Panellists:

Sargon Nissan, Recourse, moderator

Johannes Wiegand, IMF

Irene Monasterolo, Vienna University of Economics and Business

Niranjali Amerasinghe, ActionAid USA

Respondents:

Sane Jane Ahmed, Advisor to V20

Maju Varghese, Center for Financial Accountability (India)

Sargon Nissan, Recourse (moderator) – introductory remarks: Today’s event is about a journey we are undertaking over the next short decade. The countdown to the Paris Agreement commitments has begun. We are travelling there together. You’ll notice the term ‘transition’ in the title of today’s event – we are moving from one context very rapidly to another with consequences that reach into the heart of our economic policy choices. The question for today is not if we are, but how we do so.

In recent years, we’ve seen a growing number of unlikely allies join the fight against the climate crisis: investors, central banks, leading politicians and of course, the IMF. The Paris Agreement commitments explicitly set out the “pathway toward low greenhouse gas emissions and climate-resilient development”. The connection of this pathway to the terms of the transition we are undertaking is something the IMF’s Managing Director Kristalina Georgieva has herself recognised, time and again, most recently a couple weeks ago when she implored that: “We cannot have macroeconomic and financial stability without environmental and social sustainability,” during an online panel discussion hosted by the United Nations Environment Programme and Oxford University.

But today’s event is about the devil in the detail. The MD added: “We have run all the possible analysis on the transition to the new climate economy. It cannot happen fast enough without carbon pricing and right now, where are we? On average carbon price on a global scale is $2 per ton. Where we should be at this moment is $75 per ton,” she said. Acknowledging the political challenges of moving forward with carbon price policies, particularly a carbon tax, and asserting it can be conducted in a just manner, she noted, “It is politically difficult unless it is done right. When we factor in who needs to be compensated and protected by the pressures that come from carbon price, when we redistribute we get revenues and then we give it back – then it is possible to move on carbon price.”

As perhaps most of you watching are well aware, that represents a drastic change in our economies over a very short timeframe, with major decisions and agreements set to be announced in the next weeks and months, including the US Climate Summit, UK ministerial, and even within the IMF with its Comprehensive Surveillance Review shortly to be decided. Now, we face the Covid-19 crisis and the impact on countries’ revenues, stability and ability to commit public investment to energy transition. What does that mean, what risks do countries face, and what can IMF do to support this, including perhaps jettisoning the advice hindering transition?

Johannes Wiegand, IMF: Thank you for the introduction, Sargon. I am an advisor in the IMF Strategy, Policy and Review Department, which is the department that works on IMF policies, and also the co-chair of the IMF’s internal climate advisory group, which is a group with members of all the departments in the IMF that work on climate. We use this group to disseminate information and to advance the work of the IMF’s climate work more generally. I will speak generally today about the IMF’s work on climate and surveillance. I am somewhat less well positioned to answer questions about surveillance in specific countries, where of course the work is led by IMF mission chiefs.

I’d like to take a step back and discuss the IMF’s surveillance mandate, which is part of the IMF’s wider mandate, which is to help its member countries address balance of payment difficulties, and more generally to ensure macroeconomic stability. This is enshrined in the IMF’s Articles of Agreement, which are binding. That has implications for the approach the IMF takes to climate: It enters into the IMF’s work to the extent that it affects global macro-economic and financial stability. It is not an objective in itself, as it would be for, for example, a development bank.

There are distinct elements of the IMF’s mandate: Its lending, its capacity, and – what we are talking about today – its surveillance. This is a potentially potent tool, as it is universally done with all its members. From the largest economies to small island states, all of them have annual Article IVs. This means that we have a policy dialogue with all of our members.

How does climate come into all of this? This is not an entirely a new topic for the IMF. The 2008 WEO [World Economic Outlook] looked at the emissions of greenhouse gases as a potentially damaging externality. A lot of research papers have been published in the intervening years across a number of issues, including on fuel subsides, carbon pricing, resilience building to natural disasters, and the financial impact of climate change.

In terms of surveillance, we had a number of climate and energy pilots in Article IVs between 2015-2017. This was to see whether it was suitable to include these issues in surveillance. Following this, we continued to integrate these issues into Article IVs, until this was interrupted by the Covid crisis and we had to delay all Article IVs in order to focus on the immediate response to the crisis.

About a half-year ago we took up the issue again, and I think it has become clear to all of us at the Fund that we need to incorporate climate systemically into surveillance. The financial impact of climate change is so clear for all our members, although through different avenues, so climate needs to be an integral part of our surveillance.

We’re currently undertaking the Comprehensive Surveillance Review, which will set out key areas of focus of surveillance where updates are needed over the coming years, and will be published by the end of April. It will include very clear language on climate being a priority of IMF surveillance.

Specifically, what we are proposing in the comprehensive surveillance review is that our surveillance on climate would focus on the largest emitters of greenhouse gases. So, with these ones, we will seek to engage systematically under mitigation policies, at least every three years. Now of course  there are many other policy challenges related to climate change. One is adaptation. The other one is transition risks. And on adaptation and transition risks, these should be covered an Article IV if it gives rise in the country to systematic challenges for macro-economic policies.

Transition risk is really very broadly defined [by the Fund]. Transition risk is about achieving domestic policy objectives and that can be achieved in a country’s Nationally Determined Contribution under the Paris Agreement. In many countries, achieving these will require very significant policy changes to tax policies, to transfers, to financial sector policies. And wherever that is the case, in principle, Article IV consultations should cover these challenges. In practice, of course, we need to prioritise limited staff capacity at the IMF. And, we have limited staff at the IMF who are literate in both macroeconomics and climate issues. There is a need to use that staff in a way that generates the most return and gives the most value-added for engagement.

