Grafik Kommentar der Anderen: Debt Sustainability
Outside view by Carolyn Neunuebel (l.) and Natalia Alayza

Developing countries face an intertwined challenge of escalating debt and the urgent need for climate action. In the aftermath of the COVID-19 pandemic, governments are grappling with squeezed budgets and the risk of defaulting on loans amidst tightening global conditions and intensifying climate impacts. While debt is not inherently negative, its implications are increasingly hindering investments in economic development, social protection, and climate resilience for the world’s most vulnerable populations. Addressing the growing problem of debt distress in developing nations is a fundamental element to climate justice. The 34 poorest countries in the world spend 5 times more on external debt payments than on climate action. Constrained budgets limit nations‘ capacity to address the mounting impacts of climate change, leading to a detrimental cycle known as the climate debt trap.

The climate debt trap is comprised of complex and compounding dynamics between sovereign debt and climate change.

Sovereign debt, borrowed from various creditors, is crucial for confronting hardships and investing in public goods. However, debt can turn sour when governments struggle with debt servicing, exacerbated by factors such as high-interest rates, short repayment periods, and multiple crises like a pandemic coupled with natural disasters. Debt servicing costs can surpass a government’s capacity to pay especially when borrowing is in foreign currency and exchange rates fluctuate. Developing nations face higher interest rates in stark contrast to wealthier counterparts like the United States, which can issue external debt in its local currency and is deemed to have lower real and perceived risks by investors.

Countries‘ vulnerability to climate change amplifies borrowing rates, requiring additional finance to address the escalating climate-related risks and damages. The Vulnerable 20 (V20), a group of countries particularly at risk of climate-related impacts, has seen a $62 billion increase in the cost of debt over the previous decade. This climate premium is expected to more than double in the next 10 years. In other words, for every $10 paid in interest by developing countries, an additional dollar will be spent due to climate vulnerability.

Developing countries have identified a mix of debt management and fiscal and trade policy levers to address or prevent the climate debt trap.

Many governments in developing countries already treat climate action as an intrinsic element of sound economic policy and aim to increase resources through a virtuous cycle of green growth. They are increasingly adding tailored debt instruments to their toolkit, such as debt for climate or nature swaps (e.g. Belize), blue bonds (Fiji), green bonds (Peru), sustainability-linked bonds, and debt suspension clauses (also known as pause or climate-resilient) the entirety of their debt issues, they can help sovereigns transcend the climate debt trap when undertaken as part of a broader set of solutions catering to their political and economic circumstances.

Developing countries are also urging for reforms that better support debt sustainability and address the debt-climate nexus.

Official creditors (i.e., governments) which provide finance to other governments in the form of sovereign debt tend to adhere to international frameworks to provide a coordinated and collaborative approach to debt relief and sustainable debt management in countries that need it. Many official creditors, including the G20, endorsed the Debt Service Suspension Initiative (DSSI), which suspended debt service payments from eligible countries during the COVID-19 pandemic. The DSSI was replaced by the Common Framework for Debt Treatments in 2021.

Negotiations under the G20’s Common Framework for Debt Treatments in low-income countries have been lengthy and challenging so far, adding to the complexity of financial, political, and reputational costs that governments must weigh before deciding whether to pursue debt restructuring or relief. Both the Bridgetown Initiative and V20 Accra-Marrakech Agenda (initiatives led by developing countries) advocate for enhancing the G20’s Common Framework alongside increasing global liquidity to address economic shocks and unlocking additional resources for climate investments in developing countries.

Sustainable sovereign debt is vital to a prosperous world that benefits everyone.

Attracting additional finance to address developing countries’ climate needs is one part of the picture. Crucially, there is a need to diversify financial instruments to avoid exacerbating developing countries’ debt burden and to facilitate a just transition as countries strive to fulfill their climate commitments.

Multi-party discussions which deliver timely debt restructuring or relief is central to ensure liquidity for climate action, especially in the aftermath of extreme events. Creditor countries can spearhead comprehensive debt restructuring processes with multilateral lenders and private creditors and implement debt relief mechanisms to address long-term debt sustainability challenges in distressed countries.

For global climate justice, multilateral solutions should focus on reducing debt costs, creating fiscal space for climate responses, ensuring long-term debt sustainability, and fostering a virtuous cycle of green growth in developing countries.

About the authors

Carolyn Neunuebel is a Research Associate at the World Resources Institute where she focuses on the role of international financial institutions and development finance institutions in supporting an ambitious and equitable shift toward activities that align with climate and biodiversity goals. Prior to joining WRI, Carolyn was a Policy Analyst at the Organisation for Economic Co-operation and Development (OECD) where she supported governments in integrating environmental objectives into development finance. She has also conducted research on climate resilience at Oxfam Ireland, natural resource governance at Research on Poverty Alleviation (REPOA) in Tanzania, and supervisory policy and risk analysis at the Federal Reserve Bank of St. Louis.

Natalia Alayza is a Manager at the World Resources Institute where she focuses on how climate finance, at a national and international level, is addressed and can be improved to ensure countries and stakeholders can contribute to meet their climate targets. She has more than 10 years of experience developing and assessing public policies and projects related to environment and climate change.   Prior to joining WRI, she oversaw the environmental affairs at Peru’s Ministry of Economy and Finance. She holds a master’s degree from Stanford University and a bachelor’s degree from Pontificia Universidad Católica del Perú (PUCP).

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