A deep dive into the macro factors shaping how corporates operating in emerging markets tackle climate change. Enterprise’s Climate X Forum on Tuesday saw us sit down with EFG Hermes Research Head of Strategy Simon Kitchen (LinkedIn) to discuss how business leaders across global growth markets are taking action to address climate change and what’s happening at a macro level to facilitate — or impede — action.

Kitchen flagged three key ways in which the green transition is critical for the economies and businesses of emerging markets:

1- Many EMs are particularly vulnerable to the effects of climate change — and have fewer resources with which to tackle the problem than do wealthy countries. Egypt’s Alexandria is under threat from rising sea levels, and high levels of salinity in the delta regions of Egypt and Vietnam regions affect arable land for agriculture — a critical pillar of their economies. Pakistan and Nigeria both faced severe flooding earlier this year, resulting in mns of USD of damages — and mn being displaced from their homes. “These are countries with mns of people who are vulnerable to the effects of climate change,” Kitchen said.

2- For fast-growing EMs, growth is at least partly dependent on the efficiency with which they use resources: “There’s a lot of scope for growth, and yet resources are finite,” Kitchen said.

3- Foreign investors and the companies to whom we export outside our borders are helping drive the transition for corporates in EM: “If you’re a textile producer in Pakistan, your client — Nike, for example — wants to know who you’re employing, what you’re doing with your waste, whether you’re using water effectively,” he explained.

What’s driving the green push in EMs? Multiple factors — including a heightened focus on accountability across the value chain: Subsidiaries of multinationals tend to be ahead of the game compared to some local corporates because they need to be compliant with the ESG policies of their parent companies, Kitchen noted.

The use of concessional financing — lower cost finance provided by, for example, development finance institutions — puts a focus on the end use of funds and generally ties the funding to specific climate goals. Heavily-polluting industries are among the companies making the fastest progress on climate.

The big driver for corporates is capital markets. More and more investors are looking at the climate, social and governance records of the companies in which they invest — generally because the people whose money they’re managing care about the issues.

Big emitters face pressure from investors, but full divestment from polluting industries isn’t at all realistic in developing economies. Some portfolio investors across emerging and frontier markets will rule out investments in companies that, for example, use coal or manufacture cement because of their climate impact, Kitchen noted. But it’s not realistic to “say to hundreds of mns of people that they can’t use coal anymore” in the absence of readily available clean energy when these are economies that are catching up on industrial development.

For companies wanting to stay attractive to foreign investors, the key is to show progress on climate metrics: “The more realistic portfolio investors want to see more disclosure and an improvement at the margin — a recognition, for example, that if you’re using 100% coal you can shift towards 80%, then 60%,” he said.

So, who is doing a good job of greening their operations? Sector-wise, some commonly-maligned industries are stepping up to the table: Industries like cement, tobacco and chemicals are actually doing more work than “cleaner” industries, Kitchen noted. Though this is partly driven by company boards and the broader investor community, Kitchen also flagged greater complacency in industries that aren’t obviously heavily polluting.

What are investors in climate businesses looking for in EM? Getting green projects off the ground in global growth markets still requires “some quite old-school fundamentals,” Kitchen noted. These include having a predictable investment environment, a fairly stable macro framework, and reliable sources of well-priced green energy.

Making it easier for investors to come in and do business will be key as countries across the region look to land green manufacturing projects. Egypt has started a world-scale push into hydrogen that will demand it increase its renewable generation capacity more than 10-fold. That’s an opening for countries to build new manufacturing industries — to land makers of components for the renewable power and hydrogen industries.

Some are doing better than others when it comes to ease of doing business: Egypt has fallen below potential on that for a number of years while Morocco has been able to provide credible incentives “in certain clusters” for long periods of time — which has led to the building of a critical mass, allowing for the development of local feeder industries, Kitchen said. Vietnam also has quite a good template, but Pakistan faces challenges today offering the stability and predictability that potential investors are seeking, he added.

