At the end of last year, the Green for Growth Fund (GGF) launched a major new initiative to provide green finance in local currency for the markets where it operates. To understand why this is valuable and how this helps the funds partners and final beneficiaries, it is important to understand how systems of currency can affect local businesses and households.

Understanding Exchange Rate Volatility

In smaller markets where lending in foreign currency is common, businesses and households typically face a trade-off between upfront borrowing costs and exposure to exchange rate risk. Global economic uncertainty and heightened exchange rate volatility in these markets makes economies sticky, slowing down lending from the biggest bank to the smallest household both in foreign and in local currency, as neither party feels comfortable with the risks involved, particularly for hard hit sectors.

Often, businesses and households unfavourably compare the published borrowing rates for foreign currencies – which are typically lower – with their local currency and believe it would be cheaper to borrow in Dollars or Euros. For example, the average interest rate in Georgia for household/private loans in local currency can be as high as 17%, in comparison to roughly 6% in foreign currency. This decision can leave them vulnerable to economic shocks and local currency depreciation that can wipe out any benefits from a lower interest rate and lead to challenges in repaying a loan. 

Exposure to foreign exchange risk is not spread evenly throughout borrowers. Larger clients such as corporates or exporters might have foreign currency denominated income or can find other ways to balance or hedge their risk, while smaller firms and households, operating in local currency, are left more exposed.

The GGF’s new initiative offers partner banks and lending institutions access to local currency finance without the risk associated with foreign currency borrowing. This gives them the confidence to lend domestically without the risk of currency fluctuations while simultaneously investing in a greener and more sustainable future. This is particularly important for those parts of the economy that would otherwise be impacted by currency considerations.

GGF’s New Funding Mechanism

The GGF lending agreements to partner institutions can span several years, and loan periods to their end-clients can be even longer, so predicting currency exchanges on such a timescale is fraught with uncertainty. Therefore, the GGF has created a new funding mechanism, known as “L-shares,” which removes exposure to exchange-rate risks for partner banks, spurring green finance, to help businesses and households mitigate and adapt to climate change faster. Moreover, boosting affordability will be crucial as economies recover at different rates from the pandemic while still needing to make ambitious progress towards climate goals.

The L -share scheme was launched in 2020 with an investment of EUR 42.5 million from the EU and German Federal Ministry for Economic Cooperation and Development. Through these L-shares, financing in local currency will play a vital role in promoting responsible green finance and contributing to sustainable economic growth across Southeast Europe, the European Eastern Neighbourhood Region, and the Middle East and North Africa – regions burdened with the economic repercussions of the crisis.

“These countries have been hit harder because they have fewer resources to protect their economies compared to larger EU markets,” explains Oxana Binzaru, a regional director at Finance in Motion, which advises the GGF. “They are facing the twin challenges of increased debts and reduced exports. This leaves them with a reduction in their stocks of foreign currency which increases their risk of a budget deficit.”

The currency exchange risk is also higher, currently, because there is more volatility in the market. “We’re in a very low intertrade environment, and the tourist economy has disappeared,” Binzaru says. Similar to Georgia, Ukraine saw its local currency depreciate almost 20% against the Dollar last year as its economy contracted.

Financial Institutions Eligible for Local Currency Financing

Promising banks, smaller lending companies and MFIs are invited to apply for finance in local currency and already GGF partner institutions in Eastern Europe have begun receiving funds. As an impact investor, the GGF is dedicated to developing a diversity of partner institutions, including smaller lenders that are embedded in local communities. Last mile clients can often be overlooked due to their small size, but small energy efficiency loans, for example, are among the most impactful measures per their cost.

“It’s often harder or more expensive for smaller financial institutions to access financing in their markets, but at the same time they are more embedded in the communities we are trying to reach,” Binzaru says. “A key part of our mission towards a sustainable and just transition is to develop the green segments of the financial sectors in these countries. Local currency financing is often unavailable to these institutions, so the GGF, by providing them with local currency loans, can materially impact borrowing costs and support smart green growth.”

The GGF combines its lending with tailored technical assistance to help partner institutions build capacity in green lending and make them more effective champions for supporting climate action. As part of these efforts, several partner financial institutions are currently running awareness-raising campaigns to inform businesses and households of the benefits of borrowing in local currency, which have only been underscored by the challenges of the past year. These efforts will play an important role in delivering a green recovery that also places resilience and sustainable livelihoods at its heart.