One priority we have very clearly is what I mentioned earlier: That’s the focus on major emitters of greenhouse gases. So, we already had discussions with quite a few of those. Our objective is to extend that to everybody who really systematically matters in terms of contribution to global warming. If we cover the 20 largest emitters of greenhouse gases, we cover 80 per cent of greenhouse gas emissions. And our view is that the most important policy to contain climate change is to seek to reduce the dependence of the largest emitters of greenhouse gases on the consumption of fossil fuels. And, therefore, I think that’s sort of one priority of surveillance.

I should say that in this area we are also active outside of the normal Article IV process. For example, the IMF is also co-chairing the Secretariat of the Coalition of Finance Ministers for Climate Action, which we hope will become a quite important forum to discuss climate mitigation policies.

The other priority area is adaptation. Many of our members are very vulnerable to climate change because they get hit regularly and with increasing frequency by natural disasters, and that has all kinds of implications for economic policies and requires that these countries build fiscal space in order to finance adaptation investments, and to deal with disasters when they strike.

Adaptation is in many ways a trickier issue than mitigation policies to achieve a country’s contribution to the Paris Agreement. I think we have a relatively good idea what policies are needed in order to initiate a transition away from dirty to clean energies, and hence a lot of carbon pricing and regulatory policies, and then policies to compensate those negatively affected by the transition. For adaptation, this is really unique for every country, so the challenge is different. Some countries are vulnerable to hurricanes. Other ones are vulnerable to droughts. Some have large tax bases, others small ones; some are highly indebted, and so on. We have fairly promising instruments which are the Climate Change Policy Assessments (CCPAs), that we have conducted on a pilot basis together with the World Bank. The IMF focuses more on financial resilience building, and the Bank on physical resilience building, so we’re identifying investment projects needed to build resilience to climate change. But these CCPAs are very work intensive and absorb a lot of staff time, so we are evaluating how to use these going forward.

That brings me now to the topic of this presentation – transition risks. As I said before, we define ‘transition’ rather broadly. One important area of transition risk is the transition to low carbon economy, among countries who produce a lot of greenhouse gases and how to initiate that. But of course, we also very aware that fossil fuel exporters face very significant transition risks, especially among countries where government receipts from fossil fuel exports are up to 80 or 90 per cent of the total revenue. And especially for those countries where extraction costs for fossil fuels are high, they’re extremely vulnerable to a drop in demand for fossil fuels, which of course is necessary in the context of a transition to a low-carbon global economy.

I think the later presentations that will show that the IMF hasn’t done terribly much on transition risks so far, or if it has done, it has done the wrong things. I think I would first want to acknowledge that transition risk is indeed an area where we feel we have a lot of work to do. Again, we need to use our limited resources in places where we think we can have the largest impact. And I think the decision has been, so far, to concentrate that to a significant degree on mitigation, and to some degree on adaptation.

We haven’t advanced to the same degree with regards to the treatment of transition risks in Article IVs. Partly that relates to resource constraints. But I think it also reflects that this is a genuinely difficult topic. So, one aspect is, of course, countries who are resource rich and depend a lot on fossil fuels, they should probably invest the receipts, as long as they still have them, in a way that diversifies exposure: They should invest them into assets that would benefit from the transition to a low-carbon economy, rather than being harmed by the transition to a low-carbon economy. But of course while there are some countries that have large surpluses to invest, which is true for quite a few fossil fuel exporters, there are quite a few fossil fuel exporters who themselves face limited fiscal space, and don’t have large surpluses to invest. So for some countries, this advice is more relevant for others.

The more tricky issue is how to how to diversify the economy. Throughout the years, there has been a debate about how commodity-rich countries can diversify the export base, because I think we are well aware that, in the long term, relying on commodity exports is not the most promising development model. And this is just very difficult to do. If there’s one very profitable sector in the economy that absorbs most of the resources, moving resources out of that sector in order to diversify goes against all financial incentives that exist within the economies. And frankly, I do not think that economists have found really good answers over the past 30 years on how whole countries dependent on commodity exports can diversify.

It doesn’t mean, of course, that we are off the hook here. We just need to think harder to find potential policy responses from the countries that are affected, and that require capacity building from the IMF for these types of questions. And I also think that will take some time. I think we would probably need to hire quite significant additional expertise in order to be really able to address these issues comprehensively and of course this has budgetary implications.

Now before we finish I would like to say a couple of words on the paper that was distributed earlier. I think one of one of the panelists is the author, and the briefing analyzes our track record in dealing with transition risks. I’m not surprised that the overall tenor isn’t particularly positive. We are well aware that this is an area where significantly more work is needed. What I’m not so happy about is this finding that not only have we not covered it well, but we have covered it and sort of given unfavorable advice. I should say, I’ve distributed the paper within our climate advisory group for people to look at, and would also be interested in reading the full paper, because of course what was distributed so far is in highly aggregate form, and allows limited insights.

I have maybe two comments. In the first instance, on the IMF’s promotion of the privatization of state-owned enterprises (SOEs) related to energy. My suspicion is that very often that was in the context of general calls, rather than specific to energy companies, but I may be wrong. But in any case it is not totally clear to us that public energy companies are better suited for the transition to a low-carbon economy than private sector companies. What matters is that these companies operate under the right incentives and governance. For example, a clear path to higher carbon prices that provides incentives in order to transition to a low-carbon economy. And the second point, another point of criticism is that the IMF often advocates reducing energy subsidies. I was a little bit surprised by this, because without a very large change in prices from dirty to clean energy, we will not be able to do the low carbon transition, and reducing energy subsidies is very often the first step to that, so it’s not clear to me how we can have a transition to a low-carbon economy without these price signals that have implications for energy subsidies. Our policy advice in these cases is to protect the poor from any such reforms – to have compensatory schemes for cash transfers. In our World Economic Outlook from the fall of last year, I think, there is a very comprehensive strategy, not only for energy subsidies, but how to manage carbon pricing in general, to ensure the transition is job bridging and does not occur at the expense of the poorest.

