Sri Lanka, also known as the Pearl of the Indian Ocean, is in the midst of an economic and political crisis fuelled by high fiscal debt. The interest payments on its debt ranges between 70 – 100% of the country’s revenues.
Now, the island nation is reportedly looking to strike a debt-for-nature swap of up to USD 1 billion to help it deal with the problem. A debt-for-nature swap is a financial arrangement between the government of developing country in financial distress and a creditor (bank, financial consortium etc.) that buys a part of its debt at a discount.
These swaps help the country reduce or cancel its existing debt in exchange for commitments and measurable results towards the conservation of nature. A debt for nature swap varies from country to country and creditors have specific clauses regarding delays and release of funds in case the debtor nation is unable to fulfill its commitment.
Sri Lanka is not alone. According to reports, Ecuador, Cape Verde, Pakistan, Kenya, Ghana and several other African Nations are also seeking a similar solution to help them tide over their fiscal crises.
“In times of financial crisis, countries need solutions with many pockets of strength. Debt-for-nature swaps are a great solution as they address debt reduction, conservation, and policy,” explains Kevin Bender, Director of Greening Sovereign Debt, The Nature Conservancy (TNC).
Innovative financing mechanisms and collaborations like the blue bonds of Seychelles and Belize bring together different stakeholders including the government and the private sector. It's these kinds of innovative financing mechanisms that are starting to turn the tide.
Nature to the rescue
It is estimated that more than 50 developing countries (that are most vulnerable to climate change) need to collectively service debt of more than USD 500 billion in the next four years. Climate swaps offer them the chance to deal with these dual problems effectively.
According to experts, fiscal risks and climate vulnerabilities particularly in the case of smaller nations are correlated. A recent working paper of the International Monetary Fund (IMF) explains that climate change exacerbates debt vulnerabilities and debt problems reduce fiscal space for climate mitigation.
The paper points out that debt-for-nature swaps are most useful when lack of fiscal space is the main constraint to climate investment. Apart from fiscal relief, these swaps can also help countries generate additional revenues by valuing and charging for protecting and preserving their biodiversity, carbon sinks, or carbon dioxide absorbing natural environments that are required for transitioning to a low carbon economy.
Belize, home to one of the world’s largest coral reefs, is a good example of this. The country’s debt-for-nature swap enabled its government to repurchase its USD 553 million ‘Super Bond, which was refinanced multiple times, at a 45% discount.
This transaction provided Belize an immediate relief in principal repayment of USD 190 million, USD 23.5 million to seed an endowment fund and additional cash of USD 4.2 million per year as conservation finance.
On its part, Belize committed to achieving marine conservation targets including placing 30% of its ocean under protection by 2026 and using a part of the financing savings to fund conservation over 20 years.
“If they do not achieve milestones on time, they can request the year grace period and then incur additional payments of roughly USD 1.5 million per year. That money does not go to bond holders or anyone, it simply goes into an escrow account,” says Bender, who was instrumental in shaping this deal.
“Once Belize achieves the milestone it goes back to the government ‘on the budget’. In the event they never achieve it, that money will just accrue in the escrow account and when the bond matures in 19 years, that money will go to the conservation endowment.”
Belize has been the trailblazer for a new version of debt-for-nature swaps that evolved from original bilateral debt-for-nature swaps from the late 1980s. Early examples of bilateral swaps include the swap between Netherlands and Costa Rica in 1989 and Bolivia’s tripartite swap of 1987. IMF’s paper reveals that climate swaps have remained niche instruments because of high transaction and monitoring costs and commitment problems from debtor nations. But that is slowly changing.
“Innovative financing mechanisms and collaborations like the blue bonds of Seychelles and Belize bring together different stakeholders including the government and the private sector,” says Martin Koehring, former head of the World Ocean Initiative at Economist Impact.
“It's these kinds of innovative financing mechanisms that are starting to turn the tide.”
In times of financial crisis, countries need solutions with many pockets of strength. Debt-for-nature swaps are a great solution as they address debt reduction, conservation, and policy.
Until now, there have been around 140 debt-for-nature agreements around the world with a combined value of around USD 3.7 billion (EUR 3.5 billion). That’s a tiny number when compared with the United Nation’s estimate of USD 160 – USD 340 billion needed annually by developing countries to adapt to climate change by 2030.
“Asset managers and insurance companies would all love to save the world, but that's not what they're paid for. They're paid to maximise their return at acceptable risk. What we need is public participation in conservation and climate financing efforts that allows the private sector to come in and do more. That's exactly what we're doing with blended finance,” says Bender.
“We've established the proof of concept; this is not a theoretical thing. I think it’s highly scalable, and we're seeing a lot of interest growing day by day.”
That’s timely because climate adaptation finance has been a much talked about issue at the recent COP27 meet held in Sharm el-Sheikh, Egypt. With an estimated 3.5 billion people living in countries that are highly vulnerable to climate impact, there is no doubt that the time to act is now.
The recently signed UN biodiversity agreement has set a target of effective conservation and management of at least 30% of the world’s lands, inland waters, coastal areas and oceans and restoration of at least 30% of degraded terrestrial, inland waters, and coastal and marine ecosystems.
“If we just look at the UN Sustainable Development Goals (SDGs), we know that most of them are clearly underinvested in, particularly the one that focuses on the ocean and life below water (SDG 14: life below water). It has consistently attracted the least attention from investors, and that's really undermining ocean health,” says Koehring.
“But it also means that policymakers and investors have not even started to harness the full potential of the ocean economy. There are enormous opportunities for impact investors, social enterprises, accelerators, venture capital and private equity funds,” he adds.
It is estimated that the world needs to mobilise at least USD 200 billion per year in biodiversity-related funding from all public and private sources. Not only that, international financial flows from developed to developing countries, need to touch at least USD 20 billion per year by 2025, and to USD 30 billion per year by 2030.
Debt-for-nature swaps could be crucial instruments in achieving these ambitious targets. Belize stands as proof of that.