How debt for climate swaps could spur a green recovery

Due to COVID-19, we are facing a huge increase in sovereign debt that is putting pressure on our economies by increasing demands on national health spending and causing sharp downturns in economic activity. The IMF has recently issued a warning, as debt ratios are accumulating over levels that are already historically high. And while this is by no means an issue confined to low-income countries and emerging market economies, many of those are projected to be the most affected as they already find themselves in severe financial stress.

The world is in need of creative solutions that can promote debt transparency and ensure that countries are on track for a sustainable recovery. By pausing debt repayments, as the G20 countries have done, countries are buying time for more long-term solutions that can achieve debt sustainability. And, as the pandemic’s first wave slowly recedes, governments are looking at recovery plans for economic stimulus worth trillions of dollars.

In order to “build back better”, we must make sure these solutions can foster resilience to climate change. IMF Managing Director Kristalina Georgieva has emphasized the need to address both the economic and climate crises at the same time by promoting a green recovery. To do so, public finances could be used to reduce carbon emissions and promote different forms of sustainable finance, as well as to reinforce climate resilience.

Debt swaps can be one solution to tackle both challenges at once. Traditionally, these instruments represent an exchange of the existing debt contract with a new one, where the previous contract is normally “written down”, or discounted. Usually, this action is associated with specific conditions for investments, agreed both by the creditor and the debtor. In the past, such instruments have also been used to achieve climate-related objectives.

The idea of a “debt-for-climate” swap was first conceived during the 1980s by the then Deputy Vice President of the World Wildlife Fund, Thomas Lovejoy, in the wake of the Latin American debt crisis. The idea was simple: an NGO would act as a donor, purchasing debt from commercial banks at its face value on the secondary market, hence providing a level of relief on the debt’s value. The title of the debt would then be transferred to the debtor country in exchange for a specific commitment to environmental or conservation goals, performed through a national environmental fund.

In 2018, the Seychelles government worked with The Nature Conservancy, Global Environment Facility (GEF), and the United Nations Development Programme (UNDP) to develop a debt-for-nature swap for $27 million of official debt, to set up vast areas of protected marine parks for climate resilience, fishery management, biodiversity conservation and ecotourism.

Under the COVID-19 scenario, debt-for-climate swaps could represent a creative solution to tackle the sovereign debt crisis and the climate crisis at the same time. However, in order to do so, debt swaps need to free up resources in governments’ budgets. It is therefore key that payments to climate objectives are set lower than original debt service payments. In order to reach a critical mass, debt-for-climate swaps would also need to target large-scale programmes and not single projects, allow for a degree of flexibility from the recipient country’s perspective, and be delivered in a harmonized manner to achieve debt reduction on a large enough scale.

By channeling debt into climate adaptation and mitigation programmes, countries will be using national financial systems to build long-term support and encourage investments in green activities, thereby tackling both the debt and climate crisis all at once.