Irene Monasterolo, Vienna University of Economics and Business: Good morning, everybody. Indeed, I’m one of the co-authors of one of the reports that was mentioned by Johannes. I will reply to the comments that I can address because I am the macro-economist in the team, so actually I’m dealing with the macroeconomic model development, and not on the issues that are related to the textual analysis, which led to the result on the IMF’s discussion of transition risks. These were derived from a search done of Article IVs, that we mentioned in the in the paper.

In terms of energy companies, and the role of the public – yes, of course, this is a matter of incentives. However, we believe that based on experience in several low-income countries there is the possibility to promote better governance at the public level, if you boost public investment in energy and the low-carbon transition. And this is also due to the fact that, given the magnitude of the challenge of transforming the energy system, as you rightly recognize, particularly in low-income countries, this might not be done by local, private firms. And the third point, which is about reducing energy subsidies: The point is always on how you do it. And indeed, this requires some compensation, or this would disproportionately affect poorer households.

Today, I will discuss, in particular, the part of the research that I am more responsible for, and which I can hopefully provide the IMF with some recommendations on. This is from recent research on the assessment of climate related-financial risk, that incorporates some macro-critical aspects of transition risks, and in particular spill-over risk, in its assessment. So what we learned in the recent years is that climate risks are crucial for financial stability. In 2017, we published a climate stress test of the financial system, where we show that investors are highly exposed to climate transition risk, especially from risks that stem from what is called now by the Network for Greening the Financial System (NFGS) a ‘disorderly transition’. This is a situation in which climate policies are introduced in a late and sudden way, and thus cannot be fully anticipated by investors. We also found in that analysis, that focused on the EU and US financial market, that unanticipated climate policies could have implications for individual and systemic risk. In this regard, on the relation between climate risk and financial stability there has been growing research looking at macroeconomics and finance, and we tried to collect some of the best unpublished papers in our special issue which has just been published in Journal of Financial Stability on this topic.

Two years ago, I was on the same stage, with Uli Voz and Paulo Mauro, where we looked at the role of the IMF on tackling climate risks (see Dispatch Annuals 2019). The IMF has also been increasingly looking at this, including in its FSAP for Norway in 2020, which looked at the transition risks to Norway’s financial sector. At the same time, there has been growing attention on the relation between climate change and financial stability by central banks and financial regulators, and, in particular, those who joined the NFGS and are considering both physical and transition risk. Indeed, several central banks of the network have started to develop and run their own climate stress tests, such as the Dutch Central Bank, Bank of France, and more recently the European Central Bank.

What we find in our analysis is that there is space, we believe, for the IMF to catch up with what has been done by the NGFS so far and in particular on the topic of transition risk, by building for instance on the pilot analysis the IMF did with Norway last year. A main point on which we focus our analysis in the briefing, and our new research project, is on spill-over transition risk, which is what happens in low-income countries which are dependent on either export of fossil fuels or tourism services, when high-income countries introduce stricter climate policies.

Introducing climate into stress tests is crucial to assess countries’ financial stability related to climate physical and transition scenarios, and this in turn is important to build coherence across policies. This is a topic that has not been only highlighted by research, but also by several central banks, regarding the fact that monetary policies alone cannot solve the issue. There is the need to build more coherence between fiscal, monetary, and macro-prudential policies. In this time when governments are designing their Covid recovery policies, it is crucial, in particular for countries that have limited fiscal space, to avoid policy trade-offs between financing the Covid recovery and financing climate change.

What we want to highlight in our research is that both physical and transition risk are macro-critical, yet they are characterised by very different risk-transmission channels, and this should be taken into account in the macroeconomic modelling, in order to avoid misunderstanding of results. Transition risks are perhaps the most macro-critical in the short term. In the end, they could impact on the economy, livelihoods, private and public finance, as well as on our ability to mitigate physical risks in the mid- to long-term. In this context, spill-over transition risks are in particular critical for low-income countries where the development path is closely linked to the export to fossil fuels or other activities, such as tourism, that imply intensive by-side activities, such as intercontinental flights. And this could affect exports and balance of payments, and in the end their sovereign risk.

What we would like to highlight is that  the analysis that has been done, also by the IMF, in particular the macroeconomic assessment of climate change, mostly focused on physical risks and neglected the feedback from finance to economic and policy decisions. In a paper published at the beginning of this year, we call this investors’ ‘climate sentiments’. Research found that this could be crucial, and very important in affecting climate policies’ implementation, and could lead to some unintended effects.

So when we talk about spill-over transition risk, as in the new research project that we are developing with Boston University, we are considering both the direct and indirect impacts. Indonesia is a big exporter of coal. So the direct impacts will be lower coal import prices from China or South Korea, which will lead to lower coal extraction and production in Indonesia, and thus lower coal export, and this will have two different channels of transmission. On the one hand, it will worsen the balance of payments for the country, with implications on fiscal revenues and sovereign debt sustainability. On the other hand, it will affect directly the profitability of fossil fuel companies, and this in turn will have cascading effects on the economy in terms of investments, employment, wages, GDP, and households inequality, as well as on private finance, with adjustment in asset pricing, adjustments in firms’ credit risk, and in firms’ financing costs from the banks, which eventually could be affected by non-performing loans. Both the effects on the economy of private and public finance could lead to the realisation of carbon stranded assets in the economy. What we also highlight in this paper are the feedbacks of that on public and private finance.

