Webinar Summary: Using Debt-for-Climate Swaps to Solve Two Crises at Once

Quito, Ecuador. Photo by Chandler Hilken via Unsplash.

By Rebecca Ray

On Thursday, January 13, the Boston University Global Development Policy (GDP) Center and the Organisation for Economic Cooperation and Development (OECD) Development Centre hosted a webinar discussion on the potential for using debt-for-climate swaps as an innovative solution to the twin crises of climate change and debt distress. The discussion consisted of two rounds of questions to the panelists, followed by a lively Q&A session with the audience.  

Ragnheidur (Ragga) Arnadottir, Director of OECD Development Centre gave a brief introduction of the threefold crisis facing many developing countries. As the International Monetary Fund (IMF) recently highlighted, rising interest rates in high-income countries threaten to unleash a debt crisis for low- and middle-income countries (LMICs) around the world. But these LMICs are already facing high and rising climate change costs – including the challenges of paying for mitigation measures to reduce carbon emissions, adaptation measures to prepare for climate change-induced disasters and loss and damage costs from disasters that could not be prevented. Together, these factors could lead to a lost decade for developing countries.  However, while facing this challenge is complex, it is possible. Past efforts have been promising, but shy of the scale needed to effectively address either debt or climate challenges. The panel set out to explore these intertwined problems and the challenges of meeting them with ambition. 

Arnadottir was joined by Alagie Fadera, Director of National Development Planning in the Ministry of Finance and Economic Affairs of The Gambia, which is a member of the group of Climate Vulnerable Forum (V20); Thierry Watrin, Green Economy and Climate Change Advisor at Ministry and Economic Planning of Rwanda, also a V20 member; Jeromin Zettelmeyer, IMF Deputy Director of the Strategy, Policy and Review Department; Ulrich (Uli) Volz, Professor at SOAS University of London and Founding Director of the SOAS Centre for Sustainable Finance; and Iolanda Fresnillo, P​olicy and Advocacy ​Manager at the European Network on Debt and Development (Eurodad). Rishikesh Ram Bhandary, Assistant Director for the Global Economic Governance Initiative at the GDP Center provided closing remarks. 

Dr. Uli Volz began by giving a summary of a looming debt crisis, which impedes national responses to the COVID-19 pandemic and nations’ ability to invest in climate change adaptation and mitigation. The United Nations Development Programme (UNDP) recently estimated over 70 LMICs face debt vulnerabilities, which will be exacerbated by rising interest rates in high-income countries. Already Caribbean small island developing states (SIDS) face debt service requirements that account for between 30 and 70 percent of government revenue, while these economies are some of the world’s most vulnerable to natural disasters related to climate change. 

Volz emphasized the connections between climate, public health and debt repayment requirements, stating that “Governments must climate-proof their economies and public finances, because otherwise they are facing an ever-worsening spiral of climate vulnerability and unsustainable debt burdens.” However, climate vulnerabilities are diminishing access to capital and worsening sovereign risk ratings, increasing the cost of borrowing to finance the necessary long-term investments. Given the severity and immediacy of these overlapping challenges, Volz stressed the need for more extensive responses, stating that “Conventional debt-for-climate or debt-for-sustainability swaps will not do. We need much more ambitious solutions to tackle the debt crisis.”

Jeromin Zettelmeyer of the IMF continued the discussion by largely agreeing on the interconnectedness of climate and debt problems. Although relatively few countries, such as the V20 members, face such extensive climate vulnerabilities as to create significant fiscal stress, the opposite is true more broadly, in that many countries’ debt burdens create fiscal constraints that prevent sufficient long-term investment in climate resilience. 

Debt-for-climate swaps are a useful addition to the global response to both problems for two reasons. First, financing needs for climate investments are great enough to merit their inclusion as one more instrument for freeing up fiscal resources. Zettelmeyer explained, “The way we would look at debt-climate swaps is not so much as an instrument to address debt distress but as an instrument among others to increase fiscal space for many reasons, but in particular to undertake climate investment.”

