Conservation finance: Costa Rica costs its success

The news from Brazil, Colombia and Indonesia this year about widespread deforestation probably made a lot of Costa Ricans recall the 1980s. That was the decade when their country was slashing hectares of its own prime forests for ‘productive’ reasons – mainly to grow crops such as coffee.

By 1987 forests had shrunk to cover just 21% of Costa Rica’s total territory, from 85% in 1940. But starting in 1983 Costa Rica began to embrace its ecological problems in a way that has put the small country – it has a land area of just 51,100 square kilometres – at the forefront of conservation.

Paid for in part by a carbon tax and in part by the fiscal space created by policies taken earlier (such as the scrapping of its army in 1948), Costa Rica’s policy of active reforestation has been remarkably effective.

By 2013, forests covered 52.4% of Costa Rica and, although the country represents just 0.25% of the world’s landmass it now contains nearly 6% of the planet’s biodiversity.

The country’s system of national parks and reserves include islands, beaches, rain forests, active volcanoes, hot springs, caves, river canyons and waterfalls that play host to jaguars, sea turtles and coral reefs. This biological heritage is now being harnessed to drive a flourishing eco-tourism sector that brings in hard currency to these regions and generates tax revenues for the central government.

As well as being a laudable aim in its own right, the policy of reforestation, through carbon sequestration, is also a large part of the country’s project for carbon neutrality by 2021.

Carlos Manuel Rodríguez, Costa Rica’s minister of environment, is a world-renowned expert in conservation policies and finance, and his experience and success in Costa Rica is being used by many global organizations seeking to implement similar projects in other countries.

Rodríguez is the chair of the Convention on Biological Diversity’s (CBD) high-level panel for resource mobilization. He sees the need for a greater commitment to nature.

“On a global basis, we need to be mobilizing at a minimum $150 billion a year – equivalent to about 0.8% of GDP – to fill the gap between current funding for nature conservation and what is needed,” Rodríguez tells Euromoney.

Rodríguez estimates that 2018 total conservation investment was around $55 billion.

“Actually my recommendation is for 1% of global GDP – this is what Costa Rica formally presented as its commitment for conservation finance for the post-2020 finance agreement.”

The post-2020 agreement is the anticipated outcome of the UN Biodiversity Conference in China next year, which will be held under the auspices of the CBD.

It’s not as huge a number as it may sound. To contextualize the current $50 billion spending figure, Rodríguez points out that the US spends $70 billion annually on pet food.

Costa Rica offers an example of a relatively simple way to fill the funding gap for those policymakers brave enough to take on the world’s established order.

Fifteen years ago, the country introduced a carbon tax on gasoline and used the revenues to launch a system of payment for environmental services (PES), as well as the expansion of protected areas (26% of the land is now protected).

In 1997, a 3.5% levy was set for all hydrocarbons; in 2018 the tax raised 11% of all government revenue and has funded PES for 300,000 hectares, which represents nearly 13% of the country’s forest area and slightly more than 7.5% of its total territory.

“Carbon tax traditionally works to make things like gasoline more expensive and therefore limits its use through rational economic behaviour,” says Rodríguez.

He argues that while the Costa Rica taxes did have some behavioural impact, there was no available substitution for petrol cars (there was no practical electric car technology) and so in this case the tax had little direct impact on consumption.

“In Costa Rica, we went the other way [with the focus of the tax]: through the carbon tax we dealt with the market failure – the negative externalities of carbon issues – and used the tax to finance the sequestration of carbon through forests.

“The annual revenue from the carbon tax is around $32 million and it all goes directly to fund carbon sequestration. The planet needs [other countries to] develop something very similar to what we have done.”

A carbon tax can in practice achieve both aims: reduce consumption of carbon-emitting activities, as well as fund carbon sequestration. But in the developed world, governments appear far from committed to this goal.

If current energy policy frameworks don’t include explicit subsidies for carbon-emitting fuels, they certainly include implicit subsidies by not taxing their use to compensate for the environmental impact their use causes.

The IMF has quantified the distortive effect of carbon subsidies. In a May 2019 report, it stated that $5.2 trillion was spent on fossil fuel subsidies in 2018 – equivalent to more than 6.5% of global GDP and a $500 billion increase since 2015.

