Barbados Prime Minister Mia Amor Mottley spoke passionately before the United Nations General Assembly in September about the growing debt that many developing countries are carrying and its growing impact on their ability to prosper.
The average debt of low- and middle-income countries, excluding China, reached 42% of their gross national income in 2020, up from 26% in 2011. For countries in Latin America and the Caribbean, payments only for the service of this debt represented on average 30% of their total exports.
At the same time, these countries are facing a “triple crisis of climate change, pandemic and even now conflict which is leading to the inflationary pressures which are unfortunately leading people to take matters into their own hands”, Mottley said.
Rising borrowing costs coupled with high inflation and slow economic growth had left developing countries like his in a difficult position in the face of climate change. High debt repayments mean countries have fewer resources to mitigate and adapt to climate change. Yet climate change increases their vulnerability, which can increase their sovereign risk, increasing the cost of borrowing. Decreasing productive capacity and tax base may lead to higher debt risks. It’s a vicious circle.
As a solution, countries and international organizations are talking about “debt-for-climate swaps” to help solve both problems at the same time. UN Deputy Secretary-General Amina Mohammed mentioned debt-for-climate swaps ahead of the 2022 UN Climate Change Conference, November 6-18, as an option to refinance ‘crippling’ debt countries.
How Debt Swaps Work
Debt-for-climate swaps allow countries to reduce their debts in exchange for a commitment to finance national climate projects with the financial resources freed up.
They have been used since the late 1980s to preserve the environment and deal with the liquidity crisis in developing countries, including Bolivia, Costa Rica and Belize. These are commonly referred to as “debt-for-nature swaps”.
Belize, for example, was able to reduce its debt in return for committing to designate 30% of its marine areas as protected areas and to spend $4 million a year for the next two decades on marine conservation under a complex debt-for-nature swap. .
The swap, arranged in 2021 by The Nature Conservancy, involves the US environmental group lending funds at a low interest rate to Belize to buy back $553 million in commercial debt at a steep 45% discount. The Nature Conservancy raised funds from investment bank Credit Swisse through the issuance of US government-backed “blue bonds,” which gave the bonds a solid investment-grade credit rating.
Similarly, Costa Rica has made two debt-for-nature swaps with the United States. As part of the exchanges, Costa Rica agreed to allocate $53 million to conservation projects. It has already planted over 60,000 trees and reversed its deforestation.
While debt-for-nature swaps have primarily been used for conservation, the same concept could be extended to climate change mitigation and adaptation activities, such as building solar farms or levees. Some financial experts have suggested that debt-for-climate swaps could be structured to also encourage private sector bondholders to swap the national debt they hold for carbon offsets.
Three keys to successful debt-climate swaps
I work with the Climate Policy Lab at the Fletcher School at Tufts University. Our experience with debt swaps offers lessons for the design and implementation of debt-for-climate swaps.
First, the complex governance structures of debt swaps have limited their use. In the past, transactions were typically small, generating only about $1 billion in environmental finance from 1987 to 2003. A model term sheet for future climate debt swaps could reduce the complexity and reduce the time and cost involved.
Second, debt-for-climate swaps should ease the debt burden enough to allow debtor countries to invest in climate change adaptation and mitigation projects. For example, the United States created debt-for-nature swaps with Indonesia in 2009, which have been criticized for not doing enough to help the Indonesian government meet its conservation goals.
Another concern is known as “additionality” – ensuring that trade leads to additional climate efforts, as opposed to covering efforts already planned or paid for with international climate finance.
With growing gaps between the amount of adaptation aid reaching countries and the amount they need, climate debt swaps can be a significant source of finance. The Climate Policy Initiative, a non-profit research group, recently estimated that around 90% of countries’ adaptation needs listed in their Nationally Determined Contributions – the climate change plans they submit to the UN – can only be satisfied with the help of development banks or other countries.
Regions experimenting with debt swaps
Some regions are testing debt-climate swaps.
The Economic and Social Commission for West Africa has developed a debt swap linked to the Sustainable Development Goals/climate, in which it functions as a liaison between creditors and seven pilot countries. The initiative focuses on promoting sustainable development and climate goals, such as the development of more resilient agriculture.
Similarly, as part of the Caribbean Resilience Fund, the Economic Commission for Latin America and the Caribbean plans to launch a debt-for-climate change adaptation swap. It aims to reduce the $527 million in debt in three pilot countries by issuing green bonds, similar to Belize’s debt swap. Development banks would play a crucial role in guaranteeing new obligations and reducing credit risk.
With carefully designed debt-for-climate swaps and support from international institutions, developing countries could increase their financing for desperately needed climate change mitigation and adaptation actions and alleviate some of their heavy burden. debt burden.
Soyoung Ohjunior researcher, The Fletcher School, Tufts University.
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