World leaders and heads of development finance institutions met in Paris last week for a summit hosted by French President Emmanuel Macron that aims to create a new pact between rich and poor countries to ease crippling debt and fund climate action.
Developing nations are struggling to find the finance they need to adapt to worsening climate change impacts and transition to greener economies, partly because they are grappling with high levels of debt exacerbated by the Covid-19 pandemic.
Rising debt burdens and interest rates are weighing down the economies of many low-income nations - which often bear the brunt of climate change - leading to calls for new mechanisms to lighten the load, and reforms to the global financial system.
“There’s a broad coming together around the fact that debt has to be dealt with in a serious way,” said Rachel Kyte, dean of The Fletcher School at Tufts University.
Of 69 countries eligible for concessional finance from the International Monetary Fund’s (IMF) lending arm for low-income nations, 29 are in debt distress or at high risk of it and also highly vulnerable to climate impacts, the United Nations says.
“You can’t take a highly-indebted country and have it grow greener,” Kyte said in an interview. “That lies right at the very heart of this.”
The risk of defaults is on the rise as the world’s poorest nations owed over US$62 billion in annual debt service payments in 2022, a 35 per cent increase from 2021, the World Bank said in December.
Ahead of the summit, IMF chief Kristalina Georgieva told the Guardian newspaper that providing debt relief to countries struggling with extreme weather was an urgent matter.
Beyond debt, the agenda in Paris is broad - ranging from a proposed global levy on shipping emissions to encouraging investment in green infrastructure in developing countries.
Barbados Prime Minister Mia Mottley has spearheaded discussions over development finance, with a reform plan called the “Bridgetown Initiative”.
This includes a US$100 billion plan to drive more climate and development investment using currency guarantees from the IMF and other multilateral development banks (MDBs) - one idea among many to boost funding for developing nations.
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Now that international financial architecture reform is very much on the top political table … I think there’s much more prospect of these kinds of proposals getting through.
Franklin Steves, sustainable finance consultant, E3G
Mottley’s special envoy Avinash Persaud said dealing with debt was going to “play a big role” in developing countries’ response to climate change, citing a World Bank estimate that these nations require US$2.4 trillion annually for the next seven years to address costs from climate change, conflict and pandemics.
“Debt is going to increase, and debt is already very, very high for developing countries,” he told a media briefing last week.
Countries urged to ‘reverse the fatal debt doom loop’
Ahead of the Paris summit, several solutions are being touted to address debt pressures facing developing countries.
Persaud is pushing for climate-resilient debt clauses whereby repayments are suspended for two years in the event of a disaster like a hurricane, which he says would provide Barbados with funds to the tune of 19 per cent of its GDP in liquidity.
Small island developing states, which are especially vulnerable to climate impacts like rising sea levels, spend at least 18 times more on servicing debts than they receive in climate finance, according to a 2022 report by the European Network on Debt and Development, a civil society coalition.
Another favoured tool is debt-for-nature or debt-for-climate swaps, explored by countries including Cape Verde and Zambia, where debt is restructured to allow funds to be freed up for investment in measures like conservation and clean energy.
In 2021, Belize’s US$553 million swap reduced its debt level by more than 10 per cent of its GDP while investing in protection of the world’s second-largest coral reef.
“The money that’s being generated for conservation is money that otherwise would be leaving the country to pay for debt,” said Andrew Deutz, director of policy and finance at The Nature Conservancy, a US-based charity which was heavily involved in the swap agreement.
Deutz said these deals are not a “panacea for debt distress” and are expensive and complex to set up. But they can offer a “partial solution” for countries which could eventually be scaled up with a more standardised process supported by MDBs, he added.
Earlier this month, Ecuador agreed a record US$1.1 billion debt-for-nature deal to protect the Galapagos Islands, which was considered a breakthrough agreement by backers of the mechanism.
Yet some experts are sceptical about such debt relief tools.
“We don’t see any of them as viable, adequate solutions to addressing the debt crisis now,” said Tess Woolfenden, senior policy and research officer at the campaign group Debt Justice.
Debt suspension clauses fail to address the crisis because they are only temporary and do not cancel or restructure debt, Woolfenden said.
She also said debt-for-nature swaps are too small to make a meaningful difference to debt levels or nature goals, calling for debt cancellations and more grant financing instead of loans.
Last week, about 30 economists from the Earth4All initiative signed an open letter criticising the “low level of ambition” of proposals at the Paris summit and urging nations to “stop and reverse the fatal debt doom loop”, including through significant debt reductions.
Measures like the G20 group of economies’ Common Framework - a multilateral platform for debt restructuring - do not include a formal role for private creditors, which are responsible for the majority of developing countries’ sovereign debt.
Establishing a new financial order?
The Paris summit will also discuss the increasing role of MDBs in global climate action, ahead of crucial annual meetings of the World Bank and IMF in Marrakesh, Morocco, in October.
“Many MDBs are becoming climate banks”, said Annalisa Prizzon, principal research fellow at ODI, a global affairs think tank in London.
“You have long-term patient capital at a lower cost than what other sources may offer,” she said, compared to private lenders with higher interest rates and shorter loan periods.
In 2021, the biggest MDBs gave nearly US$51 billion in climate finance to low- and middle-income countries, according to a report by the lenders, but they are under pressure to do more.
The World Bank recently appointed a new president, former Mastercard CEO Ajay Banga, who this month asked the lender’s staff to “double down” on development and climate efforts.
Options available to MDBs include a capital injection from shareholders, lowering capital requirements to boost lending and, for the IMF, allocating emergency reserves to poorer countries for investments in climate adaptation and the energy transition, according to analysts.
“MDBs already work very closely indeed on climate, and there are constant efforts to work even more closely together,” said Danny Alexander, vice president of policy and strategy at the Asian Infrastructure Investment Bank (AIIB).
He said among the AIIB’s ideas is the creation of a joint MDB meeting every four years where debt and other issues can be discussed to improve the response from the MDB system.
Franklin Steves, a sustainable finance expert at the E3G think tank, said developing nations are seeking a greater voice in how MDBs are run, but the “fundamental, underlying problem” is that rich countries like the United States are reluctant to support governance reform.
He said several initiatives are being discussed to address the issue, such as new financing institutions which can fund climate projects with a more equal shareholding structure.
“Now that international financial architecture reform is very much on the top political table … I think there’s much more prospect of these kinds of proposals getting through,” Steves said.
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