Can China Contribute to Climate Action in Latin America?

Latin America has strengthened its commercial ties with China over the last decade. Besides its vast investment potential, Latin America can meet Chinese market needs for raw materials such as soybeans and lithium. Trade volume between Latin America and China reached USD 451.6 billion in 2021, up 41.1% from 2020. As of 2020, Latin America had also attracted USD 94.09 billion of Chinese investment in the infrastructure sector, including clean energy projects.

Some Latin American countries form part of China’s Belt and Road Initiative (BRI). As of March 2022, 20 BRI economies were in Latin America and the Caribbean region, the most recent being Argentina. China has also started to shift its focus from economic expansion to sustainable development, as reflected in the Global Development Initiative and China–CELAC (Community of Latin American and Caribbean States) Joint Action Plan for Cooperation in Key Areas (2022–2024).

Besides its vast investment potential, Latin America can meet Chinese market needs for raw materials.

As an investor, a creditor, and Latin America’s trading partner, can China improve its current economic practices and explore new methods to contribute to climate action in Latin America? This article seeks to provide some food for thought on three climate change-related aspects of trade between China and Latin America: (i) a crediting mechanism for clean energy projects, (ii) debt-for-climate swaps, and (iii) a greener free trade agreement.

Crediting Mechanism for Clean Energy Projects

Clean energy is essential to decarbonize the energy sector—which contributes about 40% of global emissions of carbon dioxide (CO2). China can contribute to saving 256 million to 768 million tonnes of oil equivalent annually by investing in wind power and photovoltaic projects in countries along the Belt and Road. Examples in Latin America include a photovoltaic power station in Jujuy province and wind power projects in the Patagonia region in Argentina.

Proper measurement, reporting, and verification should be in place to ensure that these projects deliver climate benefits. Moreover, green technology transfers to host countries are indispensable to improving energy efficiency. China recognized the importance of these enablers in its recent Guidance for Promoting Climate Investment and Finance.

The Joint Crediting Mechanism (JCM), a market-based mechanism developed by Japan, could serve as a reference for China. The JCM encourages the transfer of low-carbon technologies by allowing credits to be issued to project participants for emission reductions. In line with Article 6 of the Paris Agreement, the JCM uses “internationally transferred mitigation outcomes toward nationally determined contributions” (NDCs). In doing so, the mechanism quantifies emission reductions of JCM projects in host countries.

JCM credits are in the form of an emission reduction target. For instance, a project that used an advanced process control solution in the hydrogen production unit in Indonesia resulted in reductions of about 22,000 tonnes of CO2 equivalent (tCO2e) per year. In return, the investor received a credit of 2,734 tCO2e, which could count for the home country’s NDC. Approved methodologies, validations, and verifications ensure accurate calculation and avoid double counting.

Debt-for-Climate Swaps

Another way to fund climate action is through debt-for-climate swaps, which enable the creditor to relieve debt in exchange for ecological protection. Since its introduction in 1984, this model has been used to protect the Amazon rainforest and the barrier reef in the Caribbean. In 1987, foreign creditors forgave USD 650,000 of Bolivia’s debt in exchange for the government’s pledge to set aside 4 million acres of Amazon rainforest for conservation. Rainforest conservation could help mitigate climate change via forest carbon sequestration.

Debt-for-climate swaps bring triple gains: a good reputation for the creditor, financial relief for the debtor, and capital to tackle climate change. They are attractive to heavily indebted countries with rich natural resources. Some Latin American countries are interested. Among them, Ecuador appears promising.

Debt-for-climate swaps bring triple gains: a good reputation for the creditor, financial relief for the debtor, and capital to tackle climate change.

China’s debt exposure in Ecuador amounts to USD 18.37 billion, which equals 17.1% of Ecuador’s GDP. If China agrees to swap this debt for climate action, Ecuador could reduce CO2 emissions by 39 million tonnes per year, which would otherwise cost USD 12.65 billion, or 11.78 % of Ecuador’s GDP. These figures add to Ecuador’s debt swap potential.

One proposal is for China to forgive USD 440 million of Ecuador’s debt in exchange for 200,000 hectares of Amazon rainforest conservation, which would avoid 117 million tCO2 emissions. A less ambitious plan suggests repurposing USD 19.2 million in debt to support university research and expand the Colonso Chalupas Biological Reserve.

