Debt-for-climate swaps: not a silver bullet

There is a growing recognition that the debt and climate crises are intimately linked and fuelling one another. So wouldn’t it be great if we could address both issues at once?

One initiative that aims to do just that is debt-for-climate swaps – an idea that is gaining popularity amongst a diverse range of actors including global South governments, academics, and international financial institutions like the World Bank and IMF.

Debt-for-climate swaps can take multiple forms, but most simply, a government will have some of its external debt cancelled in exchange for committing an equivalent or lesser amount to climate adaptation or mitigation – both significantly underfunded areas.

This has been pitched as a ‘win-win’ scenario – on the one hand, global South governments can reduce down their debts, and on the other, they can free up resources to invest in climate goals.

When put like this, it is hard to imagine why governments would not want to participate in a debt-for-climate swap. Especially in the case of climate-vulnerable countries, such as many Caribbean islands, who face crippling debts but get little if any benefit from the G20 debt relief schemes, and have less access to grants and low-interest loans because of their income status. In fact, some global South governments are already participating in climate-for-debt swaps, such as Antigua and Barbuda, Jamaica, and Grenada.

If well-designed, debt-for-climate swaps could provide some benefit to participating countries. However, debt swaps have been around since the 1980s and past experience highlights challenges and risks that need to be carefully mitigated.

Challenges in reducing debt levels

For debt-for-climate swaps to meaningfully reduce debt levels, two things must happen together. First, a significant proportion of a country’s debt needs to be included in the swap, and second, there must be a significant amount of debt cancellation included ( not all the freed-up resources are invested in climate or other commitments).

However, to date, this has not been the case. For example, in 2007, Indonesia signed a debt-for-health swap agreement with Germany which cancelled $50 million of bilateral debt in return for the Indonesian government investing $25 million towards health, leaving the government with $25 million to invest elsewhere. The amount included in the swap was very small in comparison to Indonesia’s total external debt (0.2%) which stood at $133 billion at the time, thus having an insignificant impact on the country’s debt levels.

Researchers have also found that collectively, debt swaps have not meaningfully impacted on debt sustainability, highlighting how across a 30-year period, only $6 billion of debt was reduced via debt swaps for all participating governments. This number is tiny when you consider that developing countries spent $372 billion on debt repayments in 2020 alone.

Challenges in freeing up national resources

Even if a debt swap does not make a useful contribution to debt sustainability, could countries still benefit by freeing up resources for underfunded areas at a national level, like climate or health?

Ecuador, for example, only reduced its external debt of $8.3 billion by $1 million but doubled the amount of money it had available for parks and reserves.

However, it is not always this simple. If the participating government did not have the resources to pay the original loan in the first place, it is unlikely that they will have the resources to invest in areas agreed in the debt swap. This could potentially lead to increased budget deficits which may need to be covered by loans, thereby adding to debt burdens, or by diverting resources through austerity measures in other areas.

Conditionality and lack of democratic participation

Alongside the challenges of making a debt swap useful outlined above, they present several risks to participating governments that must be carefully managed.

Debt swaps inherently open the door to conditionality as lenders have much more control over where freed up resources are allocated than if the debt was just cancelled outright. As such, debt swaps provide yet another way for powerful lenders to exert their own interests in countries in the global South, often at odds with the needs of the population. This also poses a challenge to citizen participation in debt swaps, which to date has been underwhelming. For example, researchers previously found that out of 128 debt swaps, only 29 had some form of civil society representation.

One specific way lenders can exert their own interests through debt swaps is through tied aid, where the lenders stipulate that freed up resources must be spent on products or services in their own countries. For example, a debt swap between Spain and Cuba aimed to reduce some of Cuba’s debt to free up resources for infrastructure investment. The swap, however, was conditional on Cuba purchasing products and services from Spanish companies, generating profit for them rather than spending the money in Cuba, or getting the best value deal from around the world.

Additionality

Critically, debt swaps do not generate new funds for the global South from the global North - rather, they free up the resources of a global South government that are then directed towards agreed investments.

It is therefore problematic that the resources mobilised through debt swaps can be counted towards climate finance, aid or other financing targets which represent financial flows from the global North to the global South. There is also a risk of these commitments being double-counted, for example, in the case of concessional lending where the part of the loan to be included in the swap may have already been counted towards aid targets when it was first agreed.

This is a particularly sensitive issue in the context of global North governments’ failures to meet their promises on climate finance. Any resources mobilised by debt-for-climate swaps must be considered separate and additional to climate finance targets to prevent rich countries from being let off the hook for the amount they have committed to provide, and owe, climate-vulnerable countries.

Slow and cumbersome

Debt swaps can be burdensome to arrange. For example, they can be complex and lengthy to negotiate, sometimes taking several years to reach an agreement. Because of this, simply coming to an agreement can take up a lot of resources and require specialist skills which can be expensive. Debt swaps are not likely to offer the urgent solutions to the climate and debt crises that we need.

Legitimising illegitimate debt

Illegitimate debt refers to debt taken on by governments that do not benefit the population. This can include loans given to undemocratic regimes who use the funds to oppress the population (such as using the loans to purchase weapons which are then used against citizens) or enrich themselves.

A key demand of the global debt movement is to cancel illegitimate debt - it is unfair for populations to have to repay loans that they did not benefit from. As such, illegitimate debt must not be included in debt swaps as this risks legitimising the debt and undermining wider calls for it to be outright cancelled.

Climate-for-debt swaps must be carefully designed if they are to positively impact on debt levels and free up resources to address the climate emergency. It is clear from the history of debt swaps this has not always been the case: the majority of swaps have failed to deliver on either goal.

Based on this, and on the risks that debt swaps pose for global South governments, it is unlikely that climate-for-debt swaps will provide an adequate solution to either the climate emergency or unsustainable debt on their own. There is a risk that the growing focus on climate-for-debt swaps can reduce pressure on global North governments to address the scale of the debt crisis.

Instead, our attention and action must remain firmly planted on what is really needed to address the debt and climate crises – debt cancellation and adequate, grant-based climate finance.