Banque de France Bulletin no. 244: Article 2 Debt-for-nature swaps: a two-fold solution for environmental and debt sustainability in developing countries?

Environmental degradation (such as climate change and biodiversity loss) and the increasing difficulty of many low and middle income countries to repay their public debt are now widely recognised as two sources of risk to the stability of the international financial system (of which central banks are the guarantors). Many recent proposals aim at addressing both problems jointly through so called “debt-for-nature swaps”, whereby a country’s debt is reduced in return for a commitment to spend a share of the reduction on environmental protection. Debt-for-nature swaps can indeed improve environmental sustainability and lower public debt and thus contribute to the stability of the international financial system. However, their implementation poses many technical, financial and governance related challenges. They could thus be accompanied by adverse effects that need to be analysed in detail.

1 Low- and middle-income countries face the increased risk of unsustainable public debt and the environmental crisis simultaneously

Debt-for-nature swaps are financial transactions that aim at reducing a country’s debt in return for a commitment to spend a portion of that reduction on nature conservation. For developing countries, debt for nature swaps can help address the growing two pronged challenge of lowering excessive public debt and dealing with climate change, to which they are particularly vulnerable.
The Covid 19 pandemic has compromised the sustainability of public debt in many countries
The fight against the pandemic has increased the risk of public debt sustainability for low  and middle income countries, due to the fiscal efforts required. According to the International Monetary Fund (IMF, 2022b), their level of public debt in 2021 was higher than before the crisis: 49.6% of GDP for low income countries and 66.1% for middle income countries, compared with 43.5% and 54.6% in 2019 respectively. The total amount of this debt rose by almost USD 3,500 billion between 2006 and 2020 (World Bank, 2021). Debt service as a percentage of exports has been increasing since a historic low point in 2011 (see Chart 1). This increase is accompanied by a rise in the relative share of debt held by private creditors, to 63% of the total in 2020, compared with 14% for bilateral official creditors.
Faced with this situation, international mechanisms have been set up to prevent the risk of overindebtedness and to help the most vulnerable countries regain some fiscal room for manoeuvre. Between May 2020 and December 2021, the international community (G20) decided on a Debt Service Suspension Initiative (DSSI). This Initiative benefited 47 countries for a total amount of USD 12.9 billion. This relief enabled these countries to increase their Covid related spending, although sometimes at the expense of other key items such as education (IMF, 2021a).
However, there are some difficulties in implementing these mechanisms. In particular, the ramp up of the G20’s “Common Framework for Debt Treatments”, which replaced the DSSI, has been slow (IMF, 2021b). To date, only three countries have requested debt restructuring under this framework (Ethiopia, Chad, Zambia). Moreover, their procedures are subject to considerable delays due, among other things, to the complexity of coordinating the various creditors. Finally, middle income countries do not benefit from the tools that have been deployed so far to lower the debt burden; their financial resources are therefore spent on reducing their debt …

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Banque de France Bulletin no. 244: Debt-for-nature swaps: a two-fold solution for environmental and debt sustainability in developing countries?
  • Published on 02/24/2023
  • 12 pages
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Economy and international financing

Updated on: 02/24/2023 11:51