Another example is what could happen if the European Union, for instance, increases international flight costs, in order to compensate for the emissions. This could affect tourism arrivals in countries, for instance in the Caribbean, such as Jamaica, where tourism represents a big share of GDP, and lower the profitability of the service sector, with effects, again, on public finance where fiscal revenues are affected, on private finance of the companies active in the tourism sector, some of which are international companies, for instance international hotel chains, as well as on the wider economy.

In our analysis, we build on insights from research to include the climate considerations into stress tests. The first point that would like to make is the importance to assess the materiality of spillover transition risks. For doing so, we need standardized, transparent financial and non-financial disclosure of firms’ and activities’ contribution to climate change. And this means not only assessing what are the green companies such as what has been done by the EU taxonomy for green activities, but also complementing it with the classification of activities that are at risk for carbon stranded assets. So far, a standardised classification of stranded asset is not available yet. In our climate stress test of 2017, we introduced a classification of climate policies impact on sectors to assess activities’ exposure to climate transition risk, and this has been used by the European Central Bank, EBA, and the European Insurance and Occupational Pension Authority.

The second point is the importance to assess risk transmission channels, because different types of risk have different distribution channels, to agents and sectors of the economy and finance. To do so, we need macroeconomic models that actually embed the relation between economic and financial agents and don’t consider finance only as a friction but consider it in its complexity.

And finally, we should remember that climate change risk does not happen in isolation, but it can compound with other sources of socio-economic vulnerabilities, such as inequality and high public debt, but also with external shocks, as in the Covid crisis. We are working with the World Bank on assessing the macroeconomic impact and financial impacts of compound risk in the economy and we found that this changes the situation a lot for several low-income countries.

Further, since finance, as an impact, and in particular the feedbacks from finance, can have a big impact on the effectiveness of the policies that we introduce, this should be assessed in the macroeconomic models and responses.

Another point that usually doesn’t get enough attention when we discuss transition risk are the scenarios. The NFGS has developed a set orderly and disorderly transition scenarios, that have also started to be used by the private sector. However, those scenarios might be a bit too optimistic about the energy technology trajectories that would allow us to make the transition, simply because they don’t consider the role of finance in addressing those trajectories. For instance, they assume that capital is always available for investments.

So some recommendations, which we hope will be constructive and could actually bring some attention to the results of the research in the last year. First, is that climate transition risk and climate sentiments can largely affect implementation of climate policies, and the realisation of carbon stranded assets in an economy, and thus they should be carefully considered. And to embed countries’ climate risk in the reviews of the IMF Article IVs and FSAPs, we should recognise that both physical and transition risk within and across countries are macro-critical threats to financial and macroeconomic stability; and that spillover transitional risks can impact the balance of payments early, then triggering investors’ climate sentiment. That in turn can affect countries’ financial position, and thus their ability to respond to climate change risk. It is important to mainstream compulsory and systematic physical and transition risk assessment within and across countries. And in this regard, there is a lot of evidence already provided by research. Finally, the last recommendation is to foster knowledge co-production across stakeholders.

Niranjali Amerasinghe, ActionAid USA: I work with ActionAid USA, and along with the Bretton Woods Project, we engaged in this exercise of looking at IMF surveillance, energy transition, and also climate equity, because we felt that this equity part is sometimes a piece that gets missed in the conversation around climate change, and integrating climate risk and relevant issues into work that IFIs are doing. And especially in light of the COVID crisis and the debt crisis and the climate crisis – these tri-fold crises that countries are dealing with – it’s really important to keep the equity dimension in mind.  Irena and Johannes have talked about the importance of transition risks, the fact that they’re macro-critical, and in many countries – if they don’t take action quickly – they are going to be headed for a potential fiscal disaster when the carbon bubble eventually bursts.

But what we wanted to understand is not just to what extent the IMF is taking transition risk into account – because I think the answer to that is pretty clear, it’s not yet doing enough – but to what extent the policy advice that has been provided since the Paris Agreement is or is not exacerbating transition risks and climate risks. And the reason to focus on the policy advice – Johannes touched on this, it being one of the universal bits of what the IMF does – but also its important to keep in mind that Article IV surveillance reports oftentimes shape the policy environment of the country. And it will also influence the perception of fiscal health of that country – how the international financial market looks at a country’s economic trajectory is often influenced by the IMF Article IV surveillance reports. So it does play a huge role in influencing what countries might be doing on a policy level, and in legitimising whatever the investment trend, even if it’s unrealistic, might be for fossil fuel projects. And so this is why we wanted to really dig a little bit deeper to try to understand the role of the existing policy advice in this context because the IMF is in the space already, and if it is going to take on looking at transition risks and integrating climate change more significantly into its operations, understanding the backdrop of this is also important.

I’ll talk about why we looked at fossil fuel infrastructure development, privatization of state-owned enterprises and fossil fuel subsidies in a bit to shed some light to the questions that Johannes raised. So far what we’ve looked at is Article IV reports from December 2015 to May 2019. We’re going to update that up to 2020. These are very preliminary results and what we’ve done is an initial keyword search and looked into the reports that generated hits around the three areas that we were looking at. And we found that almost half of all the reports published in that period generate hits and covered about 114 member countries. So keep in mind that these are preliminary; we ourselves do need to dig deeper to understand the connections and some of the issues that Johannes was raising. But there are some early things that we can talk about for now, given the timeliness of the consultations that are happening on Article IV surveillance.

So of the three things that we focused on, the first one is fairly obvious, looking at where the IMF might be advising or supporting the development of fossil fuel infrastructure, and I’ll get to more specific examples in just a little bit but clearly, where there is a need to address energy infrastructure deficits, and that’s promoting the generation of fossil fuel infrastructure, that’s a potential challenge from both the climate risk and transition risk standpoint.

