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Developing countries risk falling into climate debt trap: report

Rising global borrowing costs are eating into the finances of some of the most climate-vulnerable countries just when they need the money the most to fight the devastating effects of global warming.

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It is a confluence of events that threatens to push developing countries into a “debt trap”, according to Prime Minister Shehbaz Sharif of Pakistan, who addressed world leaders at the climate talks of the COP27 in Egypt last week. Countries that borrowed heavily when interest rates were low are now struggling to finance projects that would make them more resilient to extreme weather conditions, leaving them vulnerable to even higher borrowing costs in the future.

Pakistan, which was pushed to the brink of default by flooding nearly a third of its territory this summer, is a case in point. The country received a $1 billion loan from the International Monetary Fund to help it get by, but flood damage is estimated at around $32 billion and the country has a debt of $3 billion. to be repaid until June 2023, according to Bloomberg Economics.

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Leaders of the nations most vulnerable to climate change have long argued that countries that contribute the bulk of emissions should foot the bill for mitigation and adaptation, but wealthy nations have consistently failed in their promise to deliver. $100 billion in annual climate finance to developing countries. world. While loans from individual countries and development finance organizations have helped bridge some of the gap, emerging markets have also had to rely heavily on bond markets.

“If we are to fight back, rebuild and repair our infrastructure, which must be resilient and adaptive, then of course we can only do that through additional funding, not through additional loans and debt,” Sharif said in his speech at the Sharm el-Sheikh summit.

Governments in developing countries must repay or rollover about $350 billion in dollar and euro-denominated bonds by the end of 2024, according to data compiled by Bloomberg. Meanwhile, dollar sovereign bonds from a quarter of the countries in Bloomberg’s Emerging Markets Dollar Sovereign Debt Index are trading at a spread of 1,000 basis points or more to US Treasuries. , a generally accepted measure of distress.

Climate risks are not yet widely reflected in the price of new debt, although investors are beginning to ask more questions about the impact of extreme weather events on a country’s ability to service its obligations. , according to two bankers involved in the sale of sovereign debt.

“The market as a whole is still a few steps behind,” said Christine Phillpotts, portfolio manager at AllianceBernstein LP in New York. “If we continue on the path we are headed on, discussions will be forced upon investors and governments not just about what is the correct price to pay for assets in the country, but how to actually reduce that risk premium.”

Part of the answer may lie in lower-cost loans from global development banks, which Egyptian Finance Minister Mohamed Maait demanded during climate talks last week. Another potential tool, which was on the official COP agenda for the first time this year, is a loss and damage facility, which would channel funds from wealthy countries that have historically contributed the most to those who are on the front line. climate change lines. So far, only a few wealthy countries have pledged contributions.

“From the perspective of the African Group of Negotiators, we need immediate support for loss and damage on the continent,” Barbara Creecy, South Africa’s environment minister, said on the sidelines of the conference on Sunday. “Of course” we want money right now, she added.

“Anything that helps a poor country recover” will always help reduce the risk premium embedded in its debt, according to Jens Nystedt, senior portfolio manager at Emso Asset Management in New York. “It makes sense that rich countries who are in many ways responsible” fund the installation, he added.

The Nature Conservancy, an American non-profit organization, has been pushing for debt-for-nature swaps as a potential solution. These agreements typically allow countries to restructure debt at lower interest rates or longer maturities, with the proceeds earmarked for conservation or green projects. Since 2016, the Nature Conservancy has arranged debt-for-nature swaps for Seychelles, Belize and Barbados, which together have converted over $500 million in debt into $230 million for conservation.

The instruments could “provide opportunities for developing countries with limited fiscal space to undertake urgently needed climate investments”, said Kristina Kostial, deputy director of the Strategic Policy and Review Department. at the International Monetary Fund, during a roundtable at the COP last week.

The so-called debt trap was a key topic at this year’s talks, partly because it was hosted by Egypt, a developing country already seeing the effects of climate change, and partly because global interest rates are rising. Senegalese President Macky Sall said in a speech at the conference that developing countries “are not ready to accept” the current configuration where developing countries are going into debt to finance climate change mitigation.

“We fund our own coping efforts when we are the victims,” Sall said. “We are doubly punished.