Developing countries are facing a massive investment shortfall in the renewables sector and require debt relief to create fiscal space that supports clean energy transition to meet their climate and sustainable development goals.
They require about $1.7 trillion per year in the clean energy sector but only managed to attract foreign direct investment worth $544 billion in 2022, the UN Conference on Trade and Development (Unctad), said in its World Investment Report on Wednesday.
“International investment in renewable energy has nearly tripled since the adoption of the Paris Agreement in 2015. However, much of this growth has been concentrated in developed countries,” Unctad researchers said in the report.
“More than 30 developing countries have not yet registered a single utility-sized international investment project in renewables.”
With interest rates soaring globally, the cost of capital is a key barrier for energy investment in developing countries that are grappling with mounting external debt, with limited fiscal space.
“Bringing in international investors in partnership with the public sector and multilateral financial institutions significantly reduces the cost of capital,” the report said.
The UN body called for the “de-risking of energy transition investment” through loans, guarantees, insurance instruments and the equity participation of the public sector and multilateral development banks.
“De-risking support to lower the cost of capital for energy transition investment in developing countries must be vastly expanded,” the Unctad researchers said.
The total funding needs of developing countries for the energy transition are much larger and include investment in power grids, transmission lines, storage and energy efficiency.
Developing nations face an annual funding gap of $2.2 trillion when it comes to the energy transition, a key requirement for these nations to achieve their climate goals.
This funding gap is part of a total $4 trillion annual shortfall they are facing in terms of sustainable development goals, Unctad said.
“A significant increase in investment in sustainable energy systems in developing countries is crucial for the world to reach climate goals by 2030,” Unctad secretary general Rebeca Grynspan said.
To stay close to the goal of limiting global warming to 1.5°C above pre-industrial levels, the world needs about one-and-a-half times the current global gross domestic product in investment between now and 2050, Unctad said.
However, after a steep drop in 2020 and a strong rebound in 2021, global FDI declined by 12 per cent in 2022, to $1.3 trillion.
The slowdown was driven by global crises, including the war in Ukraine, high food and energy prices, and mounting debt pressures.
International project finance and cross-border mergers and acquisitions were especially affected by tighter financing conditions, rising interest rates and uncertainty in capital markets, and Unctad expects pressure on global FDI to continue this year.
“Global FDI trends are in line with other macroeconomic variables, which show either negative or slow growth rates,” Unctad researchers said.
“Early indicators confirm the negative FDI outlook: FDI project activity in the first quarter of 2023 shows that investors are uncertain and risk averse.
“The number of international project finance deals in the first quarter of 2023 was down significantly; cross-border M&A [merger and acquisition] activity also slowed.”
Although FDI in developing countries last year increased by 4 per cent to $916 billion, or more than 70 per cent of global flows, the rise was uneven across countries, with much of the growth concentrated in a few large emerging economies.
The number of greenfield investment projects announced in developing countries increased by 37 per cent, and international project finance deals by 5 per cent, which are “positive signs for investment prospects in industry and in infrastructure”, the report said.
However, FDI in Africa dropped to the 2019 level of $45 billion after “anomalously high levels in 2021”, caused by a single financial transaction.
Greenfield project announcements increased by 39 per cent and international project finance deals by 15 per cent.
FDI inflows in developing Asia were flat at $662 billion but still accounted for more than half of global FDI, with India and members of the Association of South-east Asian Nations being the top recipients.
China, the second-largest FDI host country in the world, registered a 5 per cent increase last year, the report said.
FDI flows to Latin America and the Caribbean increased by 51 per cent to $208 billion, the highest level ever recorded.
Although FDI flows to the Gulf region declined overall, the number of project announcements increased by two thirds, according to the report.
Sustainability-themed investments remained resilient last year, with the value of the overall sustainable finance market reaching $5.8 trillion in 2022, despite high inflation, rising interest rates, poor market returns and the looming risk of a recession that all affected financial markets.
Sustainable funds continued to be more attractive to investors than traditional funds.
Despite a decline in the market value of the global sustainable fund market from its high of $2.7 trillion in 2021 to $2.5 trillion in 2022, net inflows to the market were positive, in contrast to traditional funds, which experienced net outflows, the Unctad report said.
As part of efforts to tackle climate change, public pension and sovereign wealth funds have also developed an increased focus on sustainability strategies, directing more of their assets towards the energy transition.
Renewable energy has become an attractive infrastructure sub-segment for these institutional investors, offering the stable, inflation-hedging qualities of infrastructure while supporting net-zero objectives.
“With a long-term investment horizon, SWFs and PPFs are uniquely positioned for investing in infrastructure and energy, including the renewable energy sector, and have become important investors in the sectors,” the Unctad report said.
“Between 2016 and 2022, PPFs and SWFs significantly increased their investment in renewable energy, driven by policy changes aimed at decarbonising, the continuously decreasing costs of renewables and the need for portfolio diversification.”
Last year, these funds invested $18.7 billion in renewable energy projects, a 21 per cent decline from 2021, but still almost double the annual average since 2016, Unctad said.
Canadian pension funds were the largest source of capital for investment in renewable energy, accounting for 33 per cent of total investment in 2022.
GCC investors contributed 29 per cent while Singaporean funds accounted for 26 per cent.
GIC in Singapore was the largest single investor, followed by Abu Dhabi's Mubadala Investment Company.
“Gulf SWFs are important investors in renewable energy, as they seek to diversify domestic and regional economies and progress towards the Paris Agreement goals,” the Unctad report said.