Climate finance has received international attention at recent COPs as nations seek to determine who should pay for climate action. It is expected to be one of the main topics of conversation at COP29 in Azerbaijan. However, one sector that has not attracted significant attention in climate finance is water. From 2016-2020, water-related climate finance only averaged about 3% of total climate finance. As a whole, countries would need to increase their spending by USD 131.4 to USD 140.8 billion annually to meet water-related needs—almost tripling current expenditure levels. Moving forward, determining the relationship between climate finance and water will be necessary to develop innovative funding solutions that bridge the water financing gap.
What is climate finance?
Climate finance is generally defined as the financial instruments or assets that help with mitigation or adaptation to climate change. It has become increasingly important as countries, particularly low- and middle-income, face the large-scale investments necessary to achieve global climate goals.
Historically, mitigation has received more climate funding. In 2021-2022, mitigation finance reached USD 1.2 trillion while adaptation finance only totaled USD 63 billion for the same period. Although climate flows have increased significantly in the past few years, they still only compose 1% of global GDP. In an average scenario, climate finance needs will total USD 9 trillion by 2030 and then increase by USD 10 trillion each year from 2031 to 2050.
Private actors provide 49% of climate finance (USD 625 billion). Development finance institutions such as the World Bank and the European Investment Bank contribute most of the public finance (57%). However, 17% of this finance is provided as market-rate debt, which increases the debt burden of least developed countries. Blended public and private finance also shows promise for attracting investment in climate finance by reducing risks for private investors.
How does water financing differ from climate finance?
Water financing addresses how to fund water and sanitation-related initiatives including large-scale infrastructure, smaller decentralized projects and nature-based solutions. Climate change is often viewed as primarily a water crisis, and water projects are essential for climate mitigation and resilience. For instance, improving energy efficiency in water management can reduce emissions and water projects such as solar-powered boreholes help with drought adaptation.
Not all water projects quantifiably contribute to climate change mitigation or adaptation, which can make it challenging to leverage climate finance for water. Although water is intrinsically linked with other sectors such as food, energy and ecosystems, it can be difficult to disaggregate impacts and trace and track finance flows. As such, isolating the climate aspect of water projects is essential to access climate financing streams.
Where are the greatest gaps in water financing?
The global average for water financing conceals significant disparities in water funding across regions. The largest financing gaps are in sub-Saharan Africa and South Asia. An estimated USD 200 billion per year is required in developing countries for water infrastructure and services. This demand for water for all uses may rise by 20-30% by 2050. On average, governments in developing countries spend less than 2% of expenditure on water and less than .5% in Africa.
What challenges does water financing face?
Water financing often requires high upfront investments in capital for large infrastructure projects and long pay-back periods. Smaller-scale projects have the issue of increased transaction costs as each project has separate commercial and legal due diligence requirements.
Defining revenue streams for water can also be complicated as it is commonly seen as a public good, and the benefits of water-related investments are often shared or difficult to monetize. For example, flood protection benefits the public but cannot be easily monetized, undermining investment interest.
Finally, economic data on water is often insufficient and lacks standardization; this issue will worsen in the future with climate change disrupting baselines. The lack of detailed financial data makes it challenging to attract investors.
What’s next for climate finance and water financing?
At COP29, policymakers are expected to set a New Collective Qualified Goal (NCQG) on climate finance to determine how much money to direct towards developing countries’ climate-related needs. This goal will build off a floor of USD 100 billion per year for climate finance by 2025. The size of the target will be determined by factors such as time frame, who is contributing and what climate actions are covered. Setting the NCQG has been in negotiations since COP26.
Water financing continues to develop as a field of study, and significant further research will be necessary to quantify needs and increase investment interest. Innovative financing tools are under development to attract private investment including green bonds, impact investing and new financial models. Blended finance also represents a promising avenue to attract private investment by reducing funder risks. Finally, in the absence of large-scale public and private finance, meso- and micro-level private sector actors have stepped in, including “own source” private sector capital, small and medium scale enterprises and informal water markets. These tools may represent the future of water financing.
IWMI’s research explores the mechanisms of water financing and how to better leverage it to achieve climate and sustainable development goals. IWMI will be supporting national governments, collaborating with our partners and prospective partners and engaging in discussions on water and climate at COP29.
