Sri Lanka becomes latest country to consider debt-for-nature swaps

Sri Lanka is open to a debt-for-nature swap (DNS) programme as it works to restructure its US$7.1bn debt, and is the latest developing country to look at alternative financing solutions to tackle its economic and climate woes.

“If creditors say that they would like to have those instruments, that it can be done within the timeline and do it fast, we are open,” Sri Lanka central bank governor Nandalal Weerasinghe told Reuters on 11 April.

Sri Lanka has been in talks to restructure its debt for months in the midst of the worst economic crisis since its independence in 1948. The country defaulted on its loans in April 2022, with inflation skyrocketing to 69% at its highest point, triggering social unrest and political turmoil.

Sri Lanka “is suffering acutely from a triple crisis of debt default, high and rising exposure to climate shocks, and threats to critical nature capital”, said Arend Kulenkampff, director of the sustainability-linked sovereign debt hub at public policy firm NatureFinance.

“A DNS transaction, especially one that embeds ambitious sustainability targets and follows best practices for linking outcomes to reliable and relevant key performance indicators, would help to address these three challenges”, he added.

What is a debt-for-nature swap?

As developing countries like Sri Lanka face ongoing economic crises, some climate advocates argue that debt-for-nature swaps could be one solution to help those countries restructure their debt while addressing climate issues and helping contribute to net-zero initiatives.

Debt-for-nature swaps are a sovereign debt restructuring tool that has been around since the 1980s, when NGO Conservation International swapped $650,000 worth of Bolivia’s foreign debt for conservation payments-in-kind, involving a tropical forest conservation program.

These deals allow countries to erase their debt in exchange for nature and climate conservation programmes, such as decarbonising the economy, protecting forests or reefs, or investing in climate-resilient infrastructure.

A handful of countries have used debt-for-nature swaps to restructure their debt and free up cash flow for conservation efforts. The Seychelles, for example, created a blue deal in 2015 to wipe off nearly US$22mn of its debt in exchange for doing more to protect its oceans. Cape Verde entered a debt-for-nature swap deal with Portugal in January, while Ecuador entered a debt buyback plan in April to protect the Galapagos Islands.

Ensuring long-term sustainability

One of the biggest criticisms of debt-for-nature swaps is that the funds do not always go where the need is the greatest. To make sure that funds go towards sustainable projects, it’s important that they are “vetted by lenders and other second-opinion providers” with standardised KPIs and “internationally accepted best practices for measurement, reporting, and verification”, said  Kulenkampff.

“With many sovereign bonds trading in distressed territory on rising global interest rates and heightened perceptions of sovereign risk, the opportunities for meaningful discounts have grown, while the growing awareness by the development community on the need for credit enhancement should ensure that DNS transactions can be executed on favorable terms,” he said.

While DNS is “not a silver bullet”, if they are helping contribute to a country’s efforts towards the Paris Agreement then they “can be an effective way to help combat climate change”, said Maud Abdelli, who leads the Greening Financial Regulation initiative at WWF.

“Mitigating and adapting to climate change needs a radical transformation of the global economy, that will in turn require financing, not only of the activities that can help lowering emissions but also supporting the transition for others”, she added.