A second benefit of environmentally linked debt swaps is their attractiveness for private creditors, who will need to be enticed to participate in any significant debt restructuring, particularly in V20 countries where climate risks compound fiscal risks. In these cases, Zettelmeyer explained that, “It would be rational from the perspective of a creditor to link debt relief to climate action because … the debt problem is as sensitive, or perhaps more sensitive, to climate actions … as it would be to macroeconomic adjustment, which is usually what debt restructuring agreements emphasize.” 

Alagie Fadera of The Gambia Ministry of Finance and Economic Affairs contributed depth to the discussion by explaining the Gambian case. As in many African nations, the COVID-19 pandemic adds another fiscal burden. Only about 10 percent of the population is vaccinated against the virus, showing the government’s strain to cover the costs of human health investments. Because of low vaccination rates, Fadera stated that “We are not yet out of the woods as far as the pandemic is concerned.” Furthermore, the pandemic has added to economic strains as income from tourism, a major source of foreign exchange, has declined. Thus, “the pandemic has created a double squeeze, as the government tries to provide relief for the population, but the pandemic has shown the vulnerabilities.” 

Climate change adds a third dimension to the fiscal strain. As Fadera stated, “If we add the climate change issue to the whole picture it even makes the choices we have to make much more difficult.” Currently, available programs are insufficient to meet the scale of the challenge. While The Gambia has received some relief through the IMF’s Catastrophe Containment and Relief Trust, as well as the Debt Service Suspension Initiative (DSSI) from the G20, these initiatives only provide temporary alleviation of the underlying, and worsening, problem. 

Many observers among the V20 and least developed countries (LDCs) were disappointed in the lack of ambition at the 2021 United Nations Climate Change Conference (COP26), particularly regarding funding for managing climate-related loss and damage. Instead of this cautious approach, Fadera stated that “given the prolonged nature of the pandemic, and the need to invest in communities and build climate resilience and climate-proof infrastructure, we need instruments that will mark those levels of ambition.”

Thierry Watrin of the Rwanda Ministry and Economic Planning followed with an explanation on the V20 proposal for debt restructuring for climate vulnerable nations. He linked the struggle to respond adequately to the COVID-19 pandemic and the climate crisis, stating that “V20 members work to ensure access to international finance based on the fact that not all of the countries have the fiscal space nor sufficient access to international investments to be able to fight COVID-19 as hard as we could. That’s why we want to emphasize inclusiveness when it comes to climate finance.”  

Rwanda has ambitious climate investment goals, including a 38 percent reduction in greenhouse gas emissions charted through its revised Nationally Determined Contributions to the Paris Agreement. These reductions are estimated to cost $11 billion, highlighting the need for additional access to finance. Thus, debt relief is necessary to bridge these fiscal caps, Watrin noted, stating that “Debt restructuring is essential for countries that are fiscally constrained but determined to strengthen their climate action plans.” With debt swaps in particular, “The principle is quite simple: redirecting debt payments toward climate-resilient projects, and this helps not only to protect existing investments, but it supports older green projects.” He ended by emphasizing the important role multilateral bodies such as the OECD and IMF can play in coordinating these efforts. 

Iolanda Fresnillo of Eurodad discussed the role of civil society actors in these issues. Fresnillo highlighted two areas of concern in the absence of significant debt relief and restructuring. First, governments may face pressure to cut social spending, including health and education spending, as well as food and energy subsidies. These cuts disproportionately affect women, who are traditionally tasked with providing household food, energy and care work. Women’s household work becomes significantly more difficult or even impossible in these circumstances, though these sacrifices often go unmeasured, as household work is unpaid. Secondly, governments may face pressure to increase exploitation of natural resources beyond sustainable levels to raise revenue to pay debts. These cases often see land grabs and community displacement as mines, oil and gas wells and plantations force out existing communities. In both cases, when governments prioritize debt repayment over other goals, “women, rural populations and Indigenous communities are the ones bearing most of the social cost.” 

