Responsible Investor

Green sovereign-debt restructuring

A possible solution for developing countries (and for the planet)

The Covid pandemic has exacerbated the debt burden of many countries, especially developing countries that, in addition to health challenges, are also grappling with a debt situation that may soon become unsustainable.

The World Bank estimates that some 10 trillion US dollars have been added to sovereign debt stocks since the beginning of 2020, representing 12 percent of global gross domestic product (GDP) in 2020. For some emerging countries, sovereign debt has reached an unsustainable level: according to the International Monetary Fund (IMF) and the World Bank, 36 out of 70 low-income developing countries are currently in debt distress.

Drastic choices, such as debt amnesty or debt cancellation, are often unfeasible; an innovative solution could be to restructure debt in a green way, through so-called debt-for-climate and debt-for-nature swaps.

These swaps give debtor countries the option to settle part of their external liabilities by paying an equivalent amount in local currency to finance environmental and conservation projects within their territory.

In September 2020, the International Institute for Environmental and Development issued a report that explored using climate and nature debt swaps as a policy tool to support less developed and developing countries with their growing debt, while supporting biodiversity and the fight against climate change.

During climate or nature swaps, an existing debt contract is exchanged for a new contract, with the transaction offering some form of “devaluation” or “discount” on the value of the original debt. This discount may be achieved by lowering interest rates, changing the currency of the amount held, refinancing at a lower current market value and/or cancelling the debt. The money saved is then invested in climate and ecosystem protection projects.

The IMF is taking sustainable and green debt restructuring seriously and announced on the 15th April 2021 that it will present an option for the use of this financial tool at the Cop-26 United Nations Climate Change Conference scheduled to take place in Glasgow from the 1st to the 12th of November.

During the seminar “Securing a Green Recovery: The Economic Benefits from Tackling Climate Change”, IMF Director Kristalina Georgieva said that green debt swaps may potentially stimulate accelerated action on climate change in these countries and could help address the twin crises of rising pandemic debt and climate change. The World Bank and the IMF are also developing an organisational framework to connect debt cancellation and national investment plans for green, resilient and inclusive development (GRID).

The idea of a ‘debt-for-climate’ swap was first conceived in the 1980s by the then vice-president of the World Wildlife Fund (WWF) Thomas Lovejoy in the wake of the Latin American debt crisis. The idea was simple: an NGO would act as a donor, buying the debt from commercial banks at face value on the secondary market, thus providing a level of debt relief. The debt would then be transferred to the debtor country in exchange for a specific commitment to environmental or conservation goals, executed through a national environment fund.

In 2018, the government of the Seychelles partnered with the Nature Conservancy, the Global Environment Facility (GEF) and the United National Development Programme (UNDP) to develop a debt-for-nature swap for 27 million dollars of official debt, creating vast areas of protected marine parks for climate resilience, fishing management, biodiversity conservation and ecotourism.

During 2020, several debtor countries called for post-Covid economic support plans in line with the Paris Climate Goals; Pakistan, Jamaica, Namibia and Mauritania all requested that their debts be restructured with green swaps. The debt-restructuring initiative put forward by Pakistan and Finance for Biodiversity (F4B) is especially innovative, and proposes the creation of nature performance bonds for a reforestation programme that aims to plant 10 billion trees across the territory. The programme is already underway and has been financed by the Islamabad government; it has already created 85,000 daily wage jobs in nurseries, plant care, natural forest protection and fire fighting.