Debt Relief for a Green and Inclusive Recovery: An Ambitious New Proposal for a Challenging Time

By Rebecca Ray

The triple crisis of public health, the global economy, and climate change are looming for the world, but focusing their havoc on developing countries in particular.

While low and middle-income countries (LMICs) have faced wave after wave of the COVID-19 pandemic, the pandemic also made foreign capital and hard currency scarce, necessitating a build-up of sovereign debt. That debt will be coming due soon, creating the risk of widespread economic fragility. These two crises are further complicated by the ongoing crisis of climate change, bringing unpredictable, but increasing, natural disasters that create and exacerbate economic and health shocks. How are developing nation governments to face all three at once? How can multilateral financial institutions support economic stability and climate resilience so governments can give their long-term human development goals the priority they deserve?

On June 28, 2021, the Boston University Global Development Policy Center, the Heinrich Böll Stiftung and the Centre for Sustainable Finance at SOAS University, London unveiled a new proposal to address this nexus of challenges: Debt Relief for a Green and Inclusive Recovery. This proposal links debt relief with debtor nations’ long-term goals for human development and climate change mitigation and adaptation, as well as placing a focus on the role the private sector must play in meaningful debt restructuring. It builds on learnings from multilateral responses to past debt crises to ensure that developing nations will have the fiscal space to build healthy and resilient communities.

The proposal was launched with a webinar and expert discussion on the same day:

As keynote speakers, the discussion was joined by: Dr. José Antonio Ocampo, former UN Under-Secretary-General for Economic and Social Affairs and Colombian Finance Minister and Agriculture Minister; Dr. Alicia Barcena, Executive Secretary of the UN Economic Commission for Latin America and the Caribbean and Mexico’s former Undersecretary of the Environment and Director of the National Institute of Fisheries; and Dr. Louis Kasekende, Executive Secretary of the Macroeconomic and Financial Management Institute of Eastern and Southern Africa and former Deputy Governor of the Bank of Uganda.

Dr. Stephany Griffith-Jones introduced and moderated the discussion. Dr. Griffith-Jones, financial markets director at the Columbia University Initiative for Policy Dialogue, has been a global thought leader on multilateral finance for decades and has published dozens of books and scholarly articles on the subject. The proposal was then introduced by Dr. Shamshad Akhtar, Chairperson of the Pakistan Stock Exchange and former Finance Minister and Central Bank Governor of Pakistan, and Dr. Ulrich Volz, Reader in Economics at SOAS University of London and Founding Director of the SOAS Centre for Sustainable Finance.

The Context

Shamshad Akhtar began the presentation by explaining the current context that makes Debt Relief for a Green and Inclusive Recovery necessary. She described the current environment as the “calm before the storm.” While markets have stabilized since the outbreak of the COVID-19 crisis when private capital flows fled developing economies at an unprecedented rate, this stability is likely to be short-lived.

In many nations, external debt service is greater than healthcare and education spending combined, and the pandemic itself has required vast public spending at a time when developing countries could not draw on domestic resources. Currently, sovereign debt levels are rising to levels not seen in many years. For example, sub-Saharan African external debt service obligations have now risen to the level they had before the Highly Indebted Poor Countries (HIPC) initiative of the late 1990s and early 2000s. Furthermore, climate change has required governments to protect and rebuild their communities from a continual parade of new challenges. When the “calm” gives way to the “storm,” governments will see their long-term goals of human development and climate resilience pushed further out of reach.

The current calm is provided by two temporary factors: low US interest rates, as well as high commodity prices have combined to reduce debt repayment burdens for developing countries. However, as developed countries emerge from their pandemic recessions and return to growth, both factors will recede, exposing an unsustainable – and growing – underlying debt crisis.

When that happens, governments will have to choose between meeting their debt repayment obligations, their short-term budgetary demands to address the COVID-19 crisis, or their long-term goals for development and climate resilience. Without attending to those long-term goals, governments face the prospect of a vicious cycle of climate change-linked disasters, ensuing health crises and the inability to pay future debt obligations.

