Establish new financial instrument to help developing countries phase out fossil fuel subsidies.
Even as countries work to mobilize increased amounts of clean energy financing, they are simultaneously spending six times as much – some $480 to $630 billion annually – subsidizing fossil fuel consumption. As a result, the benefits of all clean energy investments are severely undermined. The reason for such economically irrational behavior is that fossil fuel subsidies often transcend energy policy and are justified as tools to promote public welfare, particularly to those most in need. In truth, however, fossil fuel subsidies tend to be highly regressive. According to the IMF, the richest 20% of the population in developing countries capture six times more in fuel subsidies than the poorest 20%.
To address this challenge, we propose a new financial instrument aimed precisely at the political obstacles to reform: Subsidy Phase-out and Reform Catalyst (SPARC) Bonds. SPARC bonds would function much like standard concessional loans that international financial institutions (IFIs) provide for various projects, allowing developing governments access to capital on better than market terms, but with a key exception: a country would have to repay the loan using savings accrued from phasing down fossil fuel subsidies.
The bonds would not be tied to a particular category of project (e.g. clean energy), thereby empowering governments to invest in a range of projects needed to build a coalition in support of such reform. These subsidies currently have strongly ingrained interests that must be countered for reform to proceed. SPARC bonds could address these obstacles through low carbon alternatives to fossil fuels. But they would also allow for a broader range of investments outside the energy sector.
Further, this initiative would offer donor countries a new opportunity to fulfill commitments made through the Copenhagen Accord, as well as provide a tool for achieving a subsidy phase out target identified in the latest draft of the post-2015 UN Sustainable Development Goals.
Category of the action
Reducing emissions from electric power sector.
What actions do you propose?
Who will take these actions?
SPARC Bonds would be drawn on by developing countries seeking to access capital – at better than market terms – to make investments that can overcome the political obstacles to subsidy reform. International Financial Institutions, donor countries, and private investors would have the opportunity to fund and subsidize this instrument.
The ideal candidate for a SPARC bond would be a government with a moderate fiscal outlook and substantial fossil-fuel subsidies. In this context, an entrepreneurial administration or ministry could use the bond as a tool to build a political coalition around subsidy reform. Some candidate governments might include China, India, Vietnam, Mexico, Brazil, Turkey, Pakistan, Nigeria, Bangladesh, Iraq, Yemen, Algeria, and Malaysia.
It is also important to look beyond national governments. In certain jurisdictions, subnational governments supply fossil-fuel subsidies. Some Indian states have spent more than half their budgets on energy subsidies in some years. When these subnational governments have the legal right to raise debt, SPARC bonds could also be issued for them. State-owned enterprises in the energy and transportation sectors are another potential recipient of these bonds.
Where will these actions be taken?
Actions will take place globally as fossil-fuel subsidies are prevalent, though at varying degrees, across many countries and regions. The Middle East, North Africa, and India spend the highest percentages of government revenues on pre-tax fossil-fuel subsidies. Almost all energy-rich countries subsidize fossil fuels, but not all countries with subsidies are energy rich, such as China and India. On a pre-tax basis, developing countries account for nearly all fossil-fuel subsidies; on a post-tax basis, advanced countries account for 40 percent of subsidies and oil exporters account for one-third.
In some cases, the diversion of fiscal resources to fossil fuels is extreme. Egypt, Saudi Arabia, and Syria spend more than 10 percent of GDP on subsidies, while Iran spends 20 percent.
How much will emissions be reduced or sequestered vs. business as usual levels?
What are other key benefits?
- SPARC bonds would empower reformers to shift public resources away from regressive fossil subsidies and toward important public goods.
- By phasing out subsidies, countries emerge in better fiscal health after repaying a loan from a SPARC bond than they were beforehand.
- Phasing out fossil fuel subsidies would be a significant step forward in the fight against climate change. The IEA estimates that eliminating these subsidies would reduce CO2 emissions by 1.7 gigatons, equivalent to all of Russia’s annual emissions. And leveling the playing field between fossil fuels and renewable alternatives would unlock substantial clean energy investment.
- Countries would reap the myriad air quality and energy security benefits associated with curbing fossil-fuel usage.
- It would help developed countries make critical progress toward fulfilling their international commitment from the 2009 Copenhagen Accord to mobilize $100 billion of climate finance from public and private sources annually by 2020.
What are the proposal’s costs?
SPARC bonds would be supported through existing World Bank (including its Clean Investment Funds), IMF, and other international financial institutions financing, as well through some additional subsidy provided through those or new channels (e.g. the Green Climate Fund). The cost is variable and up to the discretion of donors, but would be a very small fraction of the total loan, and would be consistent with or cheaper than subsidies provided for other types of climate energy and energy efficiency projects.
The World Bank, IMF or other IFI could launch a pilot project immediately with one or two interested countries.
No similar projects.
“Subsidy Phase-Out and Reform Catalyst Bonds: A New Tool to Tackle Fossil-Fuel Subsidies” Available at: http://www.americanprogress.org/issues/green/report/2014/06/25/90277/subsidy-phase-out-and-reform-catalyst-bonds-2/