Greenhouse Gas Emissions Are Still Rising In Emerging And Frontier Markets

The decoupling of economic growth and greenhouse gas emissions has so far happened only in advanced economies. As a result, progress in reducing global greenhouse gas emissions has been offset by rapid growth of carbon emissions in emerging markets. In China, in particular, renewable energy capacity additions have not kept pace with power demand (see chart 1).

Chart 1

Accelerated economic growth in EFMs could delay the transition to net zero if the diffusion of green technologies is limited.   Historically, carbon dioxide emissions per capita have tended to rise with income (see chart 2) and the International Energy Agency (IEA) projects rising energy demand in EFMs will contribute the most to carbon emissions globally, under a current policy scenario. There are differences across countries, with the larger and faster emerging economies--like China and India--more likely to shape the pace of the global energy transition than frontier markets where carbon dioxide emissions and GDP per capita remain low.

Chart 2

There is still a shortfall in annual climate investments, especially in EFMs, despite a rapid improvement in the economics of green energy.   Renewable energy sources have reached maturity and can often be cost competitive with fossil fuels for energy generation (the levelized cost of electricity can even be below that of fossil fuels). Yet, the private sector provides less than half of climate finance outside high income countries (see chart 3). To cite one estimate, Bhattacharya et al. (2022) assess there is a 4.8% of GDP gap in annual climate investments (which includes energy transition; agriculture, forestry and other land use; adaptation; and resilience) in emerging markets other than China.

So, what explains this "climate mitigation finance gap" and the continued rise of fossil fuels in EFMs?

• Running a scenario analysis, we show that investment needs as a share of GDP are highest for countries that are less developed, even though emissions per capita remain low and their share of renewables in electricity generation may be high. In many cases this results from the large gaps in power access for the population.
• Lower resources, such as the lack of sufficient domestic savings to fund transition investments, modest international climate finance, and tight fiscal space, are an obvious hurdle to investment.
• Catch-up needs--such as rising energy demand and other infrastructure gaps--are also important, and add to other supply-side barriers that affect economic development potential, even when financial hurdles are overcome.
• Managing the macroeconomic impacts of the transition may also be challenging in EFMs because carbon taxing is more likely to weigh on growth when affordability is stretched and green subsidies may not create green industries where technology gaps are larger.
• That said, the transition can also be an opportunity for growth, with some of the key resource inputs for green growth located in EFMs.

Chart 3

Energy Transition Scenarios Point To High Investment Needs In EFMs

EFMs face a challenging path to achieve energy transition objectives. We look at two potential energy and sustainable transition scenarios to unpack the main drivers of high investment needs in EFMs by 2030 and 2050 (see Box and Appendix for details). We estimate the key EFMs that we follow will need to invest on average 6.3% of GDP by 2030 to achieve the committed share of renewables in electricity production under the STEPS scenario (see chart 4). That's $2.6 trillion, or $1.4 trillion excluding China. The financing challenge will be more acute for frontier markets, which are still lagging in terms of full electricity access for the population. Many emerging markets have a higher reliance on fossil fuels, which for some, provide electricity but also funds for their government budgets.

S&P Global Ratings estimates that frontier economies, mostly located in Africa, would need to spend 33.3% of GDP by 2030 to achieve renewable power generation goals under the SDG scenario, compared with 10.7% of GDP for other emerging markets and 4% for G7 economies (see chart 4).   Although frontier economies emit less per capita and have a higher share of renewables in their energy mix, achieving full electricity access through renewable generation would require significant investments, given a backdrop of much lower resources, suggesting it might be difficult to achieve. The median GDP per capita of frontier markets is $1,600 compared with $7,600 in emerging markets.

The challenge seems less acute in faster-growing emerging markets, which emit 8x more than frontier economies on a median per capita basis, nevertheless regional variation exists (see chart 6). In Latin America, S&P Global Ratings estimates that investment needs are lower than 2% of GDP by 2030, while they average 10.7% in the Middle East and North Africa, 13.3% in Asia, and 7.9% in Central and Eastern Europe (excluding Ukraine) (all estimates under the SDG scenario).

Chart 4

Chart 5

Chart 6

Modern renewable energy sources accounted for 12% of total final energy consumption in our EFM sample in 2021--well below the U.N. SDG for 2030.   This data is the latest available and classifies modern renewable energy sources as renewables excluding traditional uses of biomass. According to the U.N.'s SDG, to be on track to keep global temperature below the 1.5 degree Celsius threshold, the share of renewables in total final energy consumption should reach 33%-38% by 2030; this translates into 60%-65% of electricity generation. Few EFM countries are currently well positioned to achieve this (see chart 6), even when assuming overall economic development will continue lagging that of advanced economies.

