Unlocking Opportunities in Emerging Markets by Reducing the Cost of Capital
Emerging markets hold immense potential for renewable energy development. These regions are rich in solar, wind, and hydropower resources, making them critical to the global energy transition. However, the high cost of capital has long been a barrier to deploying clean energy projects at scale in these markets. Unlocking investment through innovative financing mechanisms and targeted policy interventions is essential for accelerating renewable energy adoption while driving economic growth.
The Importance of Emerging Markets in the Energy Transition
Emerging markets account for 56% of global energy consumption, with demand growing at twice the rate of developed markets. These regions are projected to require $4.3 trillion in clean energy investments to meet climate goals and provide affordable, reliable electricity to growing populations. Despite this potential, they often lag behind developed economies in renewable energy deployment.
One primary reason is the cost of capital. Renewable energy projects in emerging markets typically face higher financing costs due to risks such as currency volatility, political instability, and underdeveloped financial markets. These factors result in a weighted average cost of capital (WACC) two to three times higher than developed countries. This makes renewable energy projects less competitive, even in regions with abundant resources.
Addressing Risk Perceptions
Risk perception is a major driver of high financing costs in emerging markets. Investors often overestimate the risks associated with these regions, leading to higher interest rates and limited access to credit. To be sure, one of the most attractive ways to generate alpha in emerging markets is the risk arbitrage between the implied or perceived discount rate demanded from foreign investors versus a more accurate risk assessment from those with niche local market expertise.
Governments and multilateral organizations can play a pivotal role in the cost of capital for sustainability projects by providing guarantees and insurance products that mitigate risks. For example, political risk insurance can protect investors from losses due to government actions, while currency hedging mechanisms can address exchange rate volatility.
While global investors may enjoy the extra yield provided from these market constraints, ultimately the governments, municipalities, and startup founders receive lower bids (or valuations) from foreign investors using excessive discount rates to take capture excess returns from markets with capital scarcity.
Innovative de-risking tools, such as first-loss guarantees and blended finance structures, have also proven effective. By absorbing a portion of potential losses, these mechanisms encourage private-sector investment while reducing overall financing costs.
The Role of Policy
Strong policy frameworks are essential for attracting investment. Governments must establish clear, stable regulations that provide long-term visibility for renewable energy projects. Transparent permitting processes, predictable tariffs, and robust grid infrastructure are critical to an investor-friendly environment.
Policy-driven incentives, such as tax breaks and feed-in tariffs, can further enhance the financial viability of renewable projects. Countries like India and Brazil have successfully used reverse auctions to reduce costs and attract international solar and wind energy investment.
Regional and international collaboration can amplify these efforts. Organizations like the International Renewable Energy Agency (IRENA) and the World Bank are working with emerging market governments to design policies and programs that facilitate renewable energy deployment.
Mobilizing Private Capital
Private capital is indispensable for meeting the investment needs of emerging markets. However, attracting private investors requires addressing their concerns about returns and liquidity.
Green bonds and sustainability-linked loans have emerged as powerful tools for mobilizing private capital. These instruments align financial returns with environmental objectives, offering investors an opportunity to support climate action while earning competitive yields.
Institutional investors, including pension funds and sovereign wealth funds, represent a vast pool of untapped capital for renewable energy. Many of these investors are beginning to integrate environmental, social, and governance (ESG) criteria into their portfolios. Emerging market projects that meet these criteria can unlock significant funding streams.
Venture capital plays a pivotal role in de-risking cleantech startups in emerging markets by providing early-stage funding, expertise, and long-term support. By investing in companies at their most uncertain phases, venture capitalists help validate new business models, refine technologies, and establish operational credibility. This early confidence-building encourages other investors—such as commercial banks, infrastructure funds, and development finance institutions—to view these ventures more favorably, ultimately lowering the overall cost of capital. As startups mature into viable enterprises with proven track records, they can access a broader pool of financing options at more competitive rates, accelerating the deployment of renewable energy solutions.
Blended Finance: A Collaborative Approach
Blended finance combines public and private funding to lower the cost of capital and reduce risk. Public funds can be used to de-risk projects, making them more attractive to private investors. This approach has been instrumental in scaling renewable energy in markets where private investment alone would not suffice.
Development banks and multilateral organizations often provide concessional loans or grants to cover upfront costs while private investors fund the remaining capital requirements. This partnership model aligns the interests of multiple stakeholders and ensures that projects are both financially viable and socially impactful.
For example, the Lake Turkana Wind Farm in Kenya exemplifies the transformative potential of blended finance in advancing renewable energy projects. By combining concessional public funding with private investment from investors like Google and the IFU from Denmark, this initiative successfully mitigated perceived risks, making it more attractive for commercial lenders. With a capacity of 310 megawatts, Lake Turkana stands as one of Africa’s largest wind projects, providing reliable, clean electricity and diversifying Kenya’s energy mix. This success story illustrates how strategic financial mechanisms can spur large-scale renewable development in emerging markets.
Enhancing Local Financial Markets
Developing local financial markets is a long-term solution to reducing the cost of capital. Strengthening local banks and financial institutions enables them to provide affordable loans for renewable energy projects. This requires capacity building, regulatory reforms, and the introduction of financial products tailored to the needs of clean energy developers.
Local currency financing can also mitigate exchange rate risks, further reducing costs. Governments and international organizations should prioritize programs that promote local currency lending and develop secondary markets for renewable energy assets.
The Path Forward for Emerging Markets
Reducing the cost of capital in emerging markets is both a challenge and an opportunity. Achieving this goal requires a multi-faceted approach that addresses risk perception, strengthens policy frameworks, and mobilizes diverse funding sources.
The energy transition can only succeed with significant progress in emerging markets. These regions have the resources and demand to drive global renewable energy growth. By unlocking investment and reducing financing costs, we can ensure that emerging markets play a central role in building a sustainable, low-carbon future.
