disaster, and to work as a facilitator with other creditors. Only Grenada & Barbados have this in their loan agreements, not others in Caribbean.

We have contributed the least to climate change, but we are suffering the most. This is a fight by women, for women – it is women who are leading the fight against climate change. Women are experiencing the most severe impacts of storms, and often are more affected by debt servicing, for example when cuts to services put more stress on women’s unpaid work. As we say in the Caribbean, ‘Who feels it, knows it’.

Paolo Mauro: Thanks for inviting me and I learned a lot from the presentations. It’s obvious that this is now a macro-critical issue. I have sort of been prompted to go and look at bit more at earlier macro-stability within the Fund.

I remember when I was an incoming economist at the IMF in the 1990s, there was a debate on whether we should work on the emerging issues, including climate. But people were doing research on climate change and putting forward proposals on climate from at least 2010. That line of work was so quiet; it wasn’t really the same public issue at the time.

But now, it’s central to the implications for debt; and financial stability. It’s not only a physical risk. Implementation of carbon prices are key. It’s a question for governments is, “How can I put together a package of policies that is economically efficient, and is politically feasible?”

What can be done to promote investment to support climate mitigation? We talked mostly about the power sector, but can also think about infrastructure, as those choices will have implications for the next decades: We need to focus on how to shift investment away from fossil fuels and towards green energy.

What was committed in Paris [under nationally determined contributions] leads us to 3°C of warming [compared to preindustrial levels] – that’s way outside of the safe zone. In order for us to have a climate that is safe, you would need $75/ton carbon tax by 2030. We’re trying to act as truth tellers to the global community. I hope that you can share some of the results from the Fiscal Monitor on social media, and with your colleagues.

With respect to the Caribbean – in terms of the response, we have these rapid financing facilities that can be provided, but they are not very large. We work with the World Bank to look at disaster response. There will always be a role for multilateral actors to provide finance after storms. Together with the World Bank we have also been doing climate change policy assessments in some countries. But ultimately disaster response is the job of the international community.

Uli Volz: Signe, where do you think the Fund could be contributing the most? And what is central banks’ role?

Signe Krogstrup: It’s very early for central banks’ engagement, but the Network for Greening the Financial System, now has over 40 Central Bank members. The approach is centred around risks, but there is no pricing of climate risks. A big area is stress testing, which I think is an important area of focus.

Uli Volz: Irene, on stress testing what are the key aspects of this?

Irene Monasterolo: Forty per cent of funds in EU and US are exposed to areas relevant to climate policy. Assessing what are the drivers of risk is important to designing the policy. This is important both at the country and systemic level.

Uli Volz: That is one risk, but another, as Heron mentioned, is that climate change is already affecting cost of capital in developing countries. We did a study on the effect of climate change on V20 countries’ cost of capital, which showed it is already increasing the interest on sovereign debt repayments.

Paolo Mauro: People keep talking about how climate action is costly, but the risks to the financial sector are much greater if we don’t take actions to address the problem.

Signe Krogstrup: How do you see the likelihood that we will have a path on carbon pricing that is both steep and smooth?

Paolo Mauro: Ireland last week announced a carbon tax rising from $5 to $80 over time. This followed Sweden, which has also introduced an incrementally rising tax. What we are putting forward as a proposal is that large emitters get together and have a carbon price floor; if this was the case, hopefully others could follow.

Irene Monasterolo: Of course the timing and magnitude of the low-carbon transition and the policies we will introduce will matter. We are in a free market, but markets don’t like uncertainty. After the Paris Agreement was signed, there was network of fund managers that asked the G20 to phase out of fossil fuel subsidies.

What we saw recently in our research is that financial markets reacted to the Paris Agreement, but not the way that we expected: There was a decreased risk for clean energy indices, but risk did not increase for dirty energy.

Uli Volz: I think we clearly need to have a broader discussion around climate-related debt, as well. I recall discussions of odious debt: If money is lent to countries in bad faith, should they really be responsible for paying the debts?

Audience Q&A:

Colombian CSO: The Rio Summit was in 1992, but since then we haven’t really fundamentally changed the economy to support the environment. In the area of sustainable finance, how we can invest in companies that really are sustainable?

