New approach to debt could raise over US$400 billion for climate and nature projects in developing countries

Relieving developing countries of their debt could help to make around US$105 billion of government finance available to tackle climate change and nature loss. A further $329bn could be raised through new debt issuances linked to climate and nature in countries that are in stronger fiscal positions, according to new analysis from IIED.

The analysis published in 'Averting the crises: how a new approach to debt could raise US$400 billion for climate and nature' identified 58 countries in or at high risk of debt distress that could be supported through a climate- and nature-linked debt initiative.

Estimating their debt levels and the percentage that could be channelled towards climate and nature projects, researchers concluded that $105bn could be freed up for projects tackling climate change and nature loss through immediate debt relief. That would dwarf the $17bn of climate finance pledged in the form of grants in 2019. 

Seventy-seven per cent of this debt would be relieved in countries in sub-Saharan Africa that currently hold debts of $345.5bn.
 
The analysis identified a further set of countries who could issue climate- and nature-linked debt instruments, for example sustainability linked bonds (SLBs), and could raise upwards of $329bn for climate and nature through these instruments.

The least developed countries (LDCs) could benefit hugely from these twin approaches. The analysis showed that 29 of them could reduce debts of $244bn by $195bn, freeing up approximately $51bn for climate and nature. The remaining 17 countries in the group could raise $172.2bn in new debt issuances, of which $45.3bn could be directed towards climate and nature.

The G20 has been pivotal in addressing previous debt crises and as its finance ministers meet this weekend, addressing the triple challenges of debt, climate and nature should be one of the key items on their agenda. 

Sejal Patel, a researcher at IIED and author of the paper said: “Past experience shows that it is possible to direct savings from debt relief towards poverty reduction projects. With millions of people in the most indebted countries already suffering flooding, wildfires and scorching heat, a scheme addressing sovereign debt, alongside the climate crisis and biodiversity loss would bring three times the benefits.

“Well-designed climate and nature programmes would strengthen the economic resilience of those countries and therefore their future debt carrying capacity.”

In the aftermath of the COVID-19 pandemic and with war in Ukraine pushing up energy and food prices, debt is spiralling for many developing countries. Sri Lanka defaulted on its debt for the first time this year and protests over the government’s handling of the economy have at times turned violent.

Across low-income and emerging market economies, government debt rose by nine percentage points to 63% of GDP in 2020, the fastest one-year increase in the past 30 years.

At the same time, many of the most indebted countries are also those on the frontlines of the climate crisis. Recent IIED research found that five of the top 10 countries most affected by climate change-related disasters in 2019 were either already in debt distress or at high risk of becoming so. 

A climate- and nature-linked debt initiative would provide much needed support to these countries. There is an existing gap in the international financial architecture after the G20’s Debt Service Suspension Initiative (DSSI) finished in December 2021.

Only three countries applied to the Common Framework for Debt Treatments beyond DSSI to have their debt restructured. Given the impact of the pandemic, countries need a broad debt restructuring facility that will address the structural issues building up due to external shocks and that will make these economies more resilient. 

The International Monetary Fund's recently established Resilience and Sustainability Trust is useful for addressing medium and long-term debt sustainability but it is not designed for managing short-term debt crises.