The Global South's Debt Crisis Thwarts Climate Ambition

Dec 9 , 2023
By María Fernanda Espinosa , Rishikesh Ram Bhandary

This year’s United Nations Climate Change Conference (COP28) in Dubai would be decisive for the “Loss & Damage Fund” established at COP27, because governments must agree on how the new fund will be operationalised and financed. But equally important is the first global stocktake (GST), which will assess countries’ progress toward achieving the goals of the Paris Climate Agreement, signed in 2015.

A preliminary report on the stocktake, released in October, is underwhelming, while the most recent World Energy Outlook from the International Energy Agency (IEA) found that global carbon dioxide levels have yet to peak. This implies that to achieve our climate targets, we must fast-track the clean-energy transition and slash greenhouse gas emissions. But while this will undoubtedly require closing the massive climate financing gap, policymakers must overcome widespread sovereign debt distress.

The Debt Relief for a Green & Inclusive Recovery Report, using data from the UN Development Programme and the International Monetary Fund, estimates that 69 countries need immediate debt relief, of which 61 have at least 812 billion dollars in debt that must be restructured across all creditor classes. An IMF working paper calculated that only seven of 29 low-income countries that submitted estimates of their adaptation needs had sufficient fiscal space to meet those needs and achieve their emissions-reduction targets, also known as nationally determined contributions (NDCs).

With debt-service costs set to increase in 2024, many countries will spend more on interest payments than health or education.

As long as the debt crisis in the Global South grinds on, many emerging-market and developing economies will be unable to invest in gender-sensitive low-carbon development. This, in turn, would make these countries more vulnerable to climate shocks and fiscal instability, and would also foreclose the goal of limiting global warming to 1.5° Celsius, the target set by the Paris climate agreement.

To address the debt-climate nexus at COP28 and beyond, policymakers should focus on three objectives: a more inclusive and efficient debt-restructuring process; more concessional finance; and expansion of the size and remit of multilateral development banks (MDBs).

The G20’s Common Framework must be reformed to ensure that all climate-vulnerable countries, including middle-income countries, are eligible for debt treatment. While the Common Framework has started providing relief, recent debt-restructuring deals have been modest in scope and came at the cost of protracted negotiations that only exacerbated the problem. Future deals must ensure significant relief measures that enable countries to kickstart economic growth and achieve climate goals, rather than merely returning them to previous levels of austerity or helping them stave off the next crisis.

The need for more concessional finance has never been clearer. In October, at the annual meetings of the World Bank and the IMF in Marrakesh, IMF Managing Director Kristalina Georgieva noted that interest rates were in a “higher-for-longer era.” This comes at the same time that countries must accelerate the deployment of renewables, which are highly sensitive to the cost of capital. Climate vulnerability has been found to drive up the cost of debt and restrict access to financing.

But there is ample room to scale up concessional finance. From 2021 to 2022, low-cost project-level debt and grants accounted for only 11pc of total climate finance, according to the Climate Policy Initiative. The World Bank, as part of its “Evolution Roadmap” initiative, has indicated that it will expand concessional lending beyond the poorest countries to fund necessary climate investments. Other multilateral development banks should emulate this approach, and their shareholders should inject more capital to facilitate it. Governments can access affordable financing that does not crowd out other priorities.

Multilateral development banks must also become bigger and better equipped to supply the low-cost, long-term finance that climate-vulnerable countries need. While the World Bank has taken a step in this direction by implementing balance-sheet-optimisation measures to increase the scale of its lending by 50 billion dollars over the next 10 years, it is not enough. Other multilateral development banks should devise concrete plans for capital increases and, when presenting them to their boards, outline how a fresh injection of funds will enable them to provide low-cost finance to developing countries and make bolder bets on transformational investments.

In addition to increasing their lending capacity, multilateral development banks must reform the debt architecture.

For example, the World Bank has advanced a debt-pause clause in new and existing lending agreements that permits 45 small islands and states facing qualifying events to postpone their interest and principal payments. But loans of all borrowing countries should include such a clause. It would also be in the interest of multilateral development bank shareholders to improve the debt-restructuring process: an extended debt crisis simply means that they will need to provide concessional finance for a longer period, given that it is tied to debt indicators.

The global stocktake at COP28 is sure to find that the world is falling far short of the Paris Agreement’s targets. Accelerated action – across climate finance, global policy coordination, and renewable-energy deployment – is needed, but high debt levels stand in the way. Tellingly, Egypt, the host of last year’s COP, explicitly noted in its revised NDC that debt-service payments were limiting the country’s climate ambition.

G20 governments and international financial institutions must acknowledge that a severe debt overhang could worsen the climate crisis. Mobilising financial resources on an unprecedented scale, while important, should be complemented by measures to address heavy sovereign debt burdens. One hopes that by forcing policymakers to confront the world’s dangerously slow progress toward net-zero emissions at COP28, the global stocktake will generate the political will and trust necessary to tackle the interlocking problems of debt distress and global warming.

This article is provided by Project Syndicate (PS).

PUBLISHED ON Dec 09,2023 [ VOL 24 , NO 1232]

By María Fernanda Espinosa ( María Fernanda Espinosa is executive director of GWL Voices and Co-Chair of the Debt Relief for a Green & Inclusive Recovery Project. ) , Rishikesh Ram Bhandary ( Rishikesh Ram Bhandary is the assistant director of the Global Economic Governance Initiative at the Boston University Global Development Policy Center. )

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