A wealth of literature exists on the good design of public finance, particularly in the context of climate change (Buchner et al., 2013; Corfee-Morlot et al., 2012; Hohne et al., 2012; Jones, 2012; Kaminker et al., 2012; OECD, 2013b, 2013c; and Ryan et al., 2012). Most of the studies are aligned on several points, such as that small amounts of well-designed public funding can unlock private investment if it targets individual barriers to green investment, and occurs over a relatively long period (over five years). Also technical assistance is often crucial to building capacity in local financial institutions and scaling up green finance.
It is important that governments take a long-term view and design financial instruments or measures with stable funding sources over a relatively long period to allow investors to plan stable revenue streams. Crowding out private investment is a concern when using public financial instruments, particularly those utilizing concessional finance and grants for investments. These are of particular concern when used in functioning commercial banking systems; however, when used in countries with weak financial markets, the potential for appropriately designed interest rate subsidies to distort the economy is fairly low. A further concern over measures to reduce technology or operational risks is that of moral hazard, whereby a party insulated from risk behaves less carefully from how it would if it were exposed fully to the risk (EC, 2011).
In principle, public finance should only be used where private investment is unavailable or for sharing risks to unlock private resources. However, this can be very challenging to assess. Here we identify four important yet challenging steps for avoiding market distortion when using public financial instruments to mobilize private investment around which we structure the remainder of this section:
• Understanding the policy context and barriers, costs, and risks to be overcome through the use of a public finance incentive;
• Tailoring concessionality carefully to provide just enough incentive for the investments to take place and not distort markets;
• Ensuring transparency in terms of who benefits and how, and long-term plans (Amin et al, 2014); and
• Planning an exit strategy