There is a gap in the share of renewables needed and rapidly growing electricity demand appears to be the main driver of high investment needs.   Electricity demand is set to grow at an average per capita rate of 3.1% per year through 2030 across most EFMs according to estimates from S&P Global Commodity Insights; slightly higher than the IEA's estimate of 2.2% for the same period under STEPS).

Electricity demand growth is uneven across EFMs.   In the case of frontier markets, we assume full electricity access will be achieved, therefore we assume a 400% increase in power demand versus just a 37% increase in emerging markets between 2021 and 2030. In the cases of India and Indonesia, electricity demand is expected to grow much faster than in other emerging markets because economic growth and improving living standards boost the use of household appliances and, in the case of Indonesia, air conditioning. China is also an outlier in electricity demand growth because its economy will require a significant increase in supply to support its services and technology sectors.

Most EFMs' power demand will remain well below the average of advanced economies through 2030 (see chart 7).   This reflects the lack of development in EFMs. Consequently, if the pace of development were to accelerate, this could also intensify power demand, expanding the financing gap and climate footprint.

Our estimates consider only the capital needed to build renewable electricity generation, while keeping, or reaching, 100% access to electricity (in some cases this will require building additional fossil fuel capacity--see Appendix).   In other words, while we believe our estimated figures are a good illustration of the resources needed to achieve renewable electricity generation goals, they don't account for additional infrastructure costs such as the necessary grid lines to connect new facilities, the investments needed in decommissioning existing plants, or resources to build storage capacity. These investments could easily double the financing requirements across the board. According to IEA estimates under the SDG scenario, full energy transition costs could reach $351 billion for Latin America, that is 1.9x more than our estimate, to fulfill power generation objectives.

Chart 7

Development Gap: Starting Points Matter

This high-level look at estimated energy transition investment needs shows development is a key part of the story, particularly when it comes to sizing the gap. The same investments become relatively less affordable the lower the income of the country, which is exacerbated by high upfront costs for renewables. Lower development is also associated with greater hurdles to investments than advanced economies, such as less developed infrastructure, a lack of know-how, and greater macroeconomic and institutional uncertainty.

Achieving energy transition goals might not be a priority for many EFMs.   Over the past decade, the convergence of EFMs' GDP per capita with that in advanced economies has stalled and the buildup of fixed capital has not fully recovered since the pandemic (see chart 8). In frontier markets many aspects of living conditions are underdeveloped, including key services like security, health, education, and other basic amenities and infrastructure, such as water and sewage (see chart 9). In many cases, achieving access and delivery of these services will take precedence over energy transition goals.

Chart 8

Chart 9

Fiscal space is limited for many EFMs.   Some countries are in need of fiscal consolidation following pandemic-related spending and resulting high debt. Interest burdens have risen as well (see chart 10) due to higher interest rates, meaning a rising share of fiscal revenue is used to service debt, especially in frontier markets. Absent higher-than-normal economic growth or external funding, public investment decisions could entail trade-offs, likely favoring short-term development objectives over the energy transition.

Supply-side constraints to the energy transition are also more pronounced in EFMs.  

• Infrastructure gaps generate additional and competing investment needs to create, expand, and upgrade basic infrastructure. Investments in the power grid in EFMs (excluding China) have declined in recent years according to the IEA, despite rising demand for electricity.
• Access to the latest technology is more limited for less developed EFMs because they are further away from the technology space and the average skill level in the workforce tends to be lower than the average in advanced economies. Even if green and energy-efficient technologies are available, they are likely to be at a nascent stage and therefore more expensive and less available than in advanced economies (Comin and Mestieri, 2018). Trade frictions add another hurdle to accessing more-energy-efficient technologies, although some positive developments may come from cheaper products being developed in China.
• EFMs have a smaller pool of financing options than advanced economies to invest in the energy transition. Especially in frontier markets, financial markets are small (averaging 10.4% of GDP), less sophisticated, and less integrated globally than in advanced economies. Domestic savings available to finance investment are much lower, and energy affordability may already be stretched (see chart 11). Utilities may not have funds themselves. In sub-Saharan Africa, for instance, only about one-third of energy utilities recover their costs (World Bank, 2023).

Chart 10

Chart 11

Increased macroeconomic uncertainty makes investing in the transition harder and costlier in EFMs, despite competitive renewable energy costs.   More volatile political and economic cycles add another layer of complexity to investment decisions, while the absence of regulation and ineffective enforcement of the legal framework often reduce the visibility of project returns. These issues are not specific to climate finance, with capital inflows generally lower in countries with more risky investment climates (Eichengreen et al., 2018). Investors tend to ask for higher risk premiums or may use financial tools to manage uncertainty (like currency hedging, political risk insurance, first loss guarantees). In EFMs, such tools might not be available at scale, so these issues typically weigh on profitability, especially because renewable energy investments often start generating profits only after a decade.

