What Are Debt for Nature Swaps?
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30 December 2022 – by Heba Hashem
Last updated on 10 January 2023
What Is a Debt-For-Nature Swap?
A debt-for-nature swap is a transaction between the two countries in which one agrees to reduce or forgive the other country’s foreign debt in exchange for the implementation of environmental protection measures within that country.
Why Do Developing Countries Need Debt Relief?
The UN’s alarming revelation that 54 of the world’s poorest developing countries are on the brink of bankruptcy concerns everyone. After all, these countries represent one-third of the globe and are in danger of defaulting on their external debt.
As of 2021, this debt owed by developing countries had reached USD 11.1 trillion, the highest level on record. The situation has weighed heavily on low-income and middle-income countries, whose average debt reached 42% of their gross national income in 2020.
After years of borrowing at low-interest rates, developing countries have had to deal with several economic shocks: first, the pandemic and then the global energy crisis. Rising inflation and currency depreciations have followed this.
As a result, living costs and interest rates have soared, slowing growth across already struggling countries. Instead of using their income for projects that could make them more resilient, they have been pouring the money into interest and principal payments.
Heavily Indebted Poor Countries and Climate Change
A new World Bank report said that developing countries would pay a staggering 35% more in debt interest in 2022.
If these countries do not get access to debt restructuring, poverty will rise, and they could end up in a fiscal crisis. Such a situation could lead to political upheaval, as seen in Sri Lanka. After defaulting on all of its foreign debt, the country declared it was bankrupt, leaving millions to face fuel and food shortages.
Poorer nations have also been using loans to deal with climate change, only to see fresh disasters destroy the improvements. This forces them to borrow again, which puts them in a “climate debt trap”.
Debt is a significant inhibitor to climate action, especially in current economic conditions. With all resources directed towards improving basic living standards, climate change is taking a back seat.
Achim Steiner, the UN’s global development chief, recently warned that developing countries could even give up on climate talks. “The issue of debt has now become such a big problem for so many developing economies that dealing with the debt crisis becomes a precondition for actually accelerating climate action,” Steiner said.
Swapping Debt for Nature
Without debt forgiveness or some restructuring mechanism, developing countries cannot invest in environmental protection and climate resilience.
This is where debt-for-nature swaps can play a crucial role. The financial mechanism allows portions of a developing country’s foreign sovereign debt to be forgiven by the creditor countries. In exchange, the debtor country commits to investing in climate resilience, emissions mitigation and biodiversity protection.
“Forgiveness” could involve converting the debt into a local currency or allowing it to be paid at a lower interest. It could also mean exchanging the debt for the issuance of a bond. Or, it could mean writing off the debt altogether.
How Does a Debt Swap Work – Pros and Cons?
Debt swaps have been used since the late 1980s on a small scale. They can involve a creditor country, a commercial bank or an environmental NGO acting as a broker.
The mechanism usually helps alleviate the financial burdens of developing countries and turns their debt crisis into an opportunity. But, such deals are compromises and typically come with risks.
For instance, negotiating a debt swap can downgrade the country’s credit rating, according to an OECD report. Moreover, debt-for-nature swaps often take years of expensive negotiations to come to fruition, especially when involving commercial banks. This explains why deals have, so far, been fragmented.
Debt-for-Nature Swap Examples in Latin America
Historically, countries have only used debt swaps for conservation purposes. But, they could expand the mechanism to climate action. For example, they could leverage it to develop renewable energy or agricultural projects for climate adaptation.
First Debt-for-Nature Swap
The first debt-for-nature swap arrangement took place between Bolivia and the US in 1987. It cancelled Bolivia’s debt of USD 650,000 on the promise that the country would conserve 3.7 million acres of land near the Amazon.
Costa Rica, too, has carried out two successful debt-for-nature swaps with the US. Under these deals, the country agreed to allocate USD 53 million for conservation projects. It has already planted more than 60,000 trees and reversed its deforestation.
More recently, in 2021, Belize completed a USD 364 million debt-for-nature swap that lowered its debt by 12% of GDP. In exchange, it committed to protecting 30% of its ocean and created USD 180 million of sustainable financing for marine conservation.
Lessons learned from these debt-for-nature swap experiences will enable debtor and creditor countries to make the best use of this mechanism.
With developing countries unlikely to uphold their debt payment commitments, creditors should seize the opportunity amid the crisis. In doing so, they would be helping to boost climate action across vulnerable countries, which ultimately benefits the entire planet.