The exploration of subsidies, and the advice around reduction and elimination of finishes, I want to be clear about this: It’s not that we’re saying reduction or elimination of fossil fuel subsidies is a bad thing. Not at all. Many of us have been supportive of calls to eliminate and reduce fossil fuel subsidies. The issue is how it’s done, because it cannot be done alone. It needs to be done in a broader environment where green alternatives are being promoted, because if fossil fuel subsidies are eliminated simply as one tool that can lead to price instability, it can lead to a greater dependence on foreign debt which can be challenging for countries, and simply trying to deal with incentives for the poor can also lead to huge targeting errors. So, the elimination or reduction of fossil fuel subsidies needs to be done in a broader context where the socio-economic issues in the country have been have been dealt with, and you’ve got alternatives on the table, because otherwise consumption patterns, or at least the total consumption, is unlikely to change if we don’t have alternatives and that’s the equity and just transition piece we were trying to get a little bit of a deeper understanding on in looking at these reports.

And then the third thing we looked at was the privatisation of state-owned enterprises, and this does include specific calls as well as general calls for privatisation. And the reason that we have included this, there’s been a lot written about the relationship between privatisation and fossil fuels, and some of the work that I did in a previous job was to try to understand the vicious cycle between fiscal health and needing to invest in fossil fuels. And the more you privatised, the more you have to respond to what the market perceives as viable, and for decades we have created markets that have perceived fossil fuels as market viable. It’s only recently that we’ve seen this change in the market to greener alternatives. So, trying to understand that intersection was part of what we were looking at. But perhaps the more important point is that the more you privatise your power and energy sector or even through a general corporate privatisation, the less agency the government has to make the changes that are needed, and we know that for many countries these changes, if we want to respond to climate change, are going to be dramatic. And if the government is handing over control to the private sector, for things that need to be regulated from a public goods standpoint, it creates coordination problems, but it also transfers the risk to private balance sheets, which means that you’re going to have a stranded asset liability problem. And we’re already seeing investor-state arbitration come forward, that are potentially going to put countries in massive fiscal crisis, because they’re going to have to somehow pay off foreign investors who were planning on running fossil fuel projects for years in a given country (see Observer Winter 2020). So, this is why we looked at these issues to try to get a better understanding of how they’re playing out.

When we looked at fossil fuel infrastructure development, we found that more than a third of countries were encouraged to develop fossil fuel infrastructure – that’s about 75 countries out of 190, and some of the examples include: general references to growth in the oil sector or the gas sector, specific support for increased extraction or new power plants. There are some cases where we saw excessive optimism about the revenue horizon for oil and gas investments, and in some places we saw a very incremental approach using gas as a bridge fuel. And this is obviously a huge topic to cover but there’s increasing evidence that gas is not necessarily a good bridge fuel. Over a 20-year time horizon it is twice as polluting as coal (see Observer Spring 2021). So we need to be asking ourselves the question, should we be advising countries to take on gas as a bridge to a cleaner transition? Those are just a few examples of what we saw.

In the reduction and elimination of fossil fuel subsidies area, we saw that nearly 30 per cent of countries were advised to reduce or eliminate fossil fuel subsidies. What we’re not seeing is what I pointed to before – that broader ecosystem of looking at the socio-economic issues within the country and the promotion of green alternatives that can absorb the space, and that can provide the alternatives needed to make the transition an equitable one from fossil fuels to cleaner alternatives.

And on the privatisation question, we did see that just over a quarter of IMF members had received advice or support for privatising state-owned enterprises, and that’s both for the energy and power sector, as well as general calls which, again, the issue here is that it exposes the country to potential transition risks in the context of dealing with stranded asset liabilities.

So, in terms of preliminary conclusions: At this point it’s difficult for us to say definitively one way or another whether the IMF exacerbates these risks, but what we’re seeing is that it is likely that Fund advice may not be consistent with Paris Agreement goals. There’s a lot that goes into what Paris alignment might look like, but obviously if the Fund is supporting the development or advising the development of fossil fuel infrastructure, chances are it’s not going to be aligned with the Paris Agreement goals in the long term. There are some instances where advice may be inconsistent with the Fund’s own mandate for sustainable fiscal policy management, because if you’re projecting overly optimistic revenue for oil and gas investments, it’s ignoring the transition risk issue and the carbon budget issue.

Overall, what we’re seeing is an omission bias. There’s a lot that’s been said about transition risk and climate risk even before the Paris Agreement, but we’re not necessarily seeing that reflected in the Article IV reports since 2015. Now, because we haven’t looked at the data up to 2020, what we can’t tell you yet is whether there’s been a downward trend in these things that we’ve seen. And certainly it’s encouraging to hear Johannes talk about the fact that the IMF is wanting to take steps on this issue, so it remains to be seen whether we are going to see a change.

The last slide is to think a little bit about how the IMF can respond and obviously we need to dig a little bit deeper into our own findings before we can provide more specific recommendations for what the IMF could be doing. But at a minimum, the IMF should be adopting a ‘do no harm’ principle in its policy advice, so that it’s not undermining a country’s ability to take ambitious climate action, or it’s not exacerbating climate risks. There’s a couple different things that countries are going to face. On the one hand, they will likely face transition risks if they’re heavily fossil-fuel dependent. At some point the bubble will burst, there is going to be an ‘inevitable policy response,’ and assets are going to be stranded. So the more countries go down a path of fossil fuel dependency, the worse off they’re going to be from a financial standpoint. But there’s also the fact that if countries continue down this trajectory, we’re going to have massive physical risks, worse than what we’re seeing right now. And we’re not talking about the difference between avoiding a little climate change, and stopping it altogether. It’s the difference between catastrophic climate change, which is already here, and extinction level events. So this is the gravity of the situation, and this is why it’s so important that the IMF take a much deeper look at the advice that it’s providing.

