by Laura Kelly – Director of Sustainable Markets at IIED
July 8, 2024
Many emerging market and developing economies (EMDE) are facing a triple crisis of debt, climate and nature loss. Fiscal stress is high with increasing levels of debt, with debt servicing payments reaching more than 50% of revenues in some cases.
Many of these countries are at the forefront of dealing with the impacts of climate change and are rich in natural resources and biodiversity that function as global public goods. Debt swaps, a financial transaction where creditors forgive a portion of a country’s foreign debt in exchange for meeting climate and nature goals, are an innovative solution to address this triple crisis. It’s an idea whose time may have come.
To highlight the scale of the problem, IIED calculated that in 2021 — the most recent year of data available — the cost of debt repayments for 59 low-income countries was US$33 billion compared to just $20 billion they received in climate finance. Nine of these countries paid out more than they received in total from foreign aid.
As the debt problem becomes even more intractable, given the lack of progress under initiatives to help like the G20 Common Framework for Debt Treatment and more countries default on debt repayments (e.g., Zambia, Sri Lanka, Ghana), debt for climate and nature swaps are attracting renewed attention.
A new way forward
Debt for nature swaps have been increasing over the past five years but the amounts have been relatively small — e.g., Belize (US$553 million, 2021), Gabon (US$500 million, 2023), and Ecuador (US$1.6 billion, 2023) — and criticisms have included the high transaction costs and lack of transparency around expenditures. IIED has worked to address these issues and develop the so-called “programmatic approach,” which differs from the previous swaps. The main improvements are that:
- Debt reductions are linked to key performance indicators (KPIs) drawn from countries’ own climate and nature priorities drawn from Climate National Adaptation Plans, Nationally Determined Contributions (NDCs) and National Biodiversity Action Plans.
- Debt reductions are channelled through the debtor budget to ensure national ownership.
- A comprehensive approach involving all creditors, though agreeing on common KPIs for bilateral and private debt relief, even if a separate private finance vehicle is established.
| Previous debt swap design | New approach piloted by IIED and partners |
| Climate and nature goals set by international organisations | Climate and nature key performance indicators (KPIs) aligned with debtor governments commitments and local stakeholders’ priorities |
| Funds managed by international NGOs, making them less accountable | Programmatic approach using debtor country government systems |
| Emphasis on conservation benefits | Emphasis on long-term inclusive economic growth as well as climate and nature benefits |
| Primarily with single bilateral creditors | Comprehensive “all-creditor” approach to deliver debt relief at scale with lower transaction costs |
IIED supported the Government of Cabo Verde to pilot this approach with the government of Portugal in 2022 resulting in an agreement to swap the approximate $150 million debt owed by Cape Verde in return for environmental and climate outcomes. The approach is also gaining interest from debtor countries (including The Gambia, The Maldives, Kenya, and Gabon) and among creditors including the IMF, US, China and some private financiers including Credit Suisse and Stephen Liberatore at Nuveen.
It’s important to bear in mind though that debt-for-climate and nature swaps are only one tool to help ease the burden on emerging market and developing economies. Ideally, they should be deployed as part of a toolbox, alongside agreements that pause debt repayments when disasters strike, or “parametric” insurance that can cover payments while recovery takes place. For some countries, debt cancellation might be the right solution.
However, these swaps could provide significant resources. IIED recently undertook an analysis showing the significant finance that swaps could leverage. We calculated that more than US $100 billion of debt could be freed up to spend on restoring nature and adapting to climate change.
The analysis focused on the 49 countries most at risk of defaulting on their external debts for which data could be found. IMF/World Bank figures for 2022 public external debt stocks — the most recent available — showed they collectively owed $431 billion. Using a methodology derived from previous international debt-reduction schemes, IIED estimated that $103.4 billion of that total could be freed up for swaps. Some of these countries are among the poorest in the world (part of the UN Least Development Countries (LDC) category) and swaps could free up $33.7 billion for 29 of these countries — dwarfing the $6.1 billion they received in climate finance in 2021.
Addressing barriers to expansion of swaps: a role for the G20
While the consensus on the need for urgent action is growing, progress remains slow. The G20 provides a multilateral forum which could galvanise political action and the Brazilian Presidency has been considering how to support innovative solutions.
IIED has three key recommendations on what the Brazilians could do. First, create more awareness and understanding of potential of swaps among debtor and creditor governments and investors.
Second, support capacity building and access to up-front technical assistance for expertise and resources to identify the best debt solution(s) and to develop and close transactions. IIED has produced a range of publications on swaps, including a tool kit for debt management offices “Linking sovereign debt to climate and nature outcomes. A guide for debt managers and environmental decision makers.”
Third, encourage the World bank, IMF and regional development banks to explore credit enhancements that would make swaps attractive options for private sector investors.
These actions would help turn a tool with limited impacts into one that could deliver urgently needed resources at the scale required to support green and inclusive development in EMDEs.
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This article was originally published on IMPAKTER. Read the original article.