The G20’s response to these looming crisis – the Debt Service Suspension Initiative (DSSI) – has been widely acknowledged as inadequate by itself. In an encouraging turn, David Malpass, President of the World Bank, and Kristalina Georgieva, Managing Director of the International Monetary Fund (IMF), have announced a more robust approach that will incorporate countries’ vulnerabilities to climate change into their debt reduction talks. However, the details of such an arrangement are yet to be established. This report – the Debt Relief for a Green and Inclusive Recovery – aims to provide a blueprint for enacting such a plan.

In November 2020, this same team of authors published the first edition of this work, making the simple argument that middle-income countries (MICs) as well as low-income countries (LICs) need fiscal space to continue pursuing their climate and development goals and to prevent a cycle of economic, health and climate disasters. The updated report provides a detailed policy proposal for a mechanism to meet that goal, including meeting existing shortcomings in the G20 Common Framework.

The Proposal

Following the context presented by Shamshad Akhtar, Ulrich Volz explained the proposed Debt Relief for a Green and Inclusive Recovery mechanism. The plan includes four main components, illustrated in Figure 1 below: an enhanced debt sustainability analysis (DSA) framework incorporating climate threats, a debt swap that incorporates a partial guarantee to incentivize private creditor participation and a debtor-driven Green and Inclusive Recovery Strategy (GIRS) to guide the process.

Figure 1: Guaranteeing a Green and Inclusive Recovery

Source: Debt Relief for a Green and Inclusive Recovery, 2021.

First, the DSA process, overseen by the World Bank and IMF, will need to be overhauled. Currently, it is not fit for purpose in a world where climate change threatens to upend economic growth and human development through the threats of more frequent natural disasters and economic crises. The current framework has been frequently criticized for being overly optimistic and underestimating risk. For example, it does not currently incorporate the risks that climate change and biodiversity loss pose to economic stability and growth. Nor do they include an accounting of countries’ investment needs to avoid these risks through climate adaptation or progress toward the 2030 Sustainable Development Goals (SDGs). Thus, this proposal includes developing an enhanced DSA framework to incorporate these realistic assumptions.

The second and third elements of the proposal incorporate private and commercial lenders. Currently, countries frequently undergo debt renegotiation with official creditors without including private or commercial creditors, out of concern that such a move would hurt their ability to raise capital in the future. By creating a universal expectation of equitable treatment between private and official creditors for all debtor nations, this proposal would alleviate the stigma against those countries that have pursued it. Specifically, it calls for the IMF to make any potential new programs conditional on restructuring with private creditors. Private creditors should expect that debtor countries seeking haircuts from bilateral lenders will do the same with them.

The proposal also includes a variety of incentives for private creditors to participate, as these creditors must be convinced that participating will be more advantageous than abstaining. Experience shows that their participation needs both positive incentives (“carrots”) and negative incentives (“sticks”). The most important “carrot” proposed is a Guarantee Facility for a Green and Inclusive Recovery, to be housed at the World Bank. Loan repayment obligations will be exchanged for bonds that incorporate significant haircuts, but which are guaranteed for their principle and 18 months of interest payments. The “sticks” involve political pressure from the largest official creditor nations where private creditors are based. These creditor nations, such as China, the United States and the European Union, stand to lose out if private creditors do not participate, and they are capable of exerting significant pressure over the institutions located there.

Finally, countries’ repayments will not only be diminished, but aligned toward their own existing long-term development and climate resilience goals. These plans already exist in myriad formats such as national Sustainable Development Goals and Nationally Defined Contributions for the Paris Agreement. This proposal imagines those disparate goals being drawn together into one Green and Inclusive Recovery Strategy (GIRS). GIRS would be written by the debtor governments themselves, with input from all relevant domestic stakeholders, including those representing civil society, academia and businesses. These GIRS documents would include spending plans and performance indicators to measure progress toward those goals and form the basis for debtor nations’ path out of the current compounding health, environmental and economic crises. Debt repayments would be divided between bondholders and their GIRS fund, out of which they may spend as they wish as long as it is within the parameters spelled out by their national strategies.

The Discussion

After the authors’ presentation, the keynote speakers provided their comments and thoughts on the proposal, with Jose Antonio Ocampo beginning the discussion. He agreed that this proposed ad hoc debt resolution mechanism is appropriately designed for the current compound crisis. In past debt crises, similar ad hoc mechanisms were instrumental in returning to economic stability.