The second thing is, in the Comprehensive Surveillance Review, we think the IMF should develop a dashboard of indicators to be able to assess transition risks in Article IV surveillance. The third is the IMF could be doing more to proactively support countries to judge the costs of responses to the climate crisis in that context of the inevitable policy response. And this is particularly important for low-income countries, and for middle-income countries so that they can mobilise resources for a just energy transition. And finally, it is important for the IMF to take a close look at the role that it plays in the broader ecosystem of how countries access climate finance. There’s issues here about debt cancellation and increasing fiscal space and getting past austerity measures and the fiscal consolidation policies that have not helped developing countries, up to date, but also thinking about how countries can access climate finance. It’s not enough for the IMF to just say, ‘you’ve got huge transition risks, you’ve got huge physical risks. Our job is done.’ Developing countries are going to get stuck, because nobody’s going to want to invest, nobody’s going to want to put money into those countries. So there has to be a way to identify those risks but then also create the space for improving the quality and the quantity of climate finance or financial support for green alternatives that countries can access, and this is where there’s space for the IMF to play a positive role, if it’s doing more on identifying green alternatives and the like, then there is a greater possibility of legitimising the clean energy transition from a fiscal standpoint, that will make it easier for countries to access climate finance. And so those broader equity concerns are also important to keep in mind.

Sara Jane Ahmed, V20 (speaking in a personal capacity): Thank you for your presentations, and the work that all your institutions have done on this topic. So as the IMF is the global institution tasked with preventing and mitigating financial instability, it’s certainly important that it integrates in its functioning climate risks, both physical and transition. So just as it’s mandated in the Paris Agreement, a focus on mitigation and adaptation underscores that risk will obviously remain mismanaged and underpriced, and resources may not be deployed to deal with these growing risks. Fossil fuel use is not just a carbon emissions issue. For those importing fossil fuels, it’s an issue of high prices and price instability, sometimes even obstructing growth opportunities, including affording competitive manufacturing capacities. Or for countries dependent on fossil fuel exports, as highlighted in the presentations, there’s a just transition issue that needs to be addressed sooner rather than later.

Capital markets are obviously shifting decisively towards cleaner investments. Over 145 globally significant financial institutions have coal exclusion policies, and over 50 are including oil and gas. Asian LNG spot prices have increased 600 per cent in the last six months preceding January this year. A combination of energy transition, market competition from renewable energy and storage options, price volatility and weaker profitability have weakened the fossil fuel industry’s financial position. Consequently, the industry’s future is likely one of long-term irreversible decline, which needs to be managed for risks.

Contrary to popular belief, that energy transition triggers higher costs, it is important to realize that non-performing stranded assets today are already being paid for by end users, governments, investors, and creditors – or some combination of all four. So when poorly designed market policies increase the plant life of underperforming fossil fuel assets with guaranteed contracts, it will translate to further costs. So while we are sometimes hearing that transition risks are not macro-critical, considering the subsidies, the guarantees, and the pending EU carbon border adjustment mechanism, something to consider is ‘can fiscal space be assessed adequately without including transition risk or spillover transition risk?’ And especially for importing developing countries, fossil fuels are currently sources of financial liability and can create new sources of financial vulnerability.

On the topic of the privatisation of state-owned enterprises, I think the goal should be to ensure that the market structures used to support investments encourage players who are capable of taking market risk, while companies, whether state-owned or private, have access to strategies for hedging risks to protect consumers and the public who lack the ability to manage destabilizing price and market risk. Outdated market management decisions have resulted in excessive reliance on imported coal, fossil gas, oil and diesel units with open-ended import fuel obligations. As these options are increasingly uncompetitive, they do carry ongoing foreign currency and commodity price risks.

So perhaps IMF may consider positioning itself to engage proactively with countries in order to ascertain the degree of exposure of the financial sector, the public sector, and maybe even major economy credit agencies to fossil fuel lock in, and its accompanying non-performance or stranded asset risk. As the IMF intends to support the goals of the Paris Agreement of 1.5 degrees to keep our economy safe, it may wish to consider not only assessment of climate risks, but as Niranjali mentioned as well, making available support and resources to address the needs of climate vulnerable economies who are unable to easily print money the way major economies can, and support the building of resilience through improved mitigation, and management of climate-related macro-financial risks, new financial support for access to, and enhanced conditions for, critical investments in adaptation and development, perhaps even factoring this into its debt sustainability analysis, which could include potentially resilience benefits as part of its assessment.

So just to close, the V20 represents 48 developing economies who are on the frontlines of the climate emergency, and are proactively attempting to build back better through a planetary prosperity agenda, launched by Her Excellency, Honourable Prime Minister Sheikh Hasina of Bangladesh, through the development of climate prosperity funds. It’s clear that hard fought development gains and productivity enhancements are being undermined or, worse, reversed by the pandemic, creating a potentially deadly dynamic if the 1.5 degree limit of the Paris Agreement is breached. According to the World Bank, 115 million people fell into extreme poverty last year, and the total may reach 150 million by 2021, of which eight out of 10 are the ‘new poor’ are from middle income countries. So it’s important for the IMF to perhaps consider creating three types of spaces for developing countries on the frontlines of the climate emergency: One is a safe space for climate vulnerable developing countries’ viewpoints; two, fiscal space through exploration of special financial support options for climate frontline economies; and three, a knowledge space for capacity development and crisis assistance.

Maju Varghese, Centre for Financial Accountability: I come from India which is the world’s third largest greenhouse emitter, and also the second most populous country in the world. Climate change and its impact on its economics is really, as in many other countries, evident in the country which I live in. So, according to the study by the UN, about $80 billion occurs in economic losses due to climate change, and much of this is also disproportionate on communities which are working in, or dependent on, natural resources, whether they are coastal communities, forest communities, agriculture farmers, urban poor settlements, etc.