Demand- and supply-side issues constrain the capacity to absorb external funding, where international actors can help.   Multilateral institutions' (MLIs') mobilization of private-sector funding in high-income countries has been 2x-4x the volume in low- and middle-income countries, despite MLIs' financing commitments being roughly the same (see "Sustainability Insights: Shareholders Are Calling On Multilateral Lending Institutions To Increase Private-Sector Capital Mobilization For Climate And Development," May 28, 2024). Without the right workforce, physical and financial infrastructure, and institutional framework, it can be hard for external investors to find productive ways to invest in EFMs' energy transition. This translates into a lack of bankable projects. Therefore, focusing on the investment gap alone, without developing these other factors, might not deliver the transition.

Macroeconomic Hurdles Add Complexity To The Transition In EFMs

Domestic climate and energy policies play a major role in steering private investments toward the energy transition, but they are not as easily applicable in EFMs. The trade-off linked to affordability, high investment needs, the institutional set-up, and economic structures can be impediments to managing the costs of the transition.

• Carbon pricing can raise revenue for the transition, but is more difficult to implement at an early stage of the transition. This is particularly true in countries where there is no alternative to fossil fuel energy. In this case, pricing carbon--if not offset--can impede economic growth, since it weighs on households' purchasing power and may also affect companies' competitiveness in markets where carbon pricing is not present.
• A recent shift facilitating more subsidies for green technologies requires fiscal space, but also technology and knowledge, which could help create a local industry and jobs. Industrial policies may work in large, diversified emerging markets, like India and China, which rely on a pool of cheap labor and are not too far from sources of technology. But they may lead to higher imports where reliance on foreign technologies is high, which can contribute to imbalances in external accounts. That said, some EFMs still have fossil fuel subsidies in place, which could create incentives to delay the energy transition.
• Regulation is more difficult because of the institutional structure. Governance challenges make implementing long-term policies, such as those needed for the energy transition, more politically challenging. In some countries, there may not be an energy regulator to design relevant policies.

The structure of the economy matters.   Economies with a high reliance on hydrocarbons for exports and fiscal revenues are more at risk of losing competitiveness as fossil fuel use decreases globally. Although this may provide some incentives for other activities to develop, it also points to a bigger structural adjustment and other investment needs for less diversified economies to find other sources of growth.

Looking Ahead: Green Growth Can Help Close The Gap

Renewable energy goals and economic development objectives can overlap. Climate mitigation has been associated with growth in advanced economies that have relatively well-established power sector infrastructure (see "Shifting Green Growth Narratives Are Fostering The Green Transition," published March 20, 2024). More specifically for EFMs, building clean energy infrastructure can pave the way for further growth, since energy is a key production factor for firms and public services, a driver of industrial development and households' well-being (Toman et al., 2003; UNIDO, 2009). At a time when many international stakeholders are committed to transitioning to low-carbon value chains, having a clear climate mitigation strategy may help attract more capital and foster easier integration into international supply chains.

Some of the key resource inputs for green growth are in EFMs.   For example, the potential to generate electricity from solar energy is much greater in most EFMs than in advanced economies, due to EFMs' geographic location. This huge power source remains largely untapped. Also, a large share of critical minerals--key inputs for green technologies, are located in Latin America, Africa, and Asia. Potential future regulation regarding carbon markets and nature could also generate income via the maintenance of carbon sinks and rich biomes like the Amazon region.

Transition investment needs are high but climate change is a global challenge, offering an additional incentive for advanced economies to help EFMs catch up.   Development finance has taken on a new role in avoiding the worst impacts of climate change everywhere. Its momentum is boosting efforts to provide finance to countries most in need. This could enhance prospects for bridging both the energy transition and economic development gaps in EFMs.

Related Research

• Sustainability Insights: Shareholders Are Calling On Multilateral Lending Institutions To Increase Private-Sector Capital Mobilization For Climate And Development, May 28, 2024
• Creditweek: What Is The Climate Finance Gap? May 2, 2024
• Economic Research: Shifting Green Growth Narratives Are Fostering The Green Transition, March 20, 2024
• China's global reach grows behind critical minerals, Aug. 23, 2023
• Energy Transition: Competitive Advantages Shield GCC Sovereigns, March 8, 2023
• Gulf Nations Invest To Accelerate Deployment Of Renewable Energy, Feb. 27, 2023
• The Energy Transition: The Clock Is Ticking For Middle East Hydrocarbon Exporters, Feb. 16, 2020

