What Is Climate Finance? [Explainer]

Only 13 out of 195 countries, signatories to the Paris Agreement, submitted their Nationally Determined Contributions (NDCs) by the February 10 deadline. India was among the many countries that missed the deadline, and reports suggest its updated commitments may reflect disappointment over inadequate climate finance agreed upon at COP29 in Baku. This indicates that the issue remains contentious despite an agreement on climate finance. India’s latest Economic Survey, tabled on January 31, described the climate finance deal at the last UN climate conference as out of sync with the needs of this critical decade when urgent action is required to meet the Paris Agreement’s temperature goals.

What is climate finance?

The United Nations Environment Programme (UNEP) defines climate finance as local, national, or transnational funding that supports climate action and is sourced from public, private, and alternative financing. Climate finance is used for climate change mitigation and adaptation. It is a subset of green finance, that caters to broader environmental goals beyond climate action. Green finance, in turn, falls under sustainable finance, which supports investments considering environmental, social, and governance (ESG) factors.

However, there is no universally accepted definition of climate finance under the UN climate negotiations. Suborna Barua, a professor of finance at the University of Dhaka, says that this lack of a universal definition allows developed countries to classify a wide range of financial flows as climate finance. A recent UNFCCC report notes that an inconsistency in accounting arises from varied climate finance definitions, as each country applies its discretion on what to count as climate finance, making reported figures non-comparable. “Due to this, the Organisation for Economic Cooperation and Development (OECD), responsible for tracking climate finance from developed to developing countries, includes all forms of development finance under climate finance, further complicating the picture,” Barua explains.

The OECD’s 2024 report claimed that developed countries mobilised $115.9 billion in 2022, surpassing the $100 billion goal set for 2020. However, the OECD’s methodology has been widely questioned.

Labanya Prakash Jena, a consultant for sustainable finance at the Institute for Energy Economics and Financial Analysis (IEEFA), an international and advocacy research organisation, explains that in international negotiations, climate finance typically refers to support from developed to developing countries. Public funding that helps mobilise private investment, including debt, equity, and grants, is also counted. However, developing nations argue that debt and equity are returnable capital and should not qualify as financial support from developed countries.

Who provides climate finance?

Developed countries are primarily responsible for providing climate finance, after the 1992 Rio Declaration formally introduced the polluter-pays principle, which states that those responsible for environmental damage should bear the cost of addressing it. The declaration has 27 principles, of which, principle seven talks about cooperation among countries and the responsibilities of developed countries “…in view of the pressures their societies place on the global environment and of the technologies and financial resources they command.”

The United Nations Framework Convention on Climate Change (UNFCCC) came into force in 1994, putting the onus on developed countries to lead the way and industrialised countries. They agreed to support climate change activities in developing countries by providing financial support for action on climate change. At the climate conference COP15 in 2009, developed countries agreed to mobilise $100 billion annually by 2020 to support climate action in developing nations. In 2015, under the Paris Agreement, parties agreed to extend this goal to 2025 and to set a new climate finance goal starting from $100 billion per year, that will flow from developed to developing countries after 2025. Thus, COP29, scheduled in 2024, was focused on negotiating new climate finance goals.

The UNFCCC channels these funds through various mechanisms, including the Global Environment Facility (GEF) and the Green Climate Fund (GCF). Additionally, the Special Climate Change Fund (SCCF) and the Least Developed Countries Fund (LDCF), managed by the GEF, address specific climate vulnerabilities.

According to a response in the Rajya Sabha on February 6, India has received $803.9 million from the GCF, $346.52 million from the GEF, and $16.86 million from the Adaptation Fund for climate projects.

The Paris Agreement reaffirmed developed countries’ financial obligations and encouraged voluntary contributions from other countries too. At COP29, developed countries pushed for expanding the base of climate finance contributors, a move opposed by developing countries. However, some developing nations are already voluntarily contributing. A 2024 study by UK based think tank ODI and the Zurich Climate Resilience Alliance found that India was the second-largest contributor among developing countries in 2022, providing $1.28 billion through multilateral channels, with China as the largest contributor.

What are the concerns with climate finance?

A policy brief published by the Asian Development Bank (ADB) Institute in January highlights that while climate finance is central to climate negotiations, it remains insufficient, highly concentrated, and heavily reliant on debt. Nearly half of all climate finance is directed toward energy and transportation, with mitigation efforts receiving over 60% of total finance, while adaptation remains underfunded.

The brief also notes that debt-based financing dominates, accounting for 72% of all climate finance, with grants making up only 25% and equity contributions a mere 3%. Experts argue that this financing model is ineffective for long-term climate resilience. Lead author of the ADB policy brief, Anurag Krishna Vippala, a climate finance economist at the Livelihoods and Natural Resource Management Institute, Hyderabad, says that despite the significant sums allocated over the past decade, the actual impact on climate change remains limited. He explains that debt financing, by its very nature, dilutes the benefits of funded initiatives, as returns must flow back to the lenders. Thus, it reduces the resources available for long-term climate action.

Rohit Azad, assistant professor at Jawaharlal Nehru University’s Centre for Economic Studies and Planning, criticises the debt-based model, arguing that it reinforces financial dependence on the Global North. “Developed nations have exceeded their fair carbon share fourfold and expect the Global South to take on additional financial debt. This is a form of double indebtedness,” he says.

Barua says that around 90% of climate finance from developed to developing countries comes in the form of debt, mainly due to the lack of a clear definition. If the parties at the annual UN climate conference agree on a standardised definition, it will bring clarity on what should qualify as climate finance. While debt is inevitable, he argues that grants should form the majority of climate finance.

What is the way forward?

The outcome of COP29 has sparked discussions on how to ensure sufficient climate finance mobilisation, with suggestions ranging from better accounting methods to structural reforms of financial institutions.

The ADB Institute policy brief calls for an enhanced evaluation process to assess initiatives and measure their benefits accurately.  It calls for balancing the funding mechanism, saying, “The imbalance in the nature of funding — between mitigation and adaptation, as well as debt versus equity — must be addressed as a high priority.” Similarly, a paper by the Stockholm Environment Institute, released in January, links climate finance shortfalls to structural inequalities in the international financial system, calling for reforms in debt practices, taxation systems, and financial institutions.

Azad advocates for a neutral international body, independent of any single country, to fairly distribute climate finance. “Countries that have exceeded their carbon limits should contribute, while those below their fair share should receive funds. This is the principle that should be applied globally, ensuring that compensation accounts for historical emissions,” he suggests.

For stronger negotiations, Azad emphasises the need for an alliance of Global South countries. “The G7 countries (a group of developed countries) and European Union (EU) negotiates as a bloc, while the Global South remains fragmented,” he points out.

While experts like Azad and Barua stress the importance of securing finance from developed countries, they also highlight the need for domestic mobilisation. Azad warns that if the international framework fails, countries will have to look inward for climate funding. Barua notes that many developing countries are not fully exploring their domestic funding potential. He also foresees climate finance drying up, particularly after the U.S. withdrawal from the Paris Agreement. This could also prompt European nations to scale back contributions, making it harder for developing countries to access funds. He feels that the next COP may not renegotiate the quantum of finance, but they will negotiate the modalities of climate finance.

(Published under Creative Commons from Mongabay-India. Read the original article here)