It is certainly interesting to try to solve these problems jointly, as we already need to mobilize climate finance from rich countries (the main polluters) to support low-income countries (which will bear a disproportionate burden of climate change). The President of the European Commission, Ursula von der Leyen, declared that “the big economies have a special duty towards the least developed and the most vulnerable countries”, and the Managing Director of the International Monetary Fund, Kristalina Georgieva, declared that “It makes sense” to seek to tackle debt pressures and the climate crisis together. The idea is to organize “green debt swaps”.
The idea is not new; something similar has been tested since the 1980s. During that lost decade, so-called Brady bonds were the mainstay of an international “menu” of debt restructuring instruments. Debtors have used official IMF and World Bank loans to acquire US Treasury bonds as collateral, allowing them to swap heavily discounted bank loans for negotiable and guaranteed Brady bonds. Debt-to-nature swaps were also on the menu during this time, but they were side dishes.
The first such instruments were structured as agreements between a custodian organization, creditors, and a debtor government. In 1987, Conservation International used donor funds to acquire $ 650,000 in Bolivian external debt at the greatly reduced price of $ 100,000. In return, Bolivia pledged to protect the Beni Biosphere Reserve, providing $ 250,000 (in local currency) for its management. Similar approaches have been used to establish a marine sanctuary in the Philippines and to protect mountain gorillas in Uganda.
Debt-for-nature swaps were attractive to conservation organizations as long as they could buy distressed debt at greatly reduced prices and leverage funding from their donors. But doubts remained about the effectiveness and sustainability of these strategies, so the sums involved remained low.
The most significant deal was the $ 580 million debt-for-nature swap with Poland in 1992. This established a new model by creating a central trust fund to oversee the selection, implementation and monitoring of projects. conservation projects. A similar structure is currently in use in Belize, which allows holders of its $ 533 million 2034 bond “to offer their tickets at a 45% discount off their principal” while also committing to allocate 23, $ 4 million to a marine conservation endowment account.
Despite this encouraging recent example, debt-for-nature swaps have not taken off over the past 30 years. Yet the scale of debt and climate problems has grown to enormous proportions. The number of extreme weather events each year has doubled, tripled and even quadrupled since the 1980s.
Fortunately, the analyzes produced by the Intergovernmental Panel on Climate Change are now generally accepted. IPCC reports consistently show that the global “carbon budget” for keeping global warming below 1.5 ° Celsius is rapidly depleting. The world can only afford to emit about 300 gigatonnes more of carbon dioxide. At the current emission rate of about 35 gigatonnes per year, that gives us less than a decade.
Finally feeling a sense of urgency, many countries and companies adopted net zero emissions targets, and the financial sector began to adopt ESG (environmental, social and governance) investment criteria. But the task that awaits us is difficult. Mark Carney, the current UN special envoy for climate action and finance, estimates that a global transition to a net zero economy will require funding of $ 3.5 billion to $ 4.5 trillion annually.
Over-indebtedness is also reaching historic levels. During the pandemic, the overall debt burden of low-income countries increased by 12%, reaching $ 860 billion in 2020. When the pandemic struck, the threat of a sudden halt in capital flows and a a real financial crisis in emerging markets was looming on the horizon.
The G20 responded by adopting the Debt Service Suspension Initiative, which has been used by more than 40 countries to delay repayment. Nonetheless, an IMF analysis of 70 low-income countries reveals that seven are already in debt distress and 63 are at high or moderate risk of debt distress.
One of the problems when trying to tackle climate change and debt with one package is that they don’t line up perfectly. Climate change mitigation funding is most needed in high-income countries, with around one-third of transitional investments required in Europe and the United States, and more than half in the Asia-Pacific region, mostly in China. With few exceptions, the contribution of low-income countries to global warming is negligible. The match between financing needs and the management of the environmental externality is imperfect at best.
On the other hand, since many low-income countries are highly exposed to climate change, they will need finance to invest in adaptation. Part of this could be provided through debt relief; but, once again, the match between financing needs and over-indebtedness is imperfect. While countries like Haiti, Niger and South Sudan face both high debt and acute climate risk, many others face just one of these issues.
A related question is whether debt conversions are the most effective way to provide relief. Rich countries have generally provided bilateral debt relief without conditionality on recipient spending. If they wanted to support specific climate adaptation spending in low-income countries, they could always do so through tax transfers and conditional grants. The suitability of conditional debt relief as a financing tool for low-income countries is not always clear.
What is evident is that rich countries are responsible for the climate crisis and therefore have a moral responsibility to help poorer countries cope with the consequences. The international community is right to explore options for transferring resources for climate finance to low-income countries. Given the non-alignment of risks and financing needs, a menu of instruments for middle and low income countries will be needed.
Debt swaps for the climate can then be one option among many. They could be implemented using a Brady-type structure, which can solve the dual problem of scaling up and mobilizing private sector flows. Mobilizing both private and public finance will be essential and will require the creation of liquid markets for climate bonds and possibly some credit enhancements as part of a tripartite Brady deal.
To facilitate the process, the IMF and multilateral development banks could structure conditional debt relief and make various improvements. For example, the IMF could use recycled Special Drawing Rights to lend low-income countries the resources they need to acquire collateral for Brady Green Bonds. Private and public creditors would agree to swap their bonds at a steep discount against these green bonds, thus providing the country with fiscal space for spending on climate projects. The management and monitoring of reduction and climate investments could be done using the trust fund model which has been tested and proven in previous nature agreements.
An ambitious “Green Brady Deal” could mobilize public and private flows for climate finance in countries suffering from both high debt and climate risk. It would not be a silver bullet, nor the main course on the climate finance menu. But it could make a big difference for some of the most vulnerable countries. © 2021 / PROJECT SYNDICATE (www.project-syndicate.org)
Beatrice Weder Di Mauro is professor of economics at the University Institute of Geneva.
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