ESG and Sustainable Investing

Sri Lanka: A Cautionary Tale About a ‘Just Transition’ to Sustainability

What Investors Need to Know
By Sarah Bratton Hughes
AUG 30 | 2022
Gas containers in the back of a truck.

Climate change doesn’t recognize national borders. It doesn’t equitably distribute its devastation in proportion to the greenhouse gases each country emits. Melting polar ice caps, rising sea levels, increasingly destructive wildfires, hurricanes and floods affect the whole world.

The message is clear: No matter what hemisphere you live in or whether your country is at the higher or lower end of per capita gross domestic product (GDP), we are all in this fight together.

In our view, that’s essential to keep in mind as we push toward greener economies and a low-carbon future. The world must pursue these goals in a way that doesn’t punish people living in emerging markets (EM)countries, most of which have contributed relatively little to the historic emissions causing the problems we see today.

During this shift, we must also consider countries that may stand to lose economically. The recent unrest in Sri Lanka provides a textbook example of how good intentions can have negative consequences and why implementing a just transition is essential to achieving sustainable growth.

The headlines about the uprising in this EM nation of 22 million people described thousands of people storming the presidential compound in Colombo to demand the resignation of President Gotabaya Rajapaksa after the economy collapsed. He was forced to do so amid the chaos.

How does this first financial and political collapse of an Asian nation since the late 1990s relate to a just transition?

Sri Lanka Economic Crisis Explained

Sri Lanka, which the World Bank categorizes as “lower middle income” with per capita GDP similar to Algeria and Egypt, suffered the effects of ill-advised economic policies. The country had taken on heavy debt without paying much attention to how it could support it.

This situation should ring an alarm bell for other nations that have done the same thing, but there is more to the story. Several factors led to the inflationary spiral that caused its economy to collapse.

The COVID-19 pandemic decimated tourism and caused many Sri Lankans working overseas to return home. Remittances (money sent home from abroad) typically contributed about $6 billion of income to the country per year, a decent chunk of Sri Lanka’s annual GDP.¹ Without this remittance income and tourism dollars, the government was forced to spend much more on imports and servicing its debt.

Then when fuel prices rose following Russia’s invasion of Ukraine, Sri Lanka didn’t have enough money to import the fuel its economy needed, causing high inflation and fuel shortages. People waited days to refuel their vehicles, and the power was cut repeatedly.

Meanwhile, Sri Lankans were also experiencing food shortages thanks to the former president’s efforts to push the country toward a greener economy. In spring 2021, he abruptly (not gradually!) prohibited chemical fertilizers. While well-intentioned, this ban caused farmers to produce less food for consumption and export, reducing incomes and creating food shortages.

Implications of the Economic Crisis in Sri Lanka for Other Developing Nations

The World Economic Forum (WEF) recently reported that emerging markets need about $94.8 trillion in additional investment to help transition to a net-zero economy by 2060.² Such spending represents more than the entire world’s annual GDP, but it would be spread out over time.

EM governments have committed to investing in reducing carbon emissions to help meet long-term global warming targets, according to a 2022 Standard Chartered Bank study.³ But the WEF says research shows if emerging markets had to self-finance this effort through higher taxes, it would result in a “disruptive transition that could make some of the world’s poorest communities even poorer. The scale of the financing task is simply too great for emerging economies to bear alone.”⁴

According to Standard Charter calculations, if emerging markets had to raise this money through higher taxes and borrowing, average annual household consumption would fall by 5%.⁵ That would make EM households roughly $2 trillion poorer each year.

If you are already struggling to feed your family, higher taxes that cut your income by 5% may start to sound like a recipe for civil unrest. This would likely discourage climate action and make the net-zero transition more likely to fail.

If developed markets funded the cost of transitioning to cleaner energy, household consumption would increase, and global GDP would rise by over $108 trillion.

Here’s where we think the just transition argument gets even more compelling: If developed markets funded the cost of transitioning to cleaner energy, household consumption would increase, and global GDP would rise by over $108 trillion.⁶

Developed markets still have much to do to cut carbon dioxide emissions and transition to a sustainable energy future. At the same time, they must provide additional funding to less developed countries that need support to help the world meet critical emissions-reduction targets to prevent catastrophic, irreversible damage impacting everyone across the globe.

Our Commitment to a Just Transition

According to a recent report from the U.N. Governmental Panel on Climate Change, at least 3.3 billion people are already “highly vulnerable to climate change” and 15 times more likely to die from extreme weather.⁷ People are already being displaced by extreme weather. “Displaced” is typically used when talking about refugees from a war, and we think that’s the correct analogy. And, as with war, the world’s poor are hit the hardest.

At American Century Investments, we believe investors must pursue a just transition to a greener world. Otherwise, well-intentioned efforts will likely lead to suffering, civil unrest and worse. Sometimes, this may mean taking measured steps rather than insisting on immediate change. That can be frustrating and worrisome to some, but we believe it is the best approach to achieving sustainable change that supports rather than hampers economic growth.

We firmly believe sustainability issues shouldn’t be viewed in isolation or in Environmental-Social-Governance silos, which is why we have a top-down thematic framework that allows us to look at sustainability risks and opportunities holistically.

To us, the concept of a just transition isn’t merely fodder for philosophical debate. We actively assess how companies are positioning all stakeholders for success in a decarbonized economy and use engagement as a critical lever to produce meaningful insights that may help lead to better outcomes for all.

Author
Sarah Bratton Hughes

Sarah Bratton Hughes

Head of ESG and Sustainable Investing

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Debra Kahn, Jordan Wolman and Lorraine Woellert, “Is organic farming to blame for Sri Lanka’s crisis?” Politico, July 19, 2022.

Charlotte Edmond, “Here’s why developed economies must bear the $100 trillion cost of the net-zero transition in emerging markets,” World Economic Forum, April 5, 2022.

Standard Chartered Bank, “Just in Time: Financing a just transition to net zero,” April 2022.

Edmond, “Here’s why developed economies.”

Standard Chartered Bank, “Just in Time.”

Standard Chartered Bank, “Just in Time.”

H.-O. Pörtner, D.C. Roberts, E.S. Poloczanska, et al., eds., Summary for Policymakers, “Climate Change 2022: Impacts, Adaption and Vulnerability,” Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, February 2022.

Many of American Century's investment strategies incorporate the consideration of environmental, social, and/or governance (ESG) factors into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider ESG factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh ESG considerations when making decisions for the portfolio. The consideration of ESG factors may limit the investment opportunities available to a portfolio, and the portfolio may perform differently than those that do not incorporate ESG considerations. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.