By now, we all know the story—the world is going through a disruptive, transitional phase at historical levels. The dislocating effects of globalization have eroded support for the existing multilateral system, while exposing deficiencies in institutional structures that are decades old. Against this backdrop of geoeconomic change and increasing uncertainty, efforts to address climate change stand at a crossroads, just as debt levels in many lower-income countries reach all-time highs. Multilateral institutions, including those anchored in the Bretton Woods system, as well as forums like the United Nations Conference of the Parties (UN COP) and the Group of 20, are increasingly hampered in their attempts to achieve the consensus needed to yield action and investment at the necessary levels.
Debt Sustainability and Climate Change Together?
To some, the twin trillion-dollar challenges of debt sustainability and climate-related investments may seem distinct—but they are not. The sustainability of debt levels around the world threatens to inhibit governments from making catalytic investments in sustainable economic development, exacerbating the impact of social and economic dislocation. Climate-related shocks limit economic growth and reduce governments’ ability to invest in sustainable development outcomes and realize the market value of smart conservation.
The scale of the challenges is staggering. Post-pandemic and in a rising interest rate environment, many lower- and lower-middle-income countries face fiscal and debt-related challenges. The collective external debt of “developing” countries reached an all-time high in 2023 at $11.4 trillion. According to the International Monetary Fund, under 20 percent of low-income countries are in debt distress, and another 40 percent are at high risk of distress. Confronted with their own fiscal challenges, the appetite in higher-income countries to allocate concessional capital to help lower-income countries jumpstart clean economy market growth appears to be diminishing. Yet, solving for climate-related challenges and debt sustainability—in particular, mobilizing the catalytic capital needed to scale up resilience- and adaptation-focused investments—is imperative, as the cost of combating climate change will run into the tens of trillions of dollars over the next few decades.
An Emergent Playbook
Improvements on structural debt challenges are slow in coming, and maintaining cross-jurisdictional consensus is a Sisyphean task. Systemic reforms, including formal mechanisms for sovereign bankruptcy, must be coordinated through multilateral institutions, creditors (official and private), and debtors. Recent efforts have made incremental advancements toward greater coordination of debt challenges across stakeholders, but more needs to be done to center climate-related challenges as a critical pillar for structuring proactive, pre-default restructurings.
Thankfully, there is an emerging set of solutions that do not require slow systemic change. The new playbook starts with the fact that many countries in debt are sitting on goldmines of value—natural resources like marine reserves, wetlands, and forests. Debt-for-nature swaps, replacing existing debt with lower-cost financing while simultaneously allocating some of the fiscal savings to conservation and resilience-based investments, offer one path forward. Ecuador, the Bahamas, Gabon, and Barbados continue to demonstrate the adaptability of these tools to individual country contexts.
Monetizing the value of natural resources through carbon markets promises to channel investment at a much greater scale. To date, the efficacy and growth of voluntary carbon markets have been inhibited by issues of fragmentation, verification, and a lack of standardization. Rather than continuing with the current patchwork approach, more must be done to build out a market structure with the transparency, liquidity, and dynamic pricing necessary for greater investor participation. Public-private partnerships and bilateral agreements are pointing the way to scale. With COP30 taking place in Brazil, and the nation’s ambitious framework for a regulated carbon market set to be deployed over the next five years, organizers and the global financial community have an opportunity to demonstrate an effective model for monetizing carbon assets that other countries may follow.
Innovative approaches like mobilizing hybrid capital using Special Drawing Rights (SDRs) to increase lending capacity at multilateral development banks could also prove effective in incentivizing investments in resilience and adaptation. The instrument, estimated to raise capital at a ratio of 4:1, is already approved for use by the African Development Bank and the Inter-American Development Bank. A coalition of countries could rechannel SDRs in this fashion to provide tangible proof of commitment to capital mobilization.
Another promising instrument in the playbook is the Climate Resilient Debt Clause (CRDC). Designed as state-contingent instruments in sovereign bond issuances, CRDCs allow debt repayments (interest, principal, or both) to be temporarily paused for a prespecified period when specific conditions, like a natural disaster, are met. The funds previously destined for repayment can then be applied to resilience-focused recovery and rebuilding. Proof of concept exists. The first example of one of these clauses being triggered was in Grenada last year, when Hurricane Beryl struck the island. The Inter-American Development Bank has offered CRDCs through the principal-payment option in select loans since 2021. At COP29, the World Bank announced plans to expand CRDCs to include all natural disasters and pandemics. Currently, only small countries are eligible through the program. What is needed next is for a larger nation to include a CRDC in a debt issuance to prove it can work at scale.
Ultimately, there is no singular solution that will resolve the coextensive challenges of debt sustainability and investing in climate resilience. Forums for coordinating debt restructuring must continue to improve. The “Baku to Belém Roadmap to 1.3 Trillion,” due later this year, must lay out a path through the COP process toward capital mobilization to meet the adaptation and resilience-related goals agreed upon in Baku. Given the slow rate of structural and institutional change, we also need a broader playbook for investors and individual countries alike to constructively mobilize the capital necessary. Investor-led alliances and other innovative efforts are needed to ensure that COP30 in Brazil is the beginning point for cross-sectoral solutions that are less dependent on resolving geoeconomic tension.
This is the first in a series of posts on specific instruments aimed at addressing climate and debt together. The final playbook will be released in advance of COP30.
