78 Finance & economics The Economist December 4th 2021
ClimatefinanceSqueezing the
balloon
I
njunetheimfmadethelatestofmany
calls from economists for a marketori
ented policy to tackle climate change. “Car
bon pricing...is the leastcost option to de
liver deep emission cuts,” it argued in a pa
per written ahead of a meeting of the lead
ers of the g20 group of large economies.
Carbon taxes, as this newspaper has long
argued, can be a powerful way to force pol
luters to pay for the harm they do to the en
vironment by burning fossil fuels.
With the political will for a global tax
lacking, many places are going it alone.
The World Bank reckons that 45 countries
and 34 subnational jurisdictions have
adopted some form of carbon pricing,
ranging from taxes to emissionstrading
systems. But these schemes cover only
about a fifth of global greenhousegas
emissions. New research shows that such
piecemeal progress can have unintended
consequences.
A recent paper by Luc Laeven and Alex
ander Popov of the European Central Bank,
published by the Centre for Economic Poli
cy Research (cepr), analyses data on more
than 2m loan tranches involving banks do
ing crossborder lending between 1988 and
2021, during which time many countries
imposed carbon pricing. The authors find
that carbon taxes at home led banks to re
duce lending to coal, oil and gas compa
nies domestically, but also had the per
verse consequence of causing them to in
crease such lending abroad. The effect,
they write, is “immediate” and “economi
cally meaningful”. The shift was most pro
nounced for banks with big fossilfuel
lending portfolios, and loans were most
likely to be directed towards countries
lacking a carbon tax.
This conclusion comes on the heels of a
related ceprpaper which found that banks
increase crossborder lending in response
to stricter climate policies at home, with
the effect more evident for banks with pre
vious experience of international lending.
Steven Ongena of the University of Zurich,
one of its authors, argues that banks “use
crossborder lending as a regulatoryarbi
trage tool” by shifting dirty loans to coun
tries with laxer climate policies.
The findings suggest that cracking
down on carbon is a bit like squeezing a
balloon. Press too hard all at once and it
may pop, but squeeze only in one corner
and the air will simply flow to where there
is less pressure. Such effects also mirrorconcerns about leakages in industrial mar
kets. The eu’s carbonpricing scheme used
to grant exemptions to heavy emitters, for
fear that they would otherwise move pro
duction abroad. Now, as the eulooks to
close those loopholes, it is considering a
carbon borderadjustment mechanism to
level the playingfield.
Yet domestic carbon pricing is still a
policy worth pursuing, says Tara Laan of
the International Institute for Sustainable
Development, a thinktank. Messrs Laeven
and Popov conclude that, even after ac
counting for their efforts to shift dirty
lending overseas, carbon taxes do some
what reduce net fossilfuel lending by the
banks studied, because they lower domes
tic lending by more. Uday Varadarajan of
rmi, another thinktank, agrees, but
points out that supplementing domestic
carbonpricing policies with measures to
discourageleakage,saybyurginggreater
transparency, couldboosttheimpact of
carbonpricingschemes.
Thebestsolution,ofcourse,wouldbe
worldwideadoption.Theimfsuggeststhat
highemittingcountriesstartbyembrac
ingamodestcarbon“floor”,inorderto
providea steppingstonetoa globalprice.
Astheevidenceofperverseconsequences
arising from localised pricing schemes
mounts,themaintaskforpolicymakersis
toorchestratea globalsqueeze.nN EW YORK
The unintended financial effects of
piecemeal carbon pricing InvestmentinIndiaOver flows
A
wave ofpassive capital flows is the
handsome prize for countries that se
cure a place in major bond indices. That
prospect seems to be on the horizon for In
dia. Many analysts expect part of its gov
ernmentbond market to enter indices
compiled by Bloomberg, a data provider,
and JPMorgan Chase, a bank, as early as
next year, or perhaps 2023. The govern
ment has been keen on inclusion even as it
has been ambivalent about other types of
capital flows. Its cautious approach is
increasingly in line with economists’ shift
ing attitudes.
The flows that inclusion in major bond
indices tend to generate are one of the least
objectionable forms of international in
vestment. They tend to come from mas
sive, slowmoving funds—the opposite of
the flighty hotmoney flows that emerg
ingmarket policymakers fear. That might
be why index inclusion has been a priority
for India’s finance ministry. Until last yeara cap of 6% on the foreign ownership of
government bonds had been the main fac
tor preventing India’s inclusion in the big
bond indices. Then officials introduced a
“fully accessible route” for overseas inves
tors, which lifts the foreignownership
limit on some bonds.
Analysis by big investment banks sug
gests that reweighting by global investors
would prompt flows of $30bn40bn into
India’s bond market. That would exceed
the current stock of foreign investors’
holdings, which amounts to a mere 2% of
the more than $1trn in outstanding Indian
government securities. Reliable and regu
lar inflows of foreign capital could help
suppress publicborrowing costs. Cor
porate borrowers could also benefit from
lower benchmark rates. And the rupee
would be bolstered, according to analysts
at Morgan Stanley, a bank.
The hope for India, and many other
emergingmarket governments, would be
to mimic China’s experience. Foreign ow
nership of its centralgovernment bonds
has more than doubled from 4.5% to 10.6%
in the past four years, without any notice
able hiccups, and without jeopardising
China’s broader capital controls. But other
countries’ experiences show just how
unusually benign that is.
India’s own recent relationship with
portfolioinvestment flows explains the
government’s hesitation in opening up ful
ly (ownership caps will remain on other
bonds and assets). Sizeable outflows from
foreignbond investors occurred in 2013,
2016 and 2018, all driven by expectations of
tighter policy from the Federal Reserve.
The 2013 selloff in particular was com
bined with a sharp drop in the rupee. For
eign bondholders likewise rushed for the
door at the onset of the pandemic last year.
Even the imf, once a stalwart opponent
of capital controls, is more equivocal theseH ONG KONG
A wary welcome for foreign
bond investors