But whether the question of financial surveillance of the IMF is the best tool to integrate climate agenda to some of us is a questionable one. Why? Because the current Article IV recommendations in India, whether it is on the banking sector, privatization, or in, in terms of energy sector reforms, or opening of agriculture markets, have not been pro-people. Right now I’m sitting in the country where IMF effigies are being burned because the farmers are in the streets against the opening up of the agriculture model (see Observer Spring 2021). So financial surveillance also has kind of a role in terms of pushing an ideological paradigm in countries where there are no IMF programmes. Whether climate and the climate-related policies should come as part of financial surveillance, then it becomes questionable, because many of these ideas come without looking into national scenarios in context.

What is happening in terms of climate risk, and its impact on economies, particularly in terms of, you know, rainfall, and temperature, which is, which is more of in terms of physical risk – and what the national scenario lacks is an understanding in terms of transition risk. Many countries like India are thinking in terms of physical risks, hurricanes, floods, droughts, which have a huge impact on agriculture country like India, but the transition risk seems missing.

India is also a country which is trying to shift towards renewables in a large scale. And it seems to be one of these countries also on track towards implementing its promises under the Paris Agreement. However, the shift to renewables by itself can also have a negative impact on communities, where large amount of lands have been taken for large mega-solar power, negatively impacting communities, because of the loss of agricultural land, loss of common land, grazing land, and the like. So the shift towards renewables has to have a paradigm shift: Rather than a mere change from fossil fuel to renewable fuel, like solar. What we would like to see is to have national frameworks in place, particularly in the country where I’m coming from, there’s a huge impact of international financial institutions, in terms of the financing of both coal, fossil fuels and also the renewable plants. So what some of us would like to see is to have this transition happening not just as a mere change in fossil fossil fuel to a renewable thing, but in terms of having a just and equitable transition. The transition towards a low-carbon future is happening and needs to happen. But the question is whether we should push for equality and justice and make the transition from a heavily capitalized, centralized system to one that is locally controllable and decentralised.

Sargon Nissan: Because there’s been a few remarks from the presenters in relation to the preliminary findings and the briefings that have been shared, I’m going to turn to you Johannes, if I may, to discuss some of the points that were made.

Johannes Wiegand: I know we are short on time, so I will try to answer a few questions that came up, I probably won’t be able to cover everything comprehensively – apologies for that but I’ll do my best. So, the first presentation by Irena was a lot about stranded assets of the financial sector from the impact of climate change. Only to say, I think that’s an area where we have been doing quite a bit of work in the Fund. The Fund is a member of the NFGS; I think it’s also co-chairing a working group. I didn’t know this topic would come up because that’s dealt with by other colleagues in the Monetary and Capital Markets department. It may be interesting for you to touch base with them on that.

Also, there is ongoing work on disclosure rules for financial companies and developing economies, for green and brown assets, which in a way is a precondition both for proper disclosure and also for regulatory policies in order to put in safeguards for financial institutions and asset management, during the transition to climate change. Irena also mentioned a lot of progress in modelling. Our research department is working on developing models to assess the risks from climate transition – maybe you’re in touch with them already. If not, I’d be happy to initiate the contact. I think that could be quite a fruitful, positive exchange.

For the second presentation. So first of all, let me say I am in a very attentive listening mode. It’s interesting what you find when you analyse our past Article IV reports. That some of these results are not what I would like to see is probably the nature of the beast, and I think it’s also healthy for us to see these results.

On a few points you made, I think, I totally agree with you that the key is not energy subsidies as such, but how it’s being done, and I would like to stress that IMF standard policy advice, and we’ve put quite a bit of work into this, is that the losers of such transformations need to be compensated. So, through cash transfers, we have developed guidelines on how to deal with this. Once again, I’m not able to talk about every single staff report, simply because this of an overview of them and I haven’t written the reports that you’re referring to in the analysis. But I think IMF institutionalised views and policies is that it cannot be removing energy subsidies on his own. It needs to come with compensating measures. I’m not totally sure whether, in any case, that requires also investments into clean energy supply.

I think the bottom line is: We need a relative change in energy prices from dirty to clean energy, but also we need an absolute increase in energy prices to reduce global energy consumption and global energy dependence. This is a very clear result that came, for example, out of our last World Economic Outlook. If we only rely on unrealistic prices, then the climate mitigation targets of the Paris Agreement are simply not achievable. It is not automatically granted, that if you change the relative price between clean and dirty energy that you need to make cheap energy cleaner. Often the more appropriate way would be to compensate those directly from the change in relative prices.

On the study on state-owned enterprises and their role in fossil fuel transitions: I think there’s probably also more granularity to the argument than is maybe possible to cover to cover in such a study or presentation. If I understood correctly, your main argument was that, you’ll create a stranded asset problem in the private sector if you have private SOEs. But what is the difficulty with the stranded asset problem if instead it feeds back into the public sectors balance sheets when things go wrong? And the alternative to that is to have that on the public sector balance sheets in the first place, you are implicitly assuming that the capacity of the public sector is larger. I’m not necessarily sure that this is the case in all low-income countries, and therefore that you know we can come up with a general recommendation that state-owned enterprises that deal with energy issues should always be in public hands,

I was also grateful that you pointed out that what you picked up are calls for general SOE reforms, and then you said, if they didn’t differentiate between energy and non energy so you saw this implicitly as a call for privatizing energy. I think in many countries, this is not the foremost concern. In many countries, you have large, loss-making energy sectors. And these pose a significant risk for the fiscal balances in these countries, and therefore there is a need to come up with policies on how to deal with that.

There was a call for the CSR to develop indicators on how assess transition risk in Article IVs – only to point out the CSR is not the right document for that, as those are sort of principles of surveillance. But after this there’s guidance notes, and I think the guidance notes would be the point where this problem should be brought up.