In the medium-to-long term, he commented that the world needs a stable, multilateral sovereign debt restructuring mechanism to bring predictability to debt renegotiations and return to stability faster in the aftermath of future crises. Ideally, such a mechanism would be housed at the United Nations, although it could also be overseen by an international financial institution, such as the IMF, if it had sufficient institutional autonomy to maintain legitimacy across lenders and debtors. He also noted that the financial commitment intrinsic in this proposal is significant and will depend on the political will of developed nations for its establishment and maintenance.

Alicia Barcena continued the discussion by centering her contributions around the immediate urgency of health spending requirements from two threats: the COVID-19 pandemic and the increasingly common health crises from natural disasters linked to climate change. With health at the center of policy priorities, the need for prioritizing human development and climate change resilience in national recoveries from the current debt crisis becomes clear.

She agreed with Ocampo that the present plan should be the basis for a future stable global mechanism. In the long-term, new financial architecture will be needed, with buy-in from credit ratings agencies (CRAs) and possibly the creation of public CRAs. This ad hoc measure will need to be incorporated into a longer-term vision.

A crucial element of this proposal is the central role of debtor nations in developing and articulating their own plans. Regional United Nations commissions, such as her professional home at ECLAC, can also contribute significant technical expertise to both this immediate proposal and longer-term mechanisms. For example, ECLAC has a history of assisting Caribbean states in incorporating “hurricane clauses” into sovereign debt in order to account for climate risk. These regional commissions can also be platforms for nations to learn from each other’s experience, such as Ecuador’s recent successful debt renegotiation with private creditors and Argentina’s use of collective action clauses in its own sovereign debt.

Louis Kasekende, Executive Secretary of the Macroeconomic and Financial Management Institute of Eastern and Southern Africa (MEFMI) and former Deputy Governor of the Bank of Uganda, contributed his assessment that now is a crucial time for this type of proposal. Foreign exchange receipts and investment have dwindled while public spending needs have ballooned, creating a need for a multilateral mechanisms such as this one. He noted developing countries are effectively sitting on a ticking time bomb of social, environmental and economic crises. Freeing up resources for addressing these needs in both the short and long term is key to development goals of nations around the world.

To meet the goals of the proposal, Kaskende cautions it would be wise to remember lessons from past debt crises in several ways. First, it will be important to ensure that the GIRS plans are not overly burdensome. During the HIPC initiative, it became evident that debtor nations would not benefit from a process with challenging conditions. To this end, it may help to incorporate capacity building cooperation, particularly with regards to loan negotiations and restructuring, as well longer-term economic resilience to better weather future exogenous economic shocks such as the COVID-19 pandemic. Second, debtor nations may need assistance in addressing internal sovereign debt, which is often characterized by underdeveloped markets, dominated by a few key creditors and high interest rates. Finally, to be successful, this type of support will need to continue beyond 2021 into the medium and long term.

Attendees asked a variety of questions that added further depth to the discussion. First, several panelists discussed the role of CRAs in the current crisis and recovery, and in any future multilateral financial architecture. Shamshad Akhtar noted that Pakistan has not applied for participation in the G20 Common Framework for Debt Treatments beyond the DSSI. Their hesitation to participate is likely linked to fears of a probable sovereign credit rating downgrade, which has plagued other participating countries.  After such a downgrade, Pakistan’s ability to raise additional capital through new bond issuances would be hurt, at least temporarily, hampering their recovery efforts.

Moritz Kraemer, report co-author and Chief Economist of CountryRisk.io and Senior Fellow at SOAS, University of London, also contributed to the discussion on the role of CRAs. He stated that, ideally, the threat of a credit downgrade should not have the sway that it currently does. A well-designed multilateral debt relief plan, such as the one presented, will make the entire process more predictable. If it is predictable that a country’s balance sheet will improve after a standardized process of debt restructuring, then it should also be predictable that their credit rating will rebound quickly thereafter.

Kevin P. Gallagher, report co-author and Director of the Boston University Global Development Policy Center, addressed a question about how to best incorporate large official creditors, such as China. He noted that most Chinese finance is through long-term bank loans and is thus particularly amenable to being addressed through this type of mechanism. With bank loans, China may be over-exposed to a few economies that are currently distressed. This proposal would allow those loans to be exchanged for guaranteed bonds, which will be easy to sell, re-establishing balance and healthy diversification to the balance sheets of China, or any other large creditor.