Why investing in intermediary cities should be a priority for a green recovery

By Michael Lindfield, Senior Consultant, former Senior Specialist at the ADB

Although the COVID-19 pandemic will change the context for investment decisions – including for climate investment in intermediary cities in emerging markets and developing countries – little has been done to detail these consequences. In general, consequences for financing institutions and cities may include lower inflows to institutions like pension funds and insurance companies, and increased pressure to buy government bonds and lower revenue base, thus reducing cities’ and other urban institutions’ ability to service debt and/or provide availability payments to concessions. Additional consequences include potentially lower emerging market and developing economy sovereign and sub-sovereign credit ratings (increasing the cost of debt), and curbed economic growth, thus curtailing the potential for cost recovery in relation to green projects.    

These consequences are likely to impact intermediary cities more than capitals or megacities because they have lower credit ratings and less technical capacity. However, there will be opportunities if climate investment is integrated into COVID-19 recovery financing, creating the right incentives for investors. The critical alignment relates to the perceived risk/return profile of investments. If the rate of likely return will be sufficient to compensate for the risks of investing, then private, institutional and commercial entities will invest, provided minimum regulatory hurdles, such as minimum credit ratings, are met.

Critical to seizing these opportunities will be strategies to address the consequences of economic concentration, which makes for a fragile economy – locally and potentially also globally as we saw with the global disruption of the supply of computer chips and auto parts as a result of the 2011 Bangkok floods. The concentration of industry clusters in and around large or capital cities, and the widely differing growth rates between large and intermediary cities lead to inequality and social tension. For example, 2017 statistics show that Central Jakarta had a per capita GDP of IDR 641 m (approximately USD 43,000), while almost all other Indonesian cities had a per capita GDP of below IDR 100 million (approximately USD 6,900).   

In relation to climate issues, the critical trend is that intermediary cities are growing rapidly, and will host the majority of future urban population growth. The implications are that while they may not be the worst emitters per capita  in a country, their cumulative contribution to emissions are growing faster than the larger cities  – India and China provide examples of this trend. By 2030, the number of cities with 1 to 5 million people is projected to grow to 597 (from 467 in 2018). Almost all are intermediary cities and how they produce and consume energy, manage land use, construct infrastructure and buildings, consume water and food, and recycle and reuse waste, will have a critical impact on the planetary ecosystem.

Moreover, they are often in vulnerable areas. For example, located on estuaries and near rivers where climate impacts like storm surge and water scarcity can be significant, people may be vulnerable to both the impacts themselves and a lower capacity to build resilience and to respond to such an event. Expansion of coastal cities is expected to continue over the 21st century, with over half the global population living in mostly coastal zone intermediary cities by mid-21st century. Annual coastal flood losses could reach USD 71 billion by 2100.

Priority investments for both COVID recovery and decoupling economic growth from emissions should thus be focused on sustainable development in intermediary cities and regions. This implies building economic resilience by identifying critical elements in health and food supply chains and developing key industries to fill any strategic gaps. In doing so, the focus should be on building industry clusters and infrastructure to support their development (subject to rigorous economic cost-benefit analysis including potential costs of supply chain failure).

Another priority is to tackle regional inequality by decoupling developing clusters from the capital where possible. For example, studies on mitigating inequalities in Indonesia have shown the importance of efforts to decentralise non-resource-oriented manufacturing activities in off-Java provinces. Studies have also shown the significant impact that infrastructure expenditure has on reducing poverty and income inequality in Indonesia.

To move away from current unsustainable trends, investments should be directed at labour-intensive industry clusters supported by strategic industries and infrastructure. And next steps should involve: implementing national strategic input plans and financing (redirecting subsidies from non-green investments as a first priority); cluster mapping of existing and potential clusters in intermediary  cities and regions; developing investment plans for these clusters; and capitalising national financing facilities to finance these plans, preferably from local capital markets and if not, international financial institutions. Further steps should also include supporting project development by states, provinces and cities, as well as by development corporations and enterprises; and enabling the structuring of institutions for planning and project development, and long-term infrastructure financing, at city and regional levels.      

There is considerable experience in structuring, financing and implementing such projects. For example, the Inter-American Development Bank supported the development of nine clusters in intermediary cities in the Province of Mendoza, Argentina. Additionally, the Asian Development Bank’s current Shandong Green Development Fund provides an example of a facility structured to provide blended finance to intermediary cities, which, in turn, leverages private financing. It offers flexibility in relation to investment types (moving beyond infrastructure) and is focused on regional sustainability.

Critical to success is the choice of the appropriate intermediary – government agency, national development banks or private sector; and robust mechanisms to support project development given  the currently limited capacity for conceptualisation, development and structuring of climate projects in emerging and developing countries. In view of the huge numbers – hundreds of millions – of people that stand to benefit from healthier lives and more resilient economies, development agencies and international financial institutions should prioritise support to intermediary  cities and regions at the core of a high-impact green recovery.