The Economist - USA (20212-12-04)

74 Finance & economics The Economist December 4th 2021

Climatefinance

Squeezing 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  fifth  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  find

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  effect,

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 ceprpaperwhich found that banks

increase cross­border lending in response

to  stricter  climate  policies  at  home,  with

the effect 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  findings  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 flow to where there

is  less  pressure.  Such  effects  also  mirror

concerns 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 playing­field.

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  efforts  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“floor”,inorderto

providea steppingstonetoa globalprice.

Astheevidenceofperverseconsequences

arising from localised pricing schemes

mounts,themaintaskforpolicymakersis

toorchestratea globalsqueeze.n

N EW YORK

The unintended financial effects of

piecemeal carbon pricing 

InvestmentinIndia

Over flows

A

wave ofpassive  capital  flows  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  flows.  Its  cautious  approach  is

increasingly in line with economists’ shift­

ing attitudes.

The flows 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  flighty  hot­money  flows  that  emerg­

ing­market  policymakers  fear.  That  might

be why index inclusion has been a priority

for India’s finance ministry. Until last year

a  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  officials  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  flows  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  inflows  of  foreign  capital  could  help

suppress  public­borrowing  costs.  Cor­

porate  borrowers  could  also  benefit  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  flows  explains  the

government’s hesitation in opening up ful­

ly  (ownership  caps  will  remain  on  other

bonds and assets). Sizeable outflows 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 these

H ONG KONG

A wary welcome for foreign 

bond investors