Countries in debt distress have particular difficulty preparing for and recovering from natural disasters, creating heightened climate risks, which is why civil society has called for automatic debt relief mechanisms in the event of climate change-linked extreme events, and the creation of non-debt-creating financing for loss and damage. While debt-for-nature swaps represent additional useful instruments, they are insufficient in and of themselves and must be paired with these larger efforts at climate and debt justice. Fresnillo stated that “from the civil society perspective, what is needed is ambition and a robust response … a multilateral, transparent and just debt resolution for debt burdened countries from all creditors and sufficient and non-debt-creating public climate finance.” 

Arnadottir then directed a second round of questions to the panel for more depth. Fadera explained in greater depth the long-term development costs of debt problems. He stated that The Gambia has formulated a long-term climate vision for green growth, including climate-resilient, bankable projects. However, he emphasized that “Unless and until we have the fiscal space it may be very, very difficult for us to make those long-term investment that will help make our communities climate-resilient [and] chart low-carbon pathways to development.” He concluded by stating that “We owe it to ourselves to ensure that we are able to provide support for V20 nations and LDCs.”

Watrin gave further details on the need for a climate-linked debt restructuring framework proposal. Recent research shows that climate vulnerability increases a country’s cost of finance by an average of 117 basis points. Meanwhile, climate change itself is expected to bring significant economic pain to Africa. The African Climate Policy Centre estimates that an increase of one to four degrees Celsius in average global temperatures is likely to be associated with an African economic decline of between 2 and 12 percent of GDP. Thus, countries that can invest in climate resilience may benefit from a green multiplier effect, in which environmental protection brings economic benefits as well, if they can find the fiscal space necessary.

Zettelmeyer gave additional insight from the IMF on these issues. He stated that at the IMF, “We agree with almost everything in the V20 statement.” However, the only area of disagreement is that it may be easier to coordinate creditors to support many smaller debt restructuring instruments than one global plan. Since the outbreak of the pandemic, official multilateral efforts to provide debt relief have been hampered by coordination problems, as sovereign debt is increasingly held by creditors who are outside of the Paris Club (which previously provided coordination for these types of crisis response) or outside of the public sector altogether. Thus, it may be necessary to mobilize resources wherever they may be found, rather than focusing on one model.

Volz summarized the three essential components of any joint debt and climate resolution instrument. First, debt sustainability analyses must take climate risk into account, as well as risks from shortfalls on other sustainable development goals (SDGs). The IMF has made significant progress in this regard, but it may need additional speed and ambition to meet the scope of the current crises. Secondly, private sector creditor participation is key. Private creditors have not participated in the G20’s DSSI debt relief mechanism, but they can be induced to participate in future instruments through a combination of positive incentives, such as guaranteed bonds, and more forceful incentives, such as regulation from their major home countries. Finally, any successful effort must prioritize country ownership in environmental protection. Debtor countries have developed robust environmental strategies, which must be supported, rather than arbitrary measures imposed from outside. 

Fresnillo gave final remarks by pointing to her sources of optimism. She stated that “as an activist, I think we have the obligation of being optimistic.” Specifically, she is hopeful due to the proliferation of environmental and debt strategies emerging from debt distress and climate vulnerable countries. By listening to these impacted countries’ proposals, from governments as well as civil society and affected communities, international organizations can effectively coordinate ambitious responses to the current global crises.

Rishikesh Ram Bhandary of the GDP Center closed the discussion by highlighting a few important points from the panelists. First, the discussion clearly showed debt distress is holding climate action back, and that consensus is forming for a global response. Secondly, such a response must be ambitious, to match the tremendous current needs. He stated, “We have an opportunity and the need for immediate action … our collective global action needs to match the scale of these interlocking crises.” Any such multilateral solution must include all major creditors inside and outside the Paris Club, as well as private sector creditors. Thus, there is a crucial role for multilateral organizations, such as the IMF’s  in developing the Resilience and Sustainability Trust, which has the potential to incorporate many of the necessary components for successful debt and climate instruments discussed today. 

Arnadottir ended the webinar by thanking the organizers and panelists, looking forward to future continued conversations and following the continued work of the panelists, their organizations, and countries.   


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