At the height of the 1970s oil embargoes, the world’s industrialised nations founded the G7 as a forum to coordinate on global economic challenges. At the time, stagflation loomed. Since then, the G7 has dealt with financial crises, war and pandemics. Today the buzzword is imbalance, whether in China’s inflated net exports, Europe’s underinvestment or the United States’ consumption mix. As an influential group, the G7 can address a key imbalance in developing economies as a powerful means of reducing global macroeconomic risk: tackling the high cost of capital in emerging markets.
To understand why lowering the cost of capital for the world’s developing nations is so important, we can look to the history of global growth since the Cold War. When the Berlin Wall fell, governments across Asia and the former Soviet bloc opened their economies in a model that gave rise to the ‘Four Asian Tigers’: South Korea, Singapore, Hong Kong and Taiwan showed that combining educated workforces with export-oriented industry could produce extraordinary growth. As others followed, real global GDP growth more than doubled as rising incomes in emerging markets created significant demand for western goods and services. American farmers, German automakers, and French luxury brands all benefited from a wealthier Asia.
Central to the post–Cold War Asian growth model was the ability of these economies to borrow at low rates. Domestic savings rates across East Asia were extraordinarily high, often 30 to 40 percent of GDP, providing a deep pool of local capital. Governments in South Korea, Taiwan and Singapore used state-directed lending and development banks to channel credit to strategic export industries at subsidised rates. Because the economies were export-oriented and earning revenues in US dollars, foreign investors also faced far less currency risk than they would lending to a domestically focused economy. Many of these countries also pegged their currencies to the US dollar, further compressing borrowing costs. The result was a virtuous cycle: cheap capital enabled industrial growth, which generated export earnings, reduced risk and attracted more capital.
The challenge ahead
Africa today lacks these advantages. Domestic savings rates are far lower. At the same time, a combination of energy security and energy transition concerns means that the continent’s required investments are in clean energy technologies such as solar and wind, as well as grid investment in transmission and distribution. These projects generate revenue in local currency, creating risk for foreign investors; unlike oil or mineral investments, which trade globally in dollars, electricity cannot be exported to offset local currency exposure.
Nonetheless, Africa’s demographics make it central to global growth, as well as to lifting millions out of poverty. The continent’s population is projected to reach 2.5 billion by 2050, accounting for more than half of global population growth over the next quarter century. A more prosperous Africa would be the single largest new source of demand for goods and services in the world economy, just as a wealthier Asia was in the decades after the Cold War.
The Songwe-Stern Independent High-Level Expert Group on Climate Finance estimates that developing countries need one trillion dollars a year in cross-border financing for the energy transition alone. This capital would be deployed in electric vehicle factories and battery makers, in rural electrification and productive uses of energy, thereby powering agriculture, services, telecommunications and the other building blocks that turn a population into participants in a prosperous economy.
Article 6 and climate finance
There is no silver bullet to drive down borrowing costs in developing countries. Foreign exchange risk is a key challenge. However, there are promising proposals from the Bridgetown Initiative, amongst others, to offer hedges on volatile local currencies. Reform of multilateral development banks could also unlock more capital.
Another promising avenue comes from Article 6 of the Paris Agreement, which creates a framework for international carbon trading. Article 6 allows countries and companies in the Global North to fund emissions reductions in the Global South and claim those reductions toward their own climate targets or, in certain circumstances, to pay their carbon taxes. After nearly a decade of negotiation, the operational rules were finalised at COP29 in Baku. For wealthy countries struggling to meet ambitious climate pledges, Article 6 offers a significantly cheaper pathway than domestic decarbonisation; it costs far less to abate a tonne of carbon in a developing country than at home. For developing countries, Article 6 can channel finance into projects that build productive capacity. Private sector firms are already using Article 6 to raise lower-cost capital for projects across the Global South, including in Africa.
There are various options for the G7 to consider to lower the cost of capital for infrastructure in developing countries. Some, such as mitigating currency risk and reforming the Bretton Woods institutions, would take years; others are easier. Leaders at Évian should commit to using Article 6 credits towards their nationally determined contributions under the Paris Agreement, creating the demand signal that carbon markets need to scale. They should also consider allowing firms’ spending on credits to count for some carbon taxes, including the EU’s carbon border adjustment mechanism.
Article 6, of course, will not close the global financing gap, but it does align the interests of developed countries’ climate compliance with emerging markets’ capital needs, and therefore offers a practical starting point for leaders looking to act now rather than wait for institutional reform.
