A climate-smart sovereign debt workout mechanism to restructure US$812bn worth of debt in the global south could put the region on a path to meeting climate goals. This report by researchers at Boston University lays out how such a mechanism would work.
The framework, devised by the Debt Relief for a Green and Inclusive Recovery project (DRGR), engages all creditor classes, links relief to climate outcomes, and aims to prevent a looming debt crisis placing climate goals “out of reach” for debt-distressed countries.
External debt levels for emerging and developing economies more than doubled since 2008, from US$1.3tn to $3.6tn by 2021. As higher climate vulnerability correlates with a lower sovereign borrowing space, climate vulnerable countries are often among the most exposed to unsustainable debt, says the report.
In 2023 alone, emerging and developing economies will pay US$385bn in debt service payments, substantially constricting the fiscal space needed to take on new climate financing.
The DRGR’s proposed framework consists of three pillars: significant debt reductions by public creditors, debt reductions by private and commercial lenders, and credit enhancements for countries that lack fiscal space to fund climate action.
Through a “modern day version of the Brady Plan” and the Heavily Indebted Poor Countries (HIPC) initiatives, public and private creditors would swap old debt for newly issued “green and inclusive” Brady-like bonds at substantial haircut levels. Drawing on historical precedents for the size of relief needed, the authors estimate that public and private creditors will have to grant haircuts between US$317 and $520bn.
A World Bank guarantee facility between US$37bn and $62bn is then recommended to provide credit enhancements for new “green and inclusive recovery” Brady bonds, and a partial guarantee of the principal (80%) plus 18 months of interest payments.
The authors – Luma Ramos, Rebecca Ray, Rishikesh Ram Bhandary, Kevin Gallgher and William Kring – propose that the guarantee facility could be financed through unused special drawing rights or through the World Bank’s existing balance sheet.
Meanwhile, the authors argue, at least US$30bn in debt will need to be immediately suspended over the next five years to allow countries to reach the level of fiscal outlays emerging economies had before the Covid-19 pandemic.
Delaying full repayments until debt restructuring is agreed will also encourage reluctant creditors to come to the negotiating table and direct the strongest incentives towards creditors receiving near-term repayments, say the authors. These repayments tend to be higher interest with shorter maturities.
The authors recommend linking the outcomes of restructuring to national climate and development goals. For instance, they say that bond payments could be explicitly tied to the achievement of key sustainability performance indicators.
This page was last updated December 11, 2023
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