Financing a Green and Inclusive Recovery

The region has turned its attention in recent years to more sustainable and inclusive growth. Both economic growth and the quality of life face threats from environmental challenges such as climate change, biodiversity loss, and environmental pollution. Growth that empowers and benefits the entire population remains a work in progress. The pandemic set back these efforts and imposed disproportionate burdens on the poor and vulnerable. It also clearly demonstrated that abnormal risks can and do become reality, driving home the need to prepare for future risks, the most dire of which is worsening climate change. Society now has an opportunity to build back better. Green and inclusive recovery would strengthen resilience under future shocks.

The vast financial resources needed are often beyond the means of the public purse alone. Especially after suffering sharp contractions in fiscal revenue during the pandemic, Asian governments must close the funding gap by catalyzing more private capital and mobilizing resources from a much broader funding base. As a bonus, the participation of private capital fosters risk sharing on green and social projects across a broad coalition of public and private investors.

Comprising all financing instruments, investments, and mechanisms that contribute to the SDGs, the spectrum of green and social finance includes blended or catalytic finance, debt, equity, funds, and grants. This diversity offers the opportunity to create innovative financing models and new financial instruments to expand the supply of capital for sustainability goals.

Growth in green and social finance has been particularly strong in private capital. Financially sophisticated advanced economies, where environmental and social issues have long been high priority, still dominate the global green and social finance landscape. Meanwhile, developing Asia leads all other emerging regions in the issuance of green, social, and sustainability bonds. The region also leads the developing world in regulation and policy guidance on green and social finance. Rapid global growth in green and social finance has continued since the COVID-19 outbreak. The trend is consistent with heightened awareness in the financial industry of the importance of green and inclusive recovery from COVID-19.

However, there are currently no commonly agreed reporting standards or impact metrics for green and social finance. This failing exacerbates information asymmetry and raises concerns about green- or social-washing—inaccurate, self-serving claims that undermine investor confidence. In response, some progress has been achieved toward consolidating the many competing models for impact measurement.

Asian firms that issue green bonds typically improve their environmental performance by 17% within a year after issuance and by 30% within 2 years, as measured by corporate environmental ratings. Evidence further suggests that cities using more green bond finance enjoy significantly improved local air quality. An increase by one standard deviation in green bond financing is associated with a 0.6% improvement in the air quality index. Countries similarly record lower carbon emissions after the first green bond issuance in national bond markets.

These mechanisms facilitate risk transfer from the government and service providers to private investors, who earn returns only when desired social outcomes are achieved. Development impact bonds enable results-based private finance to participate in development programs in low- and middle-income economies. Notable examples include the Educate Girls Development Impact Bond, which improved education outcomes for marginalized school-age girls in India.

They provide direct financing and catalyze capital from public and private sources through blended finance, credit enhancement, and loan guarantees. They innovate novel financing solutions and further facilitate the development of green and social finance by strengthening market infrastructure and ecosystems, as well as government policy, knowledge, and capacity in developing economies.

Policy options include fiscal measures such as grants, direct and indirect investment, tax incentives and subsidies, and legislation and regulation. While a range of policy innovations already exists worldwide, the market would benefit significantly from legislation and regulation that enforce common standards of impact measurement and information disclosure. Governments can reshape existing policies and contribute to green and inclusive recovery through investment, catalysis, innovation, advocacy, and research in green and social finance.

Policy makers have started to incorporate sustainability risks into micro- and macroprudential frameworks, charting the way forward for safeguarding financial stability while supporting the transition to sustainable development. Financing sustainable recovery can be facilitated by sound financial market infrastructure and a viable market ecosystem. Asian policy makers need to work together to develop standards of impact measurement and information disclosure that align with international standards and promote sustainable finance as a regional agenda.

Effective tax policy measures can increase tax revenue by (i) broadening and protecting the domestic tax base; (ii) enhancing tax compliance through better taxpayer services and strengthened risk management, audit, and enforcement; (iii) developing more transparent and efficient tax administration with streamlined business processes and digital technology; (iv) striking a balance between raising tax revenue and promoting investment; (v) and strengthening international tax cooperation. Finally, tax policy measures that offer well-designed tax incentives can improve development outcomes by, for example, promoting clean energy investment.