Debt-for-climate swaps an effective means for relief

News: A global transition to a net-zero economy requires huge amounts of annual financing by vulnerable and low income countries.

Moreover, the pandemic has induced a debt distress around the world. This debt pressure and the climate crisis can be addressed jointly via Debt-for-climate swaps.

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”
How the problem of debt distress risen in the pandemic and what are the implications?

Debt distress is at historic levels.

During the pandemic, low-income countries’ overall debt burden increased 12%, reaching $860 billion in 2020.

– Debt Service Suspension Initiative: When the pandemic struck, there was a visible threat of a sudden stop to capital flows and an emerging-markets financial crisis. The G20 responded by adopting the Debt Service Suspension Initiative, which was used by more than 40 countries to postpone repayment.

Still, 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.

Implications of debt distress:

Future borrowing becomes more expensive, resulting in less access to funds. This means many countries start relying more on exporting natural resources to pay back what they owe.

Must Read: What are Green Debt Swaps?
Is the idea of green debt swaps new?

No. The idea is something similar to the Brady bonds that have been tested since the 1980s. Debtors used official loans from the IMF and the World Bank to acquire US Treasury bonds as collateral. This allowed them to exchange existing bank loans at a heavy discount for tradable, guaranteed Brady bonds.

For instance: 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.

There were doubts about the effectiveness and durability of green debt swaps, so the amounts involved remained small.

What is the issue with addressing climate crisis and debt distress jointly?

Climate-mitigation financing is needed most in high-income countries, which are not facing any debt distress at all.

On the other hand, even in many low-income countries that are highly exposed to climate change, only few are facing both problems together.

Hence, the match between financing needs and addressing the environmental externality is imperfect at best.

What is the way forward?

Bilateral debt-relief can be granted to low income countries in the form of conditional fiscal transfers and grants to incentivise climate-adaptation spending.

Mobilizing both private and public funding will also be essential. It will require the creation of liquid markets for climate bonds and probably some credit enhancements in a tripartite Brady arrangement.

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.

Management and monitoring of abatement and climate investments could be carried out using the model of the trust funds.

Source: This post is based on the article “Debt-for-climate swaps an effective means for relief” published in Livemint on 30th Dec 2021.

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