Debt for climate swaps offers a potential solution for PSIDS that are at high risk of debt distress which is directly related to their high vulnerability to climate change

The Pacific Small Island Developing States (PSIDS) are among the most vulnerable countries in the world to the impacts of climate change. The World Risk Index 2021 ranks several Pacific Island countries among the most at-risk countries, with Vanuatu, Solomon Islands and Tonga ranking first, second and third, respectively, and Papua New Guinea, Fiji and Kiribati ranking among the top-20. Although each country is affected by climate change differently, common risks include rising sea levels, stronger and more frequent tropical storms, soil erosion, food and water security, and damage to infrastructure.

Addressing the challenges of climate change in the Pacific SIDS will require a substantial mobilization of investments, especially to enhance resilience to climate-related natural disasters. However, such mobilisation faces major obstacles because of the region’s large public debt burdens, which further increased because of the COVID-19 pandemic.

According to the debt sustainability analyses (DSA) of the IMF and the World Bank, the majority of the PSIDS – including Kiribati, Marshall Islands, Federated States of Micronesia, Papua New Guinea, Samoa, Tonga, and Tuvalu – are assessed at high risk of debt distress. However, in all these countries except Papua New Guinea, this assessment preceded the pandemic.

The high risk of debt distress of the PSIDS is directly related to their high vulnerability to climate change. A good example is the IMF/World Bank DSA of Samoa of 2018. It points out that “the recovery efforts and reconstruction required after the 2009 tsunami and 2012 Cyclone Evan were largely financed by borrowing, pushing total public debt close to 58 percent of GDP in FY2014/15—well above the government’s threshold target of 50 percent.”

Therefore, investing in climate adaptation is essential not only to minimise deaths, injuries, losses of livelihoods and destruction of infrastructure caused by climate-related disasters but also to make economies more resilient to the financial consequences of such disasters.

The question is: How can the PSIDS invest substantially in resilience when their high risk of debt distress makes it difficult for them to borrow more to finance such investments? Debt for climate swaps offers a potential solution.

A debt for climate swap is an agreement between a sovereign debtor and one or more of its international creditors by which the latter forgive all or a portion of the debtor’s external debt in exchange for a commitment by the debtor to invest, in domestic currency, in specific climate projects during a commonly agreed period.

Debt for climate swaps have a precedent in the debt for nature swaps first implemented in the context of the global debt crisis of the 1980s. They aimed at both reducing unsustainable external debts and addressing worsening environmental conditions in developing countries caused by the exploitation of natural resources, including deforestation. Debt for nature swaps invested mainly on conservation projects, but their structure is suitable for the financing of climate mitigation and adaptation projects, as well as investments in other areas of sustainable development.

On 16 March 2022, ESCAP organised a workshop on debt for climate swaps in partnership with the Pacific Islands Forum Secretariat (PIFS). The workshop presented the results of a study on debt for climate swaps in the PSIDS prepared by ESCAP, discussed the experience of selected debtor countries that have implemented or are negotiating a debt for climate swap deal, and considered views on this instrument from the Pacific and China, a major bilateral creditor of the PSIDS.

An important point made at the workshop is that debt for climate swaps are not the same as debt forgiveness, in which only one party – the debtor – gains. They are, instead, mutually beneficial agreements through which both the debtor and its creditors gain.

Debtors benefit by reducing their debt burden and opening fiscal space for dedicated investments in climate projects. They also benefit by reducing pressures on the exchange rate, as their new obligations to invest in climate projects are in domestic currency.

With regards to creditors, private bondholders can benefit from a buyback agreement at a price that exceed the market price, while bilateral official creditors that are Annex II parties to the United Nations Framework Convention on Climate Change can make their funding of debt for climate count as part of the developed countries’ commitment to provide US$100 billion per year in climate finance to developing countries.

The workshop also highlighted the flexibility of debt for climate swaps as innovative financing mechanisms with regards to sources of funding. These included grants from philanthropical organisations in the Seychelles debt for climate swap of 2015 and issuance of a blue bond backed by political risk insurance by the U.S International Development Finance Corporation (DFC) in the Belize debt for climate swap of 2021.

The workshop was a pre-event of the ministerial-level Pacific Regional Debt Conference co-convened by Fiji and Tuvalu and co-organised by ESCAP and PIFS. The conference will take place virtually on 05-08 April 2022.

This feature was written by Alberto Isgut (Acting Chief, Financing for Development Section) and Exsley J. Taloiburi (Climate Change Finance Advisor and Team Leader for Climate Change and Resilience, Pacific Islands Forum Secretariat). originally published at UNESCAP on 25 March 2022, reposted via PACNEWS.