External Research

• Bhattacharya A et al. (2022). Financing a big investment push in emerging markets and developing economies for sustainable, resilient and inclusive recovery and growth. London: Grantham Research Institute on Climate Change and the Environment, London School of Economics and Political Science, and Washington, DC: Brookings Institution.
• Comin, Diego, and Martí Mestieri. (2018). "If Technology Has Arrived Everywhere, Why Has Income Diverged?" American Economic Journal: Macroeconomics, 10 (3): 137-78.
• Eichengreen, B., Gupta P. and Massetti o. (2018), Are Capital Flows Fickle? Increasingly? And Does the Answer Still Depend on Type? Asian Economic Papers (2018) 17 (1): 22–41.
• IEA (2023), Electricity Grids and Secure Energy Transitions.
• IMF (2023), Financial Sector Policies To Unlock Private Climate Finance In Emerging Market And Developing Economies, Global Financial Stability Report, Chapter 3.
• Toman M., and Jemelkova, B. (2003), Energy and Economic Development: An Assessment of the State of Knowledge, The Energy Journal, 24 (4): 93-112.
• UNIDO (2009), Energy Infrastructure and Industrial Development.
• World Bank (2023), Scaling up to phase down: Financing Energy Transitions in the Power Sector.

Appendix

Definitions

Emerging markets:   For the purpose of this paper, S&P Global Ratings defines emerging markets as countries that have been, or are, transitioning toward middle income levels, with good access to global capital markets (including the sovereign, domestic corporations, and financial institutions), evolving domestic capital markets, and global economic relevance considering their economic size, population, and share in global trade. We focus on 18 key emerging economies, which are those with larger size and market relevance, and where S&P Global Ratings can provide an opinion about sovereign, corporate, and bank ratings.

These countries are:

• In Latin America: Argentina, Brazil, Chile, Colombia, Mexico, and Peru;
• In EMEA: Hungary, Poland, Saudi Arabia, South Africa, and Turkiye; and
• In APAC: China, India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam.

Frontier markets:   For the purpose of this paper, we consider frontier markets as countries with low income per capita--below $2,500 GDP. These countries face much bigger economic challenges and financing needs. They rely on international institutions, including the IMF's Poverty Reduction and Growth Trust, for vital policy and financial support. They have shallow and narrow domestic capital markets that are often underdeveloped. These economies are often characterized by political instability, a lack of regulation and financial reporting, weak liquidity, and possible large currency fluctuations, with economies concentrated in very few sectors or commodities. Among the countries considered in this article, eight countries fall in the scope of this definition. Except for Tajikistan, all countries are in Africa.

Key scenario assumptions

We estimate the cumulative investment needs to achieve renewable power generation goals by 2030. We calculate these amounts as a percentage of our estimate of 2024 GDP for each country in our sample, using the following data:

• Our historical data for power generation mix comes from Ember and the Energy Institute – Statistical Review of World Energy; we use 2021 as our base year since all countries have available data.
• We rely on the S&P Global Commodity Insights power demand estimates for 2030 and then we model for two scenarios, one considering the IEA's Stated Policies (STEPS) scenario for renewable energy targets and a second one considering the U.N. Sustainable Development Goals (SDG) estimates, which require additional commitments, hence more investments. The STEPS scenario requires at least a 43% share of power generation to come from renewable sources, while the SDG scenario requires 62.5% in the middle range.
• Overall power demand assumptions consider, among other factors, population growth, improving living conditions, and changing population habits, such as increasing use of electric stoves or electric cars. We also assume that all African countries achieve full electricity access by 2030. To achieve this, we assume that the selected African countries in our sample (Angola, Democratic Republic of Congo, Ethiopia, Ghana, Kenya, Mozambique, and Nigeria) will meet the lowest projected per capita power demand of 1,276 kWh for an EFM economy with 100% electricity access.
• Population forecasts for 2030 come from the World Bank database.
• We assume EFM countries will go for the cheapest renewable technologies, considering both installed costs and levelized cost of electricity; our source for these costs is S&P Global Commodity Insights. In countries where there is progress in the renewable energy mix, we keep the same weight of solar and wind mix, for other countries we assume a 50/50 proportion for solar and wind energy investment.
• Many EFM economies will require additional fossil power capacity to meet their respective electricity demand and maintain electricity generation reliability. For these countries, we assume this additional capacity will come from combined cycle gas turbine (CCGT) power plants, considering costs and lower climate impact than other nonrenewable sources. CCGT power plants also offer the most cost efficient relation between the capacity factor (the ratio of electrical energy produced by a generating unit for the period of time considered to the electrical energy that could have been produced at continuous full power operation during the same period) and the capital costs versus fossil fuel alternatives and nuclear plants.