Can debt relief help countries achieve climate goals?

In the course of the coronavirus pandemic, critically indebted countries have to take additional loans. Experts now call for fast and comprehensive debt relief. Not all of them work for civil-society organisations. The World Bank and the International Monetary Fund basically agree.

At the same time, the climate crisis requires responses. Debt swaps therefore look attractive. A debtor and creditor agree that outstanding loans will be forgiven if the freed-up money is used for climate action. Since the early 1992, debt swaps with social or ecological dimensions have figured in international development affaires.   

The so-called German Debt Swap Facility is an instrument the Federal Government can use. The Facility makes it possible to waive up to an annual € 150 million in repayments provided that recipient countries commit to appropriate policies. In recent years, the German government has not even come close to exhausting these funds. It therefore could considerably increase climate financing for countries in the global south.

Limited impact of debt swaps

However, the impact of debt swaps is limited. To judge by past experience, debt swaps are generally too small, too slow and their fiscal balance too unclear for resolving a debt crisis or mobilising meaningful sums for climate protection. If a debtor country is still able to service its debts on time, only creditors with an explicit development mandate can be expected to agree to debt swaps moreover. These creditors are mostly state agencies of western countries. However, they only hold a relatively small share of low- and middle-income countries’ debt. Swapping those debts would thus only mobilise relatively modest funding for climate mitigation or adaptation. If, on the other hand, a sovereign state is unable to service its debt and facing default, it needs debt relief, not a swap.

It would often make sense to combine swaps with debt relief, and both debtor countries and international experts have spoken out in favour of this approach. A relevant part of a country’s debt would thus be forgiven, and another part would be swapped for climate commitments.

Environmental conditions for debt relief

Other suggestions focus on setting another kind of conditions for debt relief. In contrast to classic debt swaps, the idea is not to invest freed-up money in climate action immediately, but to make debtor countries adopt responsible climate policies in the long run. In exchange for debt relief, for example, debtor countries might thus commit to ending the extraction of fossil fuels and building renewables infrastructure long term.

Given the enormous climate challenges humanity is facing, this approach looks plausible at first glance. However, it is important to stem neo-colonialist tendencies. Debtor countries should not be forced to expand renewables only so that western nations can satisfy their hunger for energy. Moreover, hydropower dams or similar large-scale projects must not have detrimental impacts on local communities.   

When and if conditions for debt relief are defined, the impacts on vulnerable people must be taken into account. The circumstances they live in must improve, and no deterioration is acceptable.  

Mandatory participation

Coordination among donors is a particular challenge, both in regard to debt swaps and debt relief. When a private person or a private company default, laws ensure that there are procedures for restructuring outstanding debts. There are no such mechanisms for sovereign defaults however.  

In its coalition agreement, Germany’s new Federal Government has committed to supporting the creation of an international insolvency procedure for sovereign states (see Kathrin Berensmann on www.dandc.eu). It should take advantage of its G7 presidency this year to initiate relevant reforms. That could really make a difference. After all, climate-induced disasters are increasing and they often undermine a nation’s ability to service its debt. 

Related literature

Kaiser, J., 2022: Gestern Schulden, heute Entwicklungsfinanzierung. Sind Schuldenumwandlungen ein Weg aus der Krise? (In German only) In: erlassjahr.de, Misereor (Hrsg): Schuldenreport 2022.
https://erlassjahr.de/wordpress/wp-content/uploads/2022/01/SR22-online-Artikel-5-Gestern-Schulden-heute-Entwicklungsfinanzierung.pdf

Kaiser, J., 2020: Wenn der Klimawandel zur Schuldenfalle wird. Mit Schuldenerlass Schäden und Verluste bewältigen. (In German only) In: erlassjahr.de, Misereor (Hrsg): Schuldenreport 2020.
https://erlassjahr.de/wordpress/wp-content/uploads/2020/01/SR20-online-.pdf

Volz, U., et al., 2020: Debt relief for a green and inclusive recovery. A proposal
https://drgr.org/files/2021/01/DRGR-report.pdf

Malina Stutz is a political consultant at erlassjahr.de.
m.stutz@erlassjahr.de