Jon Sward, Bretton Woods Project: One potentially difficult aspect of tackling climate risk, which Kristalina Georgieva alluded to at the panel event on Wednesday, is creating a ‘green versus brown’ taxonomy. What do you see as the way forward on this, and how can we ensure that this taxonomy is a global public good that serves the real economy?

Daniela Gabor, UWE Bristol: How are ESG standards related to this discussion?

Paolo Mauro: When we look at the role of the financial sector and banks, we have to be very clear that we have to ensure that climate change does not affect financial risks, separate from mitigation.

The point of a green taxonomy is to create a list of activities that we want to encourage investment in. I’m not sure it’s feasible to have a financial system that says you cannot invest in certain things, because some actors will always invest in that area.

Irene Monasterolo: When you talk about potential ‘greenwashing’, this is ESG. ESG is not a good proxy for climate risk. If you ever dig into ESG ratings, you can see a big difference in ratings from different systems. They are not measuring the same things: There’s no standardisation.

The European Commission launched its sustainable finance taxonomy in July; but it was blocked by some members of the EU, and is now delayed two years. So this can be a very difficult process.

Signe Krogstrup: I think there are a lot of ways of trying to come up with green versus brown. A lot of it is ‘olive’, it starts as brown and then becomes green. It’s much more important to have more transparency, so that we can track. This also can’t replace climate policy.

Heron Belfon: As a region, the Caribbean needs more support. There is a climate insurance mechanism in the Caribbean – but its payouts are only a drop in the ocean, compared to the damages.

Uli Volz: Climate insurance only one piece of the policy response. We need to at some point phase out brown. There was an article in The Guardian just last week that showed that three of largest asset funds are still funding huge amounts of fossil fuels.

Soren Ambrose, ActionAid International: Together with a coalition of civil society groups, we’re calling for an automatic financing facility under UNFCCC & Warsaw Insurance Mechanism (WIM) to provide automatic debt relief to countries affected by natural disasters. What is the IMF’s view on this? Would it support this?

Insurance industry rep: Central Banks are asking the question of where risks lie, but isn’t it possible that this will create black hole for uninsurable assets: who picks up the pieces, in this case?

Colombia University participant: Has the IMF considered re-classifying government expenditures on adaptation as investments? Any plan for this?

Paolo Mauro: No current thought to correct analysis of investment in certain types of areas. This type of spending potentially subject to some countries gaming the system.

I hear a lot about support to countries faced by natural disasters. At the same time, we have to consider what the Fund does, which is to address short-term balance of payments issues. This is largely an issue to be solved by the global community. There is also a question, even though they are occurring more often, whether natural disasters are completely attributable to climate change.

Irene Monasterolo: Brief comment on the insurance part: There is a growing need for insurance regulators to introduce climate-related changes, that help to manage risks.

Heron Belfon: On loss and damage, one our asks is having this written into our loan agreements with lenders, so that payments can be automatically deferred in the case of large financial losses due to storms.

Signe Krogstrup: Don’t have an answer to insurance, but of course this is part of the transition – to move houses away from areas that are definitely going to be impacted by climate change.

Uli Volz: If we can get a brief final summing up thoughts from the panel: You have 30 seconds each!

Signe Krogstrup: We need a policy package for mitigation – we don’t currently have a sense of how all the different proposed policies fit together into a whole.

Heron Belfon: We strongly believe that some international support is needed to support the Caribbean. We hope the IMF and other international actors respond.

Irene Monasterolo: IMF, central banks and also the World Bank have a lot of work to do together. There are different risk transmission channels that affect countries at the local level in different ways; these institutions have the authority to signal to the global economy as to where the climate risks lie.

Paolo Mauro: I learned a lot from all of presentations, and from the audience. The IMF is going to continue work on this area.

Uli Volz: Well, as we have heard, we don’t have all the answers, but clearly we do have some of them. We need to move forward with action. What climate science is telling us, and also Greta [Thunberg], is that the house is on fire. We need to address them before the risks get completely out of control.