The challenge is on the ground. Reducing deforestation requires designing a conservation program and monitoring joint implementation, possibly over the long term. High transaction costs for negotiation, the risk of fading political support when administrations change, and the need for long-term financial commitments can discourage creditors from the swap talks.

The solution should focus on specifying a clear scope of conservation measures. Enhanced transparency can also help handle the risk of waning support when a new administration takes office. Openness to third-party participation, including private actors, could strengthen long-term financial commitments. A successful story is Belize’s conservation of coral reefs using blue bonds, wherein a private sector underwriter and a government agency insurer played critical roles in securing finance.

China has reasons to take on the debt-for-climate swap talks with Ecuador.

China has reasons to take on the debt-for-climate swap talks with Ecuador. To start with, Ecuador’s debt swap potential with China is high: it is a country heavily indebted but with rich natural resources. In addition, Ecuador demonstrates the political will to pursue the swap talks with credible proposals. It is also in China’s interest to help untangle Ecuador from a debt dilemma, especially in light of the volume of Chinese outbound investment and a looming debt crisis overseas. Being a large patent holder, China can contribute to addressing Ecuador’s climate and debt crises by transferring green technologies. For China, the reward would be more than a reputation gain: it would help bring Beijing a step closer to its carbon neutrality target by 2060.

A Greener Free Trade Agreement

The costs of climate change are growing steadily, especially as heat, drought, and hurricanes intensify. Trade can help lower the cost of eco-friendly goods, services, and technologies to tackle the climate crisis. For instance, access to affordable drought-resistant seeds could build resilience in the agriculture sector. Disseminating low-carbon technologies to low- and middle-income countries could reduce about 600 million tCO2e by 2040.

Trade barriers to environmental goods remain high in some countries. In Brazil, average tariffs on environmental goods exceed 10%, with levies on wind turbine blades and hubs up to 14%. Bilateral investment treaties between China and some Latin American countries such as Argentina and Uruguay do not reflect the current environmental considerations as they date back to the early 1990s. Uruguay is trying to clinch a new trade deal with China, but the prospect is uncertain given the lack of support from other Southern Common Market (Mercosur) members.

Given Latin America’s vulnerability to climate change, diversifying risks geographically also appears imperative.

Trade liberalization through free trade agreements (FTAs) is essential to secure affordable solutions to the climate crisis. Greener FTAs can bring more than climate benefits. They can improve export opportunities, ameliorate living quality, and create business and employment. A trade deal between Ecuador and China is expected to add nearly USD 1 billion in export opportunities to the Ecuadorian market. Given Latin America’s vulnerability to climate change, diversifying risks geographically also appears imperative.

Three elements are vital for a climate-friendly FTA: the inclusion of environmental services, clear definitions of “green” goods and services, and the use of environmental provisions. First, services are indispensable for transferring and implementing low-carbon technologies. Renewable energy projects rely on a group of services to develop and function. In terms of mode of provision, cross-border supply (mode 1) is gaining relevance due to technological development, which is also significant for transforming into a low-carbon, digital economy. Environmental services are the “software” to address the climate crisis.

Second, clear definitions of “green” goods and services are fundamental to an eco-friendly FTA. Opinions differ on whether solar panels or nuclear power generation services are green. The lack of consensus on definitions could lead to a fruitless negotiation. Countries should consider consulting recent amendments to the Harmonized System Codes that improved environmental goods classification and helped clear doubts. As for services, a study has listed specific environmental services under United Nations Central Product Classification using “ex-outs,” a technique familiar to Environmental Goods Agreement negotiators.

Finally, environmental provisions, including voluntary sustainability standards and forest conservation provisions, are relevant to climate change mitigation. Enforcing sustainability standards could help avoid or reduce the negative impacts of economic activities on the environment. Eco-labelling mechanisms could meet consumers’ increasing preference for environmentally friendly products. Incorporating multilateral environmental agreements such as the Paris Agreement in the FTA preamble could also strengthen trade partners’ environmental commitments and set a tone for further cooperation in climate action.

Sisi Tang is a Geneva-based trade lawyer and climate policy consultant with the World Bank. The views expressed are those of the author and do not reflect the opinions or views of the World Bank.