Then there were comments on climate finance, I think both in the context of adaptation, and in the coverage of transition risks. I would say that is a topic where the IMF was wrong but also runs into the constraints of its mandate. The IMF is mandated to look at balance of payments and difficulties in general financing, not financing for a specific purpose such as such as climate factors. That doesn’t mean the Fund should be out of the discussion. I think we’ve been quite vocal in terms of asking for progress on the $100 billion a year agreement in the context of the Paris Agreement, of making access to climate finance easier for countries dealing with climate funds. A potentially useful tool are the climate change policy assessments – one component of those is explicitly to identify financing needs in the context of the climate transition, and then to identify also ways finance these, in cooperation with the Bank. That’s maybe the most promising way we have to engage on a country level in the climate finance discussion. We also work with the Bank for example, on the debt-for-nature swaps.

There was mentioning about debt sustainability analysis and what it should tell you. We have work ongoing on this, and are thinking through how to integrate climate change into debt sustainability analysis. It’s a tricky issue. Few of these issues are straightforward. The question is what do you use as the baseline, what do you use as your scenario? Do you use as the baseline a country’s Paris commitment? Probably not, because the world is not on track to achieve that, but what other scenario would you take?

Finally, coming to the colleague from India, I think we need to be aware that if we talk about the transition of the world to low-carbon economy, you’re really talking about massive structural change to a degree that affects the entire globe. At the same time. As you probably haven’t seen in a long time or maybe you haven’t seen it ever. It has also, of course, very important justice and equity aspects. India is an interesting case because it’s a case where we think that with sort of relatively modest levels of carbon pricing, you could achieve quite significant effects in terms of shifting away from dirty energy, but there’s a very lively policy debate in India and it’s difficult, as in many other countries, to gain traction for this policy advice. I believe there is some work in preparation in the context of upcoming Indian Article IVs to discuss this in more depth, and what we would like to do is indeed not just leave it at the relative price change, but to go into issues on how to make such a transition socially balanced and addressing the justice concerns.

Irene Monasterolo: Just a clarification: In our policy brief we don’t talk about public companies or energy subsidies, it’s a high level policy brief, so it’s just a comment on this.

Jon Sward, Bretton Woods Project: On the privatisation of SOEs point – I don’t know that we can have a full discussion on the stranded assets piece today. But there’s been quite a bit of research looking at this. So for example, ISDS [investor-state dispute settlement] protects most of the world’s 257 foreign-owned coal plants, which would need to be retired early in order to put the planet on track to meet the 1.5C goal. So I guess, to your point on that Johannes, the clear difference we see in that case, is if you’re talking about a state owned company then that that kind of structure isn’t there, in terms of potentially stranded liabilities and significant compensation related to retiring those plants. So, Irene has set out a very comprehensive conceptual overview of how to, you know, work through some of these transition risks, and I think our work is sort of prodding at just a few of the entry points here, to be clear, and, it’s obviously a work in progress. But just wanted to sort of flag this specific issue related to Fund surveillance in this space.

Sara Jane Ahmed: On decentralised renewable energy [a question from the CSPF chat] – I think the power planning community and globally significant financial institutions are recognising the arc of new technology development. And when it comes to decentralized renewable energy, it does build grid resilience as well, but something to note, especially for small island developing states, there may be circumstances where there’s an economic case to displace the fossil fuel facility. For example, when the cost of fuel is higher than the average cost of renewables, plus the capacity payment of the diesel contract, it does make sense to just have the diesel there on backup and run the new renewalable decentralized power system.

So, I think that there are cases like this that we can likely see in different market contexts but obviously it is market specific. But certainly I think with renewable energy cost coming down, with storage costs coming down at a far greater rate than fossil fuel energy, it does change and improve prospects for decentralized power. And also if we look at markets that may be an overcapacity because of Covid impacts, if they have some incremental demand, it would make sense to have decentralized systems – they’re smaller scale, it’s not gigawatts at a time. So that may be a good alternative for such markets.

On middle-income countries [a question from the CSPF chat] – I think a lot of middle-income countries would miss out on certain support opportunities by virtue of being a middle income country, but if we look at climate vulnerable countries, a lot of small island developing states are middle income countries. Philippines as well, is a middle income country. There are difficulties in financing the transition, as well as the increase in the number of people falling into poverty. And so it would make sense perhaps to consider the impacts of Covid and climate to extend some support to these countries.

Maju Varghese: On the role of communties [a question from the CSPF chat] – I think the correct time to bring communities to the center of this transition is now, when we are moving towards this transition, where communities have the right over the production of the resources, because the technology is such that they should use the availability of sunlight, the wind, to take the production and the control over energy. Communities can play a big role in terms of using the gifts of nature in bringing this this transition. Otherwise, what will happen is this transition will mimic the same paradigm. What we need in terms of the shift is not just in terms of using fossil fuels alone, but in terms of a shift which would happen which would involve people in the production and use of those resources.

Sargon Nissan: I will take the final opportunity to thank all of our panelists, but in particular Johannes for permitting us to have this discussion, and to share some of these preliminary findings from the research that’s happened and the body of work that’s being done. As Johannes has helpfully pointed out, there is a lot at stake in terms of what the IMF is doing, not just with the Comprehensive Surveillance Review that will be published towards the end of April, but also with the work that will follow up on that decision by the board.

Equally as I set out in the beginning, we see that the United States will be hosting climate summit, I think, coinciding with Earth Day, later in April, and the process relating to the COP26 meetings in November has already engaged with many of the topics that we’ve been discussing here today, including ones such as fiscal space and aspects which aren’t necessarily just limited to the IMF’s institutional mandate, but also other international financial institutions. So, with those remarks, I look forward to continuing the discussion, and thank once again our guests.