When it comes to financing climate projects, costs are being driven up by rising interest rates and high inflation: “We’re coming out of a period in which money has been abundant. There’s been a lot of misallocation and waste. Money is going to become more scarce. Inflation is an issue and affordable financing is critical,” he said.

A new IMF facility shows how long-term, cheap financing could boost climate friendly projects: The IMF issued USD 650 bn in special drawing rights (SDRs) in 2021 for all of its member countries to help shore up their economies after the fallout from covid-19. The fund then started looking at how to channel some of those SDRs from developed member countries to a Resilience and Sustainability Trust for developing and vulnerable countries to invest in anything ranging from energy efficiency to building structures to protect from rising sea levels. So far only four countries have received funding from this trust, but it’s starting to be rolled out, he noted.

The key to the trust’s financing is that it’s very long-term, Kitchen said. Countries repay over 20 years, with a grace period of 10.5 years and low interest. “So it’s very long-term and very cheap. And it can be used for governments to invest in projects to mitigate and adapt to climate change.”

What is still needed? Mechanisms that ensure that the financing is channeled as directly as possible to the private sector — with low capital costs for particular projects that can generate not just a financial returns, deliver significant results on adaptation or mitigation, he said.

And loss and damage funding — a big W at COP27: “I think the key with loss and damage is that you need money to go to the private sector,” Kitchen said. “The danger is, if it just goes into the general pot, governments will use it to fund general expenditures or subsidies.” Globally, we’ve seen the energy crisis push governments to roll out subsidies, ultimately encouraging dependence on wasteful, hydrocarbon-based energy, he added.

Meanwhile: Debt forgiveness isn’t the answer, Kitchen believes. Instead, we’ll probably see more restructuring of unsustainable debt, as we’re already seeing in Sri Lanka, Zambia and Argentina — and is likely to happen in Pakistan, he noted. But it’s a more complicated process than it used to be, because creditors are far more diverse than just the small group of lenders led by the so-called London Club and Paris Club. “Now you have China and India as creditors, along with a lot of non-banks.” Private investors in EM debt are going to be much more reluctant to take haircuts on investments or to forgive debt than are most state actors and multilateral institutions.

General debt forgiveness that isn’t directed specifically to investment projects “seems to me as just a sort of pass,” Kitchen said. While it could be seen as a kind of reparation, it also hits on the same danger as loss and damage funding — that if these funds are broadly allocated to governments, what you’re really doing is temporarily removing constraints on general national budgets, rather than specifically investing in projects that could more effectively address climate-related issues. Kitchen noted that the Jubilee 2000 movement to write off the debt of the world’s poorest countries was a mixed blessing, where some worthwhile investments were made but a lot of the money was wasted.

2023 will likely bring some pain to EMs from continued high interest rates and inflation: Increased capital costs will likely have a major, long-term impact on the macro environment affecting EMs, Kitchen said. This will require some readjustment, because for nearly 15 years now, money has been so relatively cheap, he added. Inflation will also remain high for some time — spurred partly by insufficient investment in commodities, copper and oil and gas.

But 2023 could be a good year if you’re a buyer: Valuations across EM are very attractive right now if you’re a buyer, Kitchen said, though less so if you’re a seller.

And a push for supply-chain security could open up opportunities for EMs: Ultimately, businesses want supply security, so relying on a handful of factories concentrated in one geographic area for production is no longer enough. “It’s no longer a case of China being the workshop of the world and everyone enjoying low prices,” Kitchen noted. Continued reassessment of that value chain will open up opportunities for countries like Egypt, Morocco and Vietnam, he added. If Egypt could pitch its strategic advantages — like geographic proximity to Europe and markets in the Gulf, and its potential as a secure and stable site for manufacturing, there’s a definite advantage there, Kitchen said.

** We want to thank our friends at USAID, HSBC, Mashreq, Attijariwafa Bank, Etisalat by e&, Hassan Allam Utilities, and Infinity for making the event possible.