Debt, inflation and climate crisis: a perfect storm in the global south

September 29, 2022|Written by Daniela Berdeja Ruiz, Rodolfo Bejarano Bernal & Carola Mejia Silva
A man peels back the leaves from a maize cob, revealing that half has been eaten
Food security and crop production in the LAC region are being threatened by climate change © CIAT / Neil Palmer

The climate crisis is real and the latest mitigation report from the Intergovernmental Panel on Climate Change shows that humanity has only until 2025 to tackle it in a timely manner. At the international level, it has been recognised that many countries, mainly from the global north, bear a “historical climate debt”, but extreme climate events are mostly affecting countries in the global south. These countries are the least responsible for generating greenhouse gas emissions and do not have enough resources to invest in climate action nor to recover from these disasters, which represent billions of dollars in losses and damages.

The negative socio-economic impacts of the pandemic and the uneven response provided by governments have also widened the already huge inequities within and between countries. Pre-existing vulnerabilities have been exacerbated, again mainly in global south countries which are also affected by the effects of the ongoing invasion of Ukraine – being the poorest, they are also the most affected. As usual, low and middle-income countries have had to close fiscal gaps with more debt, creating an endless vicious circle which drains their economies.

Based on the experience of the Latin America and the Caribbean (LAC) region and from the perspective of climate and debt justice, it is possible to see how debt, inflation and the climate crisis are interlinked and are increasingly challenging, especially in the global south. It also shows how central banks could have a very important role to promote a just transition.

LAC countries face multiple crises at once

Despite having very limited responsibility for the climate crisis, LAC countries are highly vulnerable, suffering the growing impacts of extreme climate events such as hurricanes, prolonged droughts, floods and glacier retreats. These events put people’s lives, ecosystems, water and food security at risk, and represent billions of dollars in economic losses and damages that, due to the lack of fiscal resources, must be covered with more debt.

A global map showing how countries have contributed to CO2 emissions since 1750

Likewise, international public climate financing is insufficient. The pledge to deliver US$100bn in climate finance to less wealthy nations has not been fulfilled, and in 2020 71% of public climate finance was delivered through loans at the global level, often with high interest rates, which have unfairly increased the debt levels of global south countries. As a result, these countries end up paying for the global north’s historical climate debt.

In 2020, the LAC region’s economy fell by almost 7% due to the pandemic. It recovered in 2021 by 6.3%, but growth of a meager 1.8% is expected this year. This has further aggravated the precarious position of a large part of the population living on a “day by day” basis, lacking adequate jobs and quality basic services provided by the state, a situation in which women, poor families and indigenous communities are most affected. The same is happening in other countries worldwide, especially in Asia and Africa.

The pandemic also set the region back several years in terms of poverty and inequality, leaving an additional 11mn extremely poor people and increasing inequality. The number of billionaires in the region increased and their collective wealth grew by 14% between 2019 and 2021.

During the pandemic, extreme climate events continued to affect LAC countries. For example, in 2020 during the worst stages of the pandemic, hurricanes Eta and Iota devastated many countries in Central America, causing hundreds of deaths and millions in damages, affecting thousands of families and triggering migration.

Regressive tax regimes have led to increased debt

On the fiscal side, LAC is characterised by low levels of tax collection and has one of the most regressive tax regimes. The tax burden is higher on those who earn less, and huge tax evasion and avoidance is huge which ends up benefiting the wealthiest. The low collection levels and efforts to maintain spending in line with urgent needs have pushed many countries to increase their levels of indebtedness.

Public indebtedness of LAC countries, both domestic and external, increased by more than 10% during 2020. By 2021, it reached 53.7% of GDP. Sovereign external debt with private creditors represents the largest proportion, around 69% in 2020 for middle-income countries. Of these creditors, debt is mainly concentrated in bondholders, with 55.5% for the same group of countries. Loans with private creditors have higher interest rates, so the cost of increasing this debt is higher. Moreover, external debt service in the region is highest among emerging and developing economies as a percentage of exports of goods and services.

Two people wade through thick mud covering an urban street
Hurricanes Eta and Iota struck Central America in November 2020 during the height of the Covid-19 pandemic © EU

The debt burden increasingly constrains resources available for states to address multiple crises, and many LAC countries are spending more on debts than on public health care, education, social security, or climate action.

The current geopolitical context reduces even further the possibilities of tackling the climate crises. Russia’s invasion of Ukraine is clearly shifting priorities for many of the most polluting countries, as well as funding recipients as more money goes to the military and fossil fuel industries instead of clean energy. This jeopardies fulfillment of the UN’s sustainable development goals and climate commitments under the Paris Agreement, accelerating the climate crisis to the detriment of the entire global population.

In addition, spillover effects of the war on commodity, energy and food markets have hit countries in the global south hardest. LAC inflation has gone from 3% on average in early 2020 to 8% in April 2022, due to higher prices for food, fuel and fertiliser, threatening food security and increased poverty, in particular because around 80% of fertilisers used in the region are imported.

The need for debt-free climate finance

In response to inflation, central banks in the region and worldwide have increased interest rates which could have recessionary effects in a situation of high unemployment. However, despite tightening monetary policy inflation has not stopped and governments have implemented additional measures. For example, LAC governments are providing subsidies for certain products and direct aid to the most vulnerable.

Additional fiscal interventions by LAC countries create a situation of greater vulnerability for those more dependent on goods experiencing rising prices, as well as those more exposed to debts in foreign currencies. Local currency depreciation increases the burden of external debt even further. The result is a deterioration of the balance of payments, a greater fiscal gap, and the pressure for greater indebtedness, exacerbating the situation of countries already highly indebted, making it more difficult to break the vicious economic circle.

In this complex situation with multiple crises, there is an urgent need to increase non-debt creating climate finance, mainly for adaptation and to cover losses and damages. In addition, liquidity should be generated for countries in the south, for example through debt payment cancellation for low and middle-income countries and pushing private creditors to participate in debt resolution mechanisms.

Central banks of the most advanced economies such as the G7 have a responsibility in this matter. As explained in a report from the Climate and Community Project, central banks and treasuries could introduce regulations to limit private creditors’ ability to pursue debts to the detriment of debtor countries’ ability to invest in climate action.

Another way of generating liquidity without increasing the debt burden is through issuing special drawing rights (SDRs), as in August 2021. SDRs are not loans, they do not have to be repaid. Furthermore, they can be used for fiscal purposes.

In this sense, given that SDRs are allocated to countries through central banks, the latter have a fundamental role to play in ensuring that governments can use them fiscally to deal with multiple crises. They could also align financal regulations and standards with the Paris Agreement goals, helping to promote the energy transition and decarbonisation of their economies.

In order to address the problems facing the LAC region and many other countries, it is essential for central banks to recognise that debt, inflation and the climate crisis are all interconnected, and decisions taken to solve one must address them all. There is also an urgent need to move towards a financial architecture that is transformative and fair with new economic alternatives based on progressive taxation, debt cancellation and climate justice.

These alternatives must recognise the limited contribution made by the global south to the climate crisis, even as their peoples are suffering the most from its effects.

This page was last updated September 29, 2022

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