Supporting climate action and recovery through debt relief
Informed Responses. Recovery for All.
Many countries in the Global South are facing an unprecedented combination of crises that requires innovative responses and global collaboration. The members of the Vulnerable Twenty Group (V20) representing 48 climate-vulnerable countries described their situation as a “reinforcing vicious circle” of impacts from debt, the pandemic and climate change. The continued health crisis, exacerbated by inequalities in vaccine access, has led to many economic setbacks and deepened public debt in low-income countries. At the same time, climate-change impacts such as climate variability and extreme weather events are causing economic losses.
The compounding nature of these crises calls for new mechanisms to alleviate debt, finance climate action and promote inclusive recovery in low-income countries. With IDRC support, the International Institute of Environment and Development (IIED) and the UN Economic Commission for Africa (UNECA) identified ways to address the overlapping crises of debt, climate and inequalities. The solutions were presented at the recent global climate-change conference, COP26, encouraging Finance Ministers from climate-vulnerable countries to explore debt-for-climate swaps as an essential element of mobilizing much-needed climate finance.
Managing growing public debt without crippling the future
Most low-income economies are now experiencing high levels of debt distress. The African Development Bank indicated that the average debt-to-GDP ratio in Africa is expected to increase to more than 70%, up from 60% in 2019 and 30% in 2014. In low-income countries, these levels of public debt can impact economies severely, making it more difficult to access capital markets needed to finance investments in recovery.
In its State and Trends in Adaptation Report 2021, the Global Center on Adaptation indicates that most African countries could lose 2-4% of gross domestic product per year due to climate change by 2040. The risks associated with climate change are now factored into the higher cost of financing. “This means that for every ten dollars that climate vulnerable developing countries spend on interest payments, they have to pay another dollar because they are climate vulnerable,” explains the V20 statement, adding that this cost is likely to increase further.
How debt is managed matters not only for economic recovery but can have severe impacts on people’s well-being. Debt service and efforts to reduce overall debt and fiscal deficits can lead to even less investment in primary health and education or the withdrawal of support measures for vulnerable populations during the pandemic lockdowns and economic slowdowns. In analysis accompanying the work of IIED-UNECA, Jayati Ghosh concludes that reducing public finance deficits often impacts women negatively: they suffer most from cuts in the service and care sectors, from new taxation that includes essential goods and from interest-rate rises that disproportionally impact small firms where they tend to work.
Growing public debt will also limit low-income countries’ ability to invest in climate action. While having contributed little of the CO2 and other greenhouse gases in the atmosphere, these countries need to invest significantly in climate action to adapt to existing and looming impacts and transition to a low-carbon economy to avoid contributing to future global warming. A key question, therefore, is how to manage debt reduction while investing in climate priorities.
Supporting climate action while reducing debt
There have been significant international initiatives to help address the growing debt crisis such as the G20’s Debt Service Suspension Initiative, established in May 2020 to help low-income countries by temporarily halting the repayment of debt. Although welcome, these measures are still insufficient given the scale of the problem.
As highlighted in an earlier IIED paper by Stephany Griffith-Jones and Marco Carreras, addressing public debt in the past has taken a very long time. Debt relief is also more challenging now as the group of lenders has become much more diverse, with a larger role played by China and private-sector lenders, in addition to the traditional group of emerging-economy and developed-country creditors known as the Paris Club.
The V20, along with other voices at COP26, called for an official mechanism to support an ambitious debt-for-climate-action swap. There has been growing interest in debt-for-climate and nature swaps, in which a creditor allows the debt to be reduced, with the money saved committed to poverty-reducing climate initiatives. For example, a swap in the Seychelles led to a USD27 million (approximately CAD34 million) investment in fishery management, biodiversity conservation and ecotourism.
Specific actions to scale this type of debt relief are described in the IIED and UNECA paper. The authors highlight the importance of ensuring climate priorities become central to policymaking, particularly national budgets, including through the use of performance indicators built into government systems. It is critical for the countries receiving debt relief to own the commitments rather than seeing them as conditions imposed by global institutions. Equally important is transparency to allow citizens’ groups to engage in making investment choices on climate action or inclusive recovery. Finally, there are different options and trade-offs in each country, because the levels and composition of debt vary from one economy to another, as should approaches to debt swaps and other debt-relief measures.
Research to support more sustainable and inclusive societies
As the COVID-19, climate and debt crises continue to undermine global progress toward a sustainable and inclusive world, there is a growing need for evidence on these types of smart solutions to multi-faceted problems. While the overall challenges stemming from this triple crisis are common to many countries, context matters enormously in the development of solutions. Each country faces specific climate challenges and may benefit from pursuing particular climate policy avenues and options to address the debt crises. As the crisis is not abating, unlocking context-specific solutions will be critical.
Under IDRC’s Strategy 2030, we will continue to support the generation of evidence to understand what interventions and policies can contribute to inclusive and green responses to the pandemic and a post-pandemic recovery. As global institutions, including the International Monetary Fund, continue to show commitment to promoting debt relief, IDRC will support researchers, particularly in low-income economies, to contribute to the evidence and policy innovation, ensuring that debt management leads to inclusive and sustainable outcomes.