Choosing a sustainable way out of the pandemic’s economic chaos

With debt swaps governments and finance institutions can address the triple crises of debt, climate change and the destruction of nature.

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12 October 2020

Paul Steele is chief economist at IIED

View of the coast, with a small island surrounded by water, seen from some foliage

Seychelles agreed to swap parts of its debt in return for marine conversation, by designating nearly a third of its waters as protected areas (Photo: flowcomm, via FlickrCC BY 2.0)

The scale of the pandemic’s impact on everyone’s lives goes far beyond what anyone could have anticipated six months ago. This week, as the International Monetary Fund (IMF) and World Bank meet (12-18 October) to agree measures to control COVID-19’s sledgehammer effect on the global economy, governments have the opportunity to agree a recovery plan that can put the economy back on track while helping to address rising debt, as well as climate change and the accelerating loss of nature.

Debt and climate change top the meeting’s agenda. The scale of developing country debt was soaring even before the pandemic, reaching almost US$8 trillion in 2019. The pandemic has made the situation much worse. The World Bank’s new poverty projections suggest its effects and the resulting global recession will push 110 to 150 million more people into extreme poverty by 2021. 

Falling exports and declining tax revenues are causing fiscal crises and a shortage of foreign currency, leading debt in low-income countries to rocket. Already more than 100 countries had to go to the IMF, the ‘lender of last resort’, as the usual government and private commercial lender options are constrained by the economic fallout of COVID-19. It is the only lender that has cancelled any actual debt.

Addressing debt and the combined crises of climate change and biodiversity loss can seem overwhelming. But by adopting a system of large-scale debt swaps as part of post-COVID-19 recovery measures, it is possible to help address all three.  

By exchanging an existing debt contract for one that writes off debt or reduces its original value by, for example, having repayments made in the debtor country’s currency or charging lower interest rates, a developing country’s overall external debt could be reduced.

Seychelles leads the way

The money saved would be used to invest in poverty-reducing programmes and initiatives including climate-smart agriculture, renewable energy and afforestation, stimulating growth and so reducing the need for future debt.   

To date, debt swaps have been limited to a few small-scale projects, such as in the Seychelles, in which the money was managed in trust funds by international NGOs. But by creditors channelling money direct to developing country governments’ budgets, debt swaps can be large-scale.

This would link them to specific debtor government policies on tackling climate change, biodiversity loss and poverty, making them more cost effective and better at addressing the needs of the most vulnerable women, children and men living in poverty while helping to build resilience to these crises.

Increasing accountability

By having the money channelled through debtor governments’ financial systems, it increases accountability to their citizens and means they have an interest in ensuring the environmental programmes are effective.  
 
Large-scale debt swaps for climate and nature will benefit public and private lenders as debt will be invested productively to increase sustainable economic growth and so reduce the need for further debt write-offs. For public creditors, they provide a new source of money for addressing these problems.

This particularly applies to China, the largest bilateral holder of debt, which will host the UN Convention on Biological Diversity (CBD COP15) in 2021, and help meet one of the conference’s key objectives of increasing biodiversity financing. The system will also help private creditors meet their commitments to shareholders and the wider public to improve their environmental standards and action.  

By adopting large-scale debt swaps for climate and nature, governments and powerful finance institutions meeting this week can help repair markets and address the triple crises of debt, climate change and the destruction of nature.

This blog was originally posted on the Thomson Reuters Foundation News website.

About the author

Paul Steele (paul.steele@iied.org) is chief economist at IIED

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