The report also said the removal of these subsidies “would have lowered global carbon emissions by 28% and fossil fuel air pollution deaths by 46%, and increased government revenue by 3.8% of GDP”.

Rodríguez suggests that something similar to a carbon tax – a means of capturing funds to pay for carbon sequestration – could be introduced on a global scale.

“There should be an international financial mechanism,” he says. “Initially it would be fund based – eventually it would be a market mechanism – that would generate finance to pay for the sequestration of carbon emissions by tropical countries. That would tackle climate change and biodiversity.”

Today, however, global policymaking lags surprisingly far behind. Despite much discussion about carbon taxes and carbon trading schemes, there has been little concerted action.

The same is true in more enlightened areas of finance. For example, the IFC recently issued a green bond in conjunction with Banco Davienda in Costa Rica to lower carbon emissions from real estate.

When asked about the potential issuance of green bonds to fund conservation projects – those that would protect biodiversity and include carbon sequestration – the bank confirmed that such projects wouldn’t qualify for such green-bond status.

Rodríguez is adamant that economic development and conservation are not necessarily at odds with each other.

“Costa Rica was able to triple the size of its economy while we doubled the size of its forests and also while moving to almost 100% of renewable energy production,” he says. “Investing in nature conservation isn’t a burden or a barrier to growth. On the contrary, we made a link between nature conservation and economic development.”

Thanks to Costa Rica’s efforts around restoring and conserving its natural areas, tourism has become an important economic force.

Roy Gonzalez is a coordinator for the Biodiversity Finance Initiative (Biofin) in Costa Rica, a United Nations Development Programme aimed at encouraging private-sector financing in projects that protect biodiversity.

He says the development of high-value tourism based on sustainable ecosystems has been a benefit for the economy.

“Tourism makes up 8.2% of the Costa Rican economy and 9% of all employment,” he says. “That’s more than agriculture – which is worth 5.6% – and not far behind manufacturing.”

The numbers sound impressive, but Gonzalez acknowledges that having 52% of the country’s landmass taken up with an industry that produces around 8% of GDP “also represents a huge economic opportunity cost”.

It is not as if the country doesn’t have financing pressures.

Costa Rica’s advanced-to-middle income status has come at a cost; it no longer attracts European conservation funds or other international flows designed to encourage environmental protection.

Costa Rica also has a long-standing and seeming uncloseable fiscal gap. The central government’s overall deficit has widened to 6.2% of GDP in the 12 months that ended in July 2019 – and that’s despite the country not spending on defence.

There’s a sacrifice being made by Costa Rica. If the country decided to reverse its unilateral approach to conservation and, for example, followed other countries by authorizing deforestation to build up cattle ranching or soy cultivation, the country’s GDP would probably be higher. Any such decision would, however, come at an enormous cost to the planet in terms of CO₂ emissions and biodiversity loss.

Understandably Rodríguez believes there should be a global system that compensates countries that protect the habitats that capture and store carbon dioxide, paid for by the countries that have negative emissions – so-called sink funds.

The Reducing Emissions from Deforestation and Forest Degredation (Redd+) agreement, adopted by the UN Framework Convention on Climate Change in 2010, was designed to be the mechanism that could drive this north-south flow of capital for conservation finance.

It was ambitious, but it has failed to make much impact from the point of halting or reversing deforestation, largely because global markets in carbon credits have not materialized.

And Rodríguez is far from impressed that Redd+ has now proposed $5 for a credit worth one tonne of carbon dioxide. He describes that price as: “An insult to anyone who is working to stop deforestation.”

It certainly doesn’t come close to the opportunity costs of maintaining these natural assets, nor as a pricing mechanism to incentivize carbon sequestration.

Biofin’s Gonzalez agrees: “The main objective of Biofin is to help reduce the financing gap in conservation provided by the public sector and the country’s needs – which in Costa Rica is estimated to be about $50 million a year for the next nine years.”

Biofin works with the public sector (mainly the Sistema Nacional de Areas de Conservacion, or Sinac) to promote the commercial use of protected areas to bridge this financing gap.

One helpful addition would be: “Building a better international business case for the international support of carbon sequestration,” says Gonzalez. “Costa Rica’s reforestation to 52.6% coverage is a great effort, but it obviously represents a constraint on the potential productive use of this landscape.

