A new era of climate finance for Sri Lankan industries

When it comes to switching to renewables and implementing energy efficiency measures, one of the biggest barriers Sri Lankan businesses face is cost. Now a new national financial strategy for industrial decarbonization looks set to change things.

For Sri Lankan businesses, the benefits of moving away from expensive and polluting imported fossil fuels are clear. But for many companies, the cost of the technologies and expertise needed to decarbonize are still too high, and there is a lack of affordable loans and other financial incentives to make investing in decarbonization viable. On top of this, businesses are still reeling from Sri Lanka’s economic crisis, which has reduced spending and increased operating costs, and seen the cost of borrowing skyrocket.

With UNIDO’s support, this is a situation the Sri Lankan government is determined to change. At the end of 2023, under the Accelerating Industries’ Climate Response in Sri Lanka programme, environmental consultancy firm Econoler was commissioned to assess the current situation and work with Sri Lankan policymakers, banks and businesses to develop an industrial decarbonization financing strategy to improve it.

“The idea of the landscape analysis was to understand what the situation is when it comes to financing industrial decarbonization in Sri Lanka and what the challenges, obstacles and barriers are that prevent the market from scaling up,” says Lilit Gharayan, Senior Sustainable Finance Advisor at Econoler.

“A good mix of different sized businesses and different industries were involved. Their needs in terms of size of investment and financing are different, depending on the size of the business, but the challenges are very similar. …The main driver [to invest in decarbonization] for SMEs [small and medium enterprises] is to save energy; to have faster or bigger returns while investing less… Bigger companies are more compliance driven. They have to comply with certain requirements of big multinationals in order to be able to export, for example.”

Supply and demand

Around 20 policymakers, financial institutions and businesses participated in the landscape analysis. The research focuses on textiles and apparel, food and beverages, rubber and plastics as these are the industrial sectors with the highest environmental and economic impact in Sri Lanka, but its findings are relevant to all Sri Lankan industries.

Crucially, the analysis looked at both ‘demand’ (the industrial businesses that need climate finance) and ‘supply’ (the banks and financial institutions tasked with providing green loans and investments).

For industrial businesses, one of the biggest challenges identified is the lack of affordable financing. Interest rates for green loans are still quite high, maturities are usually shorter, and the collateral requirements are high. In addition, banks are not proactive when it comes to offering green loans and other financial products targeted at industrial decarbonization.
On the supply side, the most pressing issue facing financial institutions is the lack of access to affordable funding sources, such as funding from multilateral development or the government.

“But it’s not only about access to finance and about the costs,” explains Lilit. “In many cases, it’s also about the knowledge, experience and capacities – in financial institutions and in companies – which means possible areas [for decarbonization] that might be really economically viable do not get explored…Starting from the policy and regulatory framework up to the lack of suppliers of [affordable] technology, suppliers of services, suppliers of knowledge, these are all big obstacles that are preventing investment.”

Developing an industrial decarbonization strategy

Work is now underway to develop a national strategy to increase Sri Lankan businesses’ access to decarbonization financing. The strategy will propose a range of financial solutions based on evidence of what works from countries with similar economic outlooks, tailored to the specific needs and context of Sri Lanka which the landscape analysis identified.

“One of the most effective tools is loan interest subsidizations for investments in a certain technology or area. For example, energy efficiency,” says Lilit. “This is when the government will specify certain industries that can get subsidies for certain energy efficient technologies. So if a company gets a loan with a 15% interest rate from the bank, for example, a proportion of that will be subsidized – say 10% – so the effective interest rate will be 5%.

“Another very popular instrument is a guarantee or risk sharing mechanism. This is where either the government or a donor institution or an IFI [international financial institution] shares the risk with the bank. This can mean, for example, 50% of the default will be covered by the institution sharing the risk. This makes the banks more courageous to lend.

“It [the strategy] will also look at capacities on both sides. In the financial institutions, the idea will be to enhance capacities among different layers of staff – even the salesperson should know what renewable energy is to offer it to the client. And capacities are not only about training, it can be about creating a financial product specifically targeted at decarbonization investments, or about creating processes and structures to assess specific risks, or to audit or monitor loans. In the companies, it will also be about building capacities to ensure projects are effective [so that decarbonization can happen].”