Reconciling sovereign debt and natural capital in low-income countries

Falls in FDI and trade imposed by lockdowns, concurrent with the need to manage unstable health and economic systems, has plunged low-income countries (LICs) into a debt spiral. Globally, sovereign debt has increased by around $10 trillion. Not to say that it was stable before the pandemic; in fact, the IMF signalled half of LICs were in debt distress in January 2020. But the emergency fiscal stimulus packages being deployed globally show countries are going beyond rationales of debt vulnerability, instead investing in much needed social infrastructure. Mass sovereign debt restructuring is around the corner.

World Bank, IMF

It’s imperative that the recovery from Covid-19 be compatible with climate and nature requirements, because this decade is determinant for climate change mitigation. That’s why a growing number of voices in policy and finance have called for approaches that endorse sustainability-oriented debt instruments. With $281 trillion total active sovereign debt globally, this can be a great avenue for advancing natural capital principles. Natural capital represents the value that nature delivers to the economy but is not monetised. As climate change and environmental degradation intensify, we lose natural capital, with knock-on effects on our economies.

Stakeholders now recognise the interoperability between economic and ecological systems, the fact that agricultural output needs pollinators, or that our cities depend on the provision of natural resources and ecosystem services, for example. LICs are home to large portions of the world’s critical biodiversity. Neglecting its conservation will have severe consequences for these countries’ wealth, but also global economic repercussions. In the current context, debt restructuring is a key means of safeguarding natural capital.

For nature to have its rightful place in debt portfolios, incentives must be provided on both sides. Attaching green-performance-linked interest rates to securities or local currency swaps would better enable sovereigns to protect their natural assets. For creditors, natural capital could serve as a condition for a debtor’s creditworthiness, informing their investment decisions. According to the Finance for Biodiversity Initiative, the priority is twofold. First, multilateral financial institutions must support a common framework for green sovereign debt relief. Second, investors need the guarantee that green debt serves their needs, can be easily priced, and provides adequate liquidity.

One idea put forward is the creation of a designated fund connecting investors with SDG-related market debt. Refinancing would be geared towards nature conservation projects or simply infrastructure development respective of natural capital. Green bonds would then be phased in progressively. The Green Economy Coalition notes that this approach does not erect barriers to sectors like health or education. In fact, nature conservation can go hand-in-hand with systemic SDG pursuit.

Gathering political momentum around this issue is of utmost important this year, as Nationally Determined Contributions (NDCs) are readjusted at the COP26 and the Global Biodiversity Framework is established at the CBD15. Multilateral development banks in particular will seek to converge private capital with their own sustainable bonds. States will need to endorse such a reward-based debt framework, with precursors able to draw from the experience of green bond issuance; France, for example, has so far issued $40.7bn worth of green sovereign bonds. The momentum among industrialised countries must diffuse across the lower-income bracket, so as to avoid yet another fossil-intensive round of debt restructuring.

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