Active Stocks
Thu Mar 28 2024 15:59:33
  1. Tata Steel share price
  2. 155.90 2.00%
  1. ICICI Bank share price
  2. 1,095.75 1.08%
  1. HDFC Bank share price
  2. 1,448.20 0.52%
  1. ITC share price
  2. 428.55 0.13%
  1. Power Grid Corporation Of India share price
  2. 277.05 2.21%
Business News/ Politics / News/  Debt-for-climate swaps an effective means for relief
BackBack

Debt-for-climate swaps an effective means for relief

Debt-for-nature swaps were attractive for conservation organizations as long as they could purchase distressed debt at highly discounted prices and secure leverage for their donor funding.

Photo: AFPPremium
Photo: AFP

What if there was a magic bullet to address the climate crisis, the pandemic-induced debt crunch, and the need to boost development finance all at once?

It certainly is attractive to try to tackle these issues jointly, because we already need to mobilize climate finance from rich countries (the main polluters) to support low-income countries (who will bear a disproportionately large burden from climate change). European Commission President Ursula von der Leyen has said that “major economies do have a special duty to the least developed and most vulnerable countries", and International Monetary Fund Managing Director Kristalina Georgieva said that “it makes sense" to seek to address debt pressures and the climate crisis jointly. The idea is to arrange “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 main item on an international “menu" of debt-restructuring instruments. Debtors used official loans from the IMF and the World Bank to acquire US Treasury bonds as collateral, allowing them to exchange existing bank loans at a heavy discount for tradable, guaranteed Brady bonds. “Debt-for-nature" swaps were also on the menu during this period, but they were side dishes.

The earliest such instruments were structured as deals between a conservation organization, creditors, and a debtor government. In 1987, Conservation International used donor funds to acquire $650,000 of Bolivian external debt at the heavily discounted price of $100,000. In return, Bolivia undertook to protect the Beni Biosphere Reserve, furnishing $250,000 (in local currency) for its management. Similar approaches were used to establish a marine sanctuary in the Philippines and to protect mountain gorillas in Uganda.

Debt-for-nature swaps were attractive for conservation organizations as long as they could purchase distressed debt at highly discounted prices and secure leverage for their donor funding. But there were doubts about the effectiveness and durability of these strategies, so the amounts involved remained small.

The largest 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 conservation projects. A similar structure is currently in use in Belize, which is allowing holders of its $533 million 2034 bond “to tender their notes at a 45% discount to their principal" while also committing to earmark $23.4 million for 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 both debt and climate issues has grown to enormous proportions. The number of extreme weather events each year has doubled, tripled, and even quadrupled since the 1980s.

Fortunately, the analyses produced by the Intergovernmental Panel on Climate Change are now generally accepted. The IPCC’s reports consistently show that the world’s “carbon budget" for keeping global warming under 1.5° Celsius is rapidly being depleted. The world can afford to emit only around 300 gigatons more of carbon dioxide. At the present emissions rate of about 35 gigatons per year, that gives us less than a decade.

Feeling a sense of urgency at last, many countries and companies have adopted net-zero emissions targets, and the financial sector has begun to embrace ESG (environmental, social, and governance) investing criteria. But the task ahead is daunting. Mark Carney, the current UN special envoy for climate action and finance, estimates that a global transition to a net-zero economy will require $3.5-4.5 trillion of annual financing.

Debt distress is also at historic levels. During the pandemic, low-income countries’ overall debt burden increased 12%, reaching $860 billion in 2020. When the pandemic struck, the threat of a sudden stop to capital flows and a full-blown emerging-markets financial crisis loomed large.

The G20 responded by adopting the Debt Service Suspension Initiative, which was used by more than 40 countries to postpone repayment. Nonetheless, an IMF analysis of 70 low-income countries finds that seven are already in debt distress, and that 63 are at high or moderate risk of debt distress.

One problem with trying to address climate change and debt with a single package is that they do not align perfectly. Climate-mitigation financing is needed most in high-income countries, with about one-third of the required transition investments being in Europe and the US, and more than half in the Asia-Pacific region, mostly China. With few exceptions, low-income countries’ contribution to global warming is negligible. The match between financing needs and addressing the environmental externality is imperfect at best.

On the other hand, because many low-income countries are highly exposed to climate change, they will need financing to invest in adaptation. Some of this could be provided through debt relief; but, again, the match between financing needs and debt distress is imperfect. While countries such as Haiti, Niger, and South Sudan face both high debts and acute climate risk, many others are confronting only one of these problems.

A related question is whether debt swaps are the most effective way of delivering relief. Rich countries usually have granted bilateral debt relief without attaching conditionality to recipients’ expenditures. If they wanted to support specific climate-adaptation spending in low-income countries, they could always do so through conditional fiscal transfers and grants. The suitability of conditional debt relief as a financing tool for low-income countries is not always obvious.

What is obvious is that rich countries are responsible for causing the climate crisis and therefore have a moral responsibility to assist poorer countries in dealing 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-for-climate swaps then can be one option among others. They could be implemented using a Brady-type structure, which can solve the dual problem of scaling and leveraging flows from the private sector. Mobilizing both private and public funding will be essential, and will require the creation of liquid markets for climate bonds and probably some credit enhancements in a tripartite Brady arrangement.

To facilitate the process, the IMF and the multilateral development banks could structure conditional debt relief and provide various enhancements. For example, the IMF could use recycled special drawing rights to lend to low-income countries the resources they need to acquire collateral for green Brady bonds. Private and public creditors would agree to swap their bonds at a heavy discount for these green bonds, thus providing the country with fiscal space for spending on climate projects. Management and monitoring of abatement and climate investments could be carried out using the model of the trust funds that were tried and tested in previous nature deals.

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 magic bullet, nor would it be the main dish on the menu of climate finance. 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 Graduate Institute, Geneva.

 

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Politics News and Updates on Live Mint. Download The Mint News App to get Daily Market Updates & Live Business News.
More Less
Published: 30 Dec 2021, 11:25 PM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App