The IMF wants poor countries’ debt erased in exchange for climate action

The Seychelles used a debt-for-climate swap to fund ocean conservation. Economists and the IMF want to see more programs, at a much larger scale.
The Seychelles used a debt-for-climate swap to fund ocean conservation. Economists and the IMF want to see more programs, at a much larger scale.
Image: REUTERS/Ahmed Jadallah
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In 2011, the Seychelles, an archipelago nation of 100,000 people in the Indian Ocean, decided it should do more to protect the marine ecosystems that comprise 99% of its territory. There was just one problem: The country was broke, staggering under more than $900 million in debt (nearly equal to its GDP) to France and other European sovereign lenders.

So the government approached The Nature Conservancy, the US environmental nonprofit, with an idea to chip away at that debt—or at least make it work in the country’s favor. TNC could buy a small portion of that debt, erase some of it, and channel the rest into conservation programs.

TNC roped in a few funders and agreed, eventually assuming $21.6 million in Seychelles debt (TNC originally sought $80 million, but couldn’t convince creditors to agree to that amount). $1.4 million was canceled, and as the government repaid TNC for the rest, TNC redirected most of that money into a fund managed by a board whose members included Seychellian government ministers and civil society groups. They tapped the fund for coral reef restoration, setting aside an area the size of Germany as a protected zone, and other green initiatives.

Ten years later, the effort has become a widely cited model for how debt swaps can be used to create some small but meaningful wiggle room in a country’s budget for the pursuit of environmental goals. “They hit their targets ahead of schedule, so we achieved the protection we set out to do,” said Charlotte Kaiser, managing director of NatureVest, TNC’s conservation investment arm.

Today, many of the countries that are most vulnerable to climate change impacts are struggling with similarly unmanageable debt burdens. Their vulnerability makes them a riskier bet for lenders, and loans become more expensive—a self-perpetuating cycle that economists described as the “climate investment trap” in a June 30 article in Nature. And the pandemic has made everything worse.

“Sovereign debt was already a problem before Covid. Now the debt situation has worsened significantly, and this is impeding much-needed investment in climate resilience even more,” said Ulrich Volz, a development economist at the School of Oriental and African Studies (SOAS) in London. Volz is among the growing chorus of economists and policymakers who think debt-for-climate swaps—which until now have been small and sporadic—need to be much bigger and widespread.

And after this year, they likely will be: Kristalina Georgieva, managing director of the International Monetary Fund (IMF), has said that her institution will roll out rules to boost debt-for-climate swaps in time for the global climate summit, COP26, in Glasgow in November.

The sovereign debt crisis is a major obstacle to climate action

Poor countries are in desperate need of cash to confront the climate crisis: Money to spend on seawalls and other adaptive infrastructure, to build solar and wind farms, to fill gaps in national budgets that would otherwise be filled by revenue from fossil fuel extraction.

The most obvious source is the pot of $100 billion in climate adaptation finance per year that rich countries had promised to raise and deliver annually to the global south by 2020. But that pot is still no more than three-quarters filled, and is predominantly in the form of loans that come with interest and other strings attached. Another source is the $55 billion in “special drawing rights” that the IMF recently made available to low-income countries to facilitate a green economic recovery from the pandemic.

“But even with those things, the math just doesn’t add up,” said Kevin Gallagher, director of Boston University’s Global Development Policy Center.

According to the International Energy Agency, developing countries collectively need to spend at least $1 trillion per year on clean energy by 2030 to avert catastrophic levels of greenhouse gas emissions. On top of that, the UN estimates that the total cost of climate adaptation could reach $300 billion annually by 2030.

Meanwhile, poor countries first have to dig out from a massive pile of sovereign debt: The UN estimates that $1.1 trillion in debt service payments will be owed by low- and middle-income countries in 2021 alone. In remarks to a gathering of G20 finance ministers on July 9, UN secretary general António Guterres said he is “deeply concerned” about the lack of progress on climate finance.

How debt-for-climate swaps could work

Last month, Gallagher and Volz laid out a proposal for how debt-for-climate swaps could tackle both problems at once. The IMF and World Bank would oversee an analysis of a country’s debt that takes account of climate risks (which are typically ignored in those institutions’ standard debt analyses). That analysis would yield a percentage by which the debt needs to be reduced for the country to have a reasonable chance at paying it back while still being able to afford necessary investments in climate, public health, and other sustainable development priorities.

Then, the IMF would act as an intermediary to creditors (private banks and/or other countries) and broker a deal. Like in the Seychelles case, some debt would be erased (a “haircut,” in finance lingo), and some would be redirected to pay for climate goals (a reduction in emissions per unit of GDP, for example) designated by the debtor country for itself.

The payback would be guaranteed by the IMF, to warm any cold feet on the creditor side—especially those of China, which is a major holder of developing-world debt—and make them more amenable to the haircut. And after a period of years, if the debtor country doesn’t follow through, the original debt could be re-imposed.

Debt swaps work, but come with risks

Environmental debt swaps aren’t new, and trace their roots to legislation passed by the US Congress in 1989 that tasked the US Agency for International Development to work with nonprofit groups on rainforest conservation-based debt swaps as a means of helping Latin American countries manage a debt crisis. Since then, European countries and Canada have also engaged in various debt-for-forests swaps over the years.

On the whole, the programs seem to have worked. According to a 2018 analysis by Stockholm University economists, since 1990, debt-for-nature swaps globally have raised at least $900 million for conservation, erased nearly $3 billion in debt in at least 21 low- and middle-income countries, and resulted in statistically significant reductions in deforestation. And so far, there have been no defaults on these deals, TNC’s Kaiser said. Although the pace has slowed considerably since the 1990s, new debt swaps continue to trickle out, most recently in Pakistan.

But Volz said that the scale of previous swaps is not commensurate to the climate crisis, and will need to ramp up considerably in order to make a serious impact. The Seychelles swap, for example, amounted to just a few percentage points of the country’s debt. “All of these have been tiny,” he said. “We’re now facing a situation where tiny debt swaps here or there will not do the trick.”

Debt swaps also carry some risks, both for debtor countries and for the climate, said Shakira Mustapha, a public finance research fellow at the Overseas Development Institute, a UK think tank. For one, they could damage the debtor country’s credit rating in the short term, worsening the problem of access to capital that the swap is meant to fix. And unless they scale up to a much bigger portion of a country’s debt, that may be a risk many finance ministers are unwilling to take.

“These ideas sound great on paper, but they haven’t taken off because of what they mean for market access,” she said.

Then there’s the issue of verification. Although satellite monitoring can help, it’s not easy to confirm whether a country is really hitting its conservation goals. As with the market for nature-based carbon offsets, there’s a serious risk of greenwashing—intentionally or not—if countries claim they are “conserving” forest that was never at risk of being cut down in the first place. The IMF would also need to set rules for what kinds of energy technologies—nuclear plants, for example, or carbon capture systems on natural gas plants—could really qualify as “green.”

Still, the sovereign debt crisis is a big enough worry on its own that new solutions are badly needed, Mustapha says. And for the IMF to frame debt swaps as a form of climate action could be what persuades China, the US, and other creditors to sign on in a bigger way.

“The tie to climate change is what matters to developed countries right now,” she said. “That’s how you’re going to get political support for this.”