How debt-for-climate swaps can help solve low-income countries' fiscal and environmental challenges at the same time

Barbados Prime Minister Mia Amor Mottley spoke passionately to the United Nations General Assembly in September about the mounting debt many developing countries are shouldering and its increasing impact on their ability to thrive.

The average debt for low- and middle-income countries, excluding China, reached 42% of their gross national income in 2020, up from 26% in 2011. For countries in Latin America and the Caribbean, the annual payments just to service that debt averaged 30% of their total exports.

At the same time, these countries are facing a “triple crisis of climate change, of pandemic and indeed now the conflict that is leading to the inflationary pressures that lead regrettably to people taking circumstances into their own hands,” Mottley said.

Rising borrowing costs coupled with high inflation and slow economic growth have left developing countries like hers in a difficult position when it comes to climate change. High debt payments mean countries have fewer resources for mitigating and adapting to climate change. Yet climate change is increasing their vulnerability, and that can raise their sovereign risk, increasing the cost of borrowing. Declining productive capacity and tax base can lead to higher debt risks. It’s a vicious cycle.

As one solution, countries and international organizations are talking about “debt-for-climate swaps” to help tackle both problems at the same time. U.N. Deputy Secretary-General Amina Mohammed mentioned debt-for-climate swaps ahead of the 2022 U.N. Climate Change Conference, Nov. 6-18, as one option for refinancing countries’ “crippling” debt.

How debt swaps work

Debt-for-climate swaps allow countries to reduce their debt obligations in exchange for a commitment to finance domestic climate projects with the freed-up financial resources.

They have been used since the late 1980s to preserve the environment and address the liquidity crisis in developing countries, including Bolivia, Costa Rica and Belize. These are commonly known as “debt-for-nature swaps.”

Belize, for example, was able to lower its debt in exchange for committing to designate 30% of its marine areas as protected areas and to spend $US4 million a year for the next two decades on marine conservation under a complex debt-for-nature swap.

The swap, organized in 2021 by The Nature Conservancy, involves the U.S.-based environmental group lending funds at a low-interest rate to Belize to buy back $553 million in commercial debt at a deep discount of 45%. The Nature Conservancy raised funds from the investment bank Credit Swisse via the issuance of “blue bonds” backed by the U.S. government, which gave the bonds a strong investment-grade credit rating.

Similarly, Costa Rica has carried out two debt-for-nature swaps with the United States. Under the swaps, Costa Rica agreed to allocate $53 million for conservation projects. It has already planted more than 60,000 trees and reversed its deforestation.