What are Debt-for-climate swaps?

• A debt-for-climate swap is a financial agreement in which a nation burdened with substantial debt is given relief from this debt. In return, the country agrees to invest in projects that mitigate or adapt to climate change.
• Such an arrangement allows governments to bolster their resilience to climate change without triggering a fiscal crisis, as it frees up fiscal resources.
• These swaps are transparent and create fiscal space for climate investments.
• Debt-for-nature swaps, which were first introduced in Latin America in the 1980s, are the precursors to debt-for-climate swaps. In these swaps, the remaining debt is redirected towards environmental investments that both parties agree upon, deviating from the original loan agreement.

Impact on Wealthy and Developing Countries:

• Debt-for-climate swaps encourage investment and policy action, while also providing debt relief.
• In such a swap, a creditor forgives or reduces a debtor’s foreign debt in exchange for the debtor’s commitment to invest in an environmental project. It has become a popular method to finance large-scale climate mitigation and adaptation projects.
• It's in the best interest of creditor countries to engage in debt-for-climate swaps as they are obliged to provide financial assistance to developing countries under global agreements. These swaps also ensure transparency.
• Small island developing states are considering debt-for-climate swaps as a solution to the dual challenges of climate risk and financial distress.

Case Study: Sri Lanka's Climate-Debt Situation:

• Sri Lanka is one of the countries most affected by climate-induced disasters, with millions of Sri Lankans predicted to live in climate change hotspots by 2050.
• The country is also facing a sovereign debt crisis, owing around $45 billion to creditors, which has prompted talks of a debt-for-nature swap deal worth up to $1 billion.
• This deal would provide climate-focused financing for developmental projects without further debt accumulation.

The flip side of debt-for-climate swaps:

• While debt-for-climate swaps may cause policy disruptions, they do create fiscal space.
• They are beneficial for small developing countries, but the scaling up of these swaps is still limited.
• Creditors may not be willing to participate in the swaps if they do not see any gain, and the swaps can only succeed if creditors are flexible about the debt’s value.

Conclusion:

• Wealthy nations have a responsibility to aid poorer nations in the Global South by forgiving their debt, as the Global North bears responsibility for the climate debt resulting from their disproportionately high greenhouse gas emissions.
• Debt-for-climate swaps can be a tool to support vulnerable countries’ climate resilience.