Countries that are most vulnerable to climate change—and the associated
loss of natural biodiversity—are often those least able to afford
investment to strengthen resilience because their budgets are burdened by
debt. Such countries face a high risk of fiscal crisis,
IMF staff research shows.
Debt-for-climate swaps and debt-for-nature swaps seek to free up fiscal
resources so that governments can improve resilience without triggering a
fiscal crisis or sacrificing spending on other development priorities.
Creditors provide debt relief in return for a government commitment to,
say, decarbonize the economy, invest in climate-resilient infrastructure,
or protect biodiverse forests or reefs.
These instruments have existed in various forms for decades, and more
countries are considering them following recent agreements in
Barbados,
Belize and
Seychelles.
In cases where action would not have been taken without the swap, the
arrangement aids climate action or protects nature. And to the extent that
debt reduction exceeds the new spending commitments, borrowers get fiscal
relief through budget savings. There can be other benefits, too, such as an
upgrade to a country’s sovereign credit rating, as was the case in Belize,
which makes government borrowing cheaper.
Swaps could even create additional revenue for countries with valuable
biodiversity by allowing them to charge others for protecting it and
providing a global public good. This is also true of carbon sinks, or
natural environments which absorb carbon dioxide from the atmosphere and
are an important part of the transition to a lower carbon economy.
In most cases, it’s more effective to address debt and climate or nature
separately.
For example, a simple climate-conditional grant tends to be more efficient
on the climate side without the added complexity of a debt-swap operation.
For countries with unsustainable debt, a swap cannot restore solvency
unless it involves a sufficiently large share of a country’s debt and
substantial relief—an extreme case. So far, no swap has come close to
achieving this.
Swaps are thus not substitutes for debt restructuring when it is needed.
Instead, a broad-based restructuring (through the
Group of Twenty’s Common Framework,for instance) would best restore solvency. Measures to support climate or
conservation investment could then follow.
That said, grants and concessional loans from bilateral donors and
multilateral development banks are scarce relative to the enormous need for
climate and nature financing, particularly for middle-income countries that
do not normally qualify for grants. And restructuring is often not
available to countries until their debts become unsustainable and they lose
market access.
Under these circumstances, it may not be feasible to deal with the issues
separately. Swaps may then be among the few tools that are available to
help with both debt and environmental objectives. So there are
circumstances in which they can complement other climate-finance
instruments.
Need to scale up transactions
Yet for swaps to really have an impact, the number and size of transactions
must be scaled up significantly. This means addressing barriers to scale
and improving the financial terms under which swaps are conducted.
There are several ways to help swaps progress from niche products, often
linked to small projects that are expensive to structure and monitor, to
more mainstream instruments.
IMF staff have proposed: structuring deals around broad climate and environmental
goals such as de-carbonizing the energy industry, investing in adaptation,
or protecting nature; moving away from custom projects and supporting
budgetary spending on climate in countries with strong public financial management and policy
credibility; and linking swaps to simple-to-monitor metrics such as carbon
emissions, deforestation, or ocean exploitation.
In addition, the fiscal space that is created by swaps could be increased
by improving the terms of the transaction in three ways:
- Include as large a share of a country’s debt as possible. This requires
more financing and, to this end, more third parties such as governments,
foundations and civil-society organizations could be encouraged to buy debt
on secondary markets and use it for climate or nature swaps. - Repurchase debt at the lowest possible price, through carefully designed
secondary-market transactions that minimize the increase in price as debt
is bought back, or through incentives for creditors, such as allowing them
to trade in carbon credits arising from the transaction. - Minimize the cost of financing the debt buy-back. As in the above
transactions, donors could offer partial guarantees that lower the risk for
investors and reduce the expense.
While other institutions with relevant expertise must be involved and the
market participants able to arrange these complex transactions increased,
the IMF can play an important supporting role. Through annual Article IV
consultations, financing arrangements and capacity development, the Fund
can help countries develop macroeconomic and budget frameworks to integrate
the impact and thus support the use of swaps. Our debt sustainability
analysis now includes the impact of natural disasters and climate change.
Our new
Resilience and Sustainability Trust
could support resilience-enhancing climate-related policy reforms with
affordable long-term financing.
The resources could potentially be used to buy back expensive debt in
cases where this meaningfully reduces the debt-servicing burden.
The Trust also aims to catalyze additional official and private financing.
Reforms in the context of Fund-supported programs could allow country
authorities to signal their policy ambitions, and possibly encourage
parties interested in swaps. Promising avenues include energy sector
reforms or the greening of public financial management.
In sum, swaps can play a role in some circumstances. They are unlikely to
provide a universal solution for countries struggling with debt or
confronting climate change or nature loss. And they should not come at the
expense of traditional debt relief or concessional finance. However, they
can be scaled up to complement existing instruments and strengthen
resilience in countries on the front line of climate change and loss of
natural biodiversity at a time when financing is scarce.
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