“That’s why it is necessary to support developing countries such as Costa Rica, so they persevere in their efforts to preserve the ecosystems and associated biodiversity,” he adds. “It is not only fair but necessary to share the maintenance cost of the natural capital that we still have, and it is essential for the long-term survival of the planet.”

But for now, at least, local private-sector engagement with conservation finance projects is largely left to small project-based impact investments or the work of trusts and environmental funds.

The largest national philanthropic conservation project has been Forever Costa Rica Association (FCRA), which began in 2010. It included $57 million of private-sector funds led by the Linden Trust for Conservation, the Gordon and Betty Moore Foundation, and the Nature Conservancy, and included a $27 million ‘debt-for-nature’ swap from the US government. The project has permanently protected over 5,000 square miles of sensitive terrestrial habitat and one million acres of critical marine habitat.

Zdenka Piskulich, executive director at FCRA, says the organization works closely with Sinac to integrate its activities and sees itself as contributing to the country’s overall environmental targets, but she stresses the fund is not allowed to support the recurrent needs of the government.

Despite much of FCRA’s focus being on the preservation of marine ecosystems, still only 3% of the marine area of Costa Rica is protected.

“We are lagging far behind the international commitment” to protect between 10% and 30% of marine habitat by 2020, says Piskulich.

A difficult challenge has been to the fund’s financial resources: lower global interest rates have limited income, squeezing its ability to fund projects.

“When FCRA was created, we modelled around 5% annual returns – we are down to 3.5% now – and that’s if we are lucky,” says Piskulich.

As well as seeking to raise additional funds, she says that FCRA is also working with a local banking partner, Promerica, to use its capital proactively as a lending portfolio – aimed at conservation projects – rather than simply as a passive investment.

“I think we would have gone down this path even without the endowment crisis,” she says of the collapsing returns on the FCRA’s capital. “If I were a millionaire, I wouldn’t have all my money in the bank – I would be using it. Obviously, this policy brings risk and we have to measure and manage that risk with great discipline, but it is an opportunity to leverage [the impact of] the fund.”

Piskulich says that FCRA has also accelerated its attempts to link private-sector investors to conservation projects in the country.

“Impact investors are often worried about how genuinely sustainable projects on the ground are and, in return, locals are worried about engaging with foreign investors – we can help bring both sides together,” says Piskulich. “Global goals are becoming more ambitious as the world is moving towards China 2020, and most of the funding for these goals won’t be provided by traditional providers – the only way to meet them is to leverage other sectors and use private and blended finance.”

To facilitate these agreements FCRA, which assumes the leadership of the Latin America and Caribbean Network for Environmental Funds in October this year, is creating blue prints for investment principles in blue- and green-finance initiatives.

“Conservation finance is always an innovative field, and the future will require organizations like FCRA working with strong, private-sector companies to unleash more capital that is aligned to our sustainable goals,” says Piskulich.

In 2012 – in a joint project with the World Bank – the Costa Rican central bank began to work on placing a value on the country’s natural resources.

Working alongside members of the ministry of planning, the ministry of the environment and the Hacienda (finance ministry), the central bank introduced a programme to create accounting valuations for the country’s natural assets.

The bank believes that creating monetary values for its forests, water resources and natural energy sources will enable better measurement and management of the country’s environmental policies.

“We decided to produce multiple sets of accounts to build a time series and enable us to see how policy impacts on these physical resources,” says Irene Alvarado, head of the environmental statistics unit at the central bank.

Following the methodology proposed by the UN’s Central Framework of the System of Environmental Economic Accounting, stocks and flows of natural resources are presented in physical and monetary terms for those assets with a market value. For example, forests are valued by the price the timber would fetch at market.

Valuation of assets and flows that do not have a market value are not included, but future versions of the accounting methodology may include the value of ecosystems and therefore be able to provide value for carbon sequestered by the forests.

Alvarado says the accounts provide data that is needed to improve both public and corporate policies, and stresses that policymakers in governments around the world should be both aware of, and use, such accounts that their own central banks are creating. (Rodríguez cited these accounts in his interview with Euromoney).

“Those responsible for developing environmental accounts need to focus on how to make them accessible and of interest to policymakers, otherwise they are only used by a couple of researchers,” says Alvarado. “You need to socialize the accounts in an attractive way. In Costa Rica, for example, the minister of the environment knows about them – he trusts the process behind them and they are credible so become integrated with policy development.”