Alexandra Tracy, Green Finance Advisor of Friends of the Earth (HK)
Following the global policy response to Covid 19, and with the war in Ukraine pushing up energy and food prices, debt levels are spiralling for many developing countries. As of December 2022, the world’s poorest countries owed US$62 billion in annual debt service payments, an increase of 35% over the previous year. The rising debt load puts immense pressure on emerging economies, leading to greater risk of defaults by their governments.
At the same time, the most highly indebted countries are in many cases also those that are most vulnerable to the impacts of climate change and the resulting loss of biodiversity. Research by the International Institute for Environment and Development (IIED) found that five of the top ten countries most affected by extreme weather events in 2019 (Mozambique, Zimbabwe, Malawi, Afghanistan and South Sudan) were either already in debt distress or at high risk of becoming so.
This is the terrible conundrum that emerging market governments need to try to solve. Countries that most urgently need to invest in climate adaptation and resilience are the least able to afford it because their budgets are burdened by debt.
Innovative debt swaps
Part of the solution to this challenge could come in the form of innovative “debt for nature” swaps.
Traditional debt swaps are a financial mechanism which allow a government to agree with its creditors, – who might be other governments, development banks or commercial financial institutions – to change the terms of its loan obligation to make it more manageable. By negotiating more favourable conditions, such as lower interest rates or longer repayment terms, debt swaps can help the world’s poorest nations to avoid default and to redeploy part of their debt service costs to invest into policy priorities. (Creditors are also likely to support a proposal that reduces default risk and ensures that at least part of the loan is eventually repaid).
In the case of debt for nature swaps, debt restructuring comes with a commitment from the debtor government to ensure action on climate, biodiversity or environmental protection, and part of the scheduled repayments will be reallocated for investment to support these targets.
Debt for nature swaps are not entirely new – the government of the Seychelles in 2015 pledged to protect 30 percent of its territorial waters as part of a debt restructuring deal, for example – but the few transactions that have been completed tended to be relatively small.
Belize agrees swap for marine conservation
This began to change in 2021 when Belize’s government reached an agreement with conservation group The Nature Conservancy under which its external debt would be reduced by US$553 million, or 10 percent of national GDP. Belize was able to buy back part of its existing debt at a discount and replace it by issuing US$364 million of blue bonds. The US government’s development bank, the International Development Finance Corporation, also provided support for the deal.
In return, the Belize government agreed to spend around US$4 million every year on marine conservation until 2041. It will increase the area of its marine protection parks – containing coral reefs, mangroves and sea grasses, which are habitats for some 1,400 species – from almost 16 percent of its oceans to 30 percent by 2026. In addition, an endowment fund of US$23.5 million will finance conservation after 2040.
Similar swap deals
A number of developing countries are currently in negotiations to implement similar swap deals.
In January, Cape Verde, an archipelago nation off the coast of West Africa, signed an agreement with the government of Portugal worth nearly US$200 million to swap part of its debt for investment in an environmental and climate fund. Ecuador is in talks with creditors and the Pew Charitable Trust about restructuring as much as US$800 million of indebtedness and reallocating the resulting savings from lower debt service to protecting the ecosystem in and around the Galapagos Islands. Sri Lanka, which defaulted on its debt in 2022, is also thought to be discussing a deal worth as much as US$1 billion.
Some experts believe the potential to free up capital for investment in climate resilience and biodiversity through debt restructuring is considerable. Research by the IIED last year found that debt relief in countries in or at high risk of debt distress could help to make around US$105 billion of government finance available for climate and nature.
In order for debt for nature swaps to have a real impact, the number and size of transactions must be scaled up significantly. There needs to be greater standardisation to move from niche products, often linked to small projects that are expensive to structure and monitor, to more mainstream instruments. Improvements are also needed in how government pledges on nature and client are monitored and verified so that creditors will be satisfied that countries are meeting their commitments.
But already debt for nature swaps are making an important contribution to allowing developing nations to tackle climate and biodiversity challenges, as evidenced by the growing number of governments hoping to replicate the successful case studies. As confirmed by Patricia Scotland, Secretary General of the Commonwealth (which represents 56 countries around the world): “Lots of my members are looking at it and we’re looking at it with them”.