Escaping the sustainability debt trap
Debt conversions can unlock fiscal space for developing countries while mobilising sustainable finance at scale
Many lower-income countries are facing a catastrophic combination of high debt burdens, ever-increasing costs of climate-induced extreme weather events, and critical biodiversity loss. The levels of funding recently committed at the biodiversity and climate COPs are insufficient. Financial innovation is needed to help solve this triple crisis.
The cost of emerging markets servicing debt has roughly doubled in the past ten years in response to multiple shocks, tightened financial conditions and exchange rate pressures, with data from the Institute of International Finance (IIF) warning that debt in these markets is approaching a record $105 trillion, equivalent to 245% of GDP. Such is the scale of the challenge that the World Economic Forum’s latest Global Risks Report, which will frame the discussions taking place next week in Davos, cites rising debt as the 15th most severe global risk.
These same countries are also the most likely to bear the brunt of climate change impacts, which are deeply intertwined with global patterns of inequality. They therefore face a trade-off where debt servicing costs risk taking finance away from urgent sustainable development priorities. 3.3 billion people now live in countries where debt interest payments are greater than expenditures on health or education.
These are financial headwinds emerging markets can ill afford. This next five years needs to see investment channelled, fast, for infrastructure in energy, healthcare, nature-based solutions and other sectors to drive sustainable economic growth and support adaptation. Our own research found emerging markets must invest an additional USD95 trillion to transition to net zero alone, on top of the capital already allocated. This does not factor in adaptation costs, with just ten emerging markets in a separate Standard Chartered study facing USD377 billion in damages and lost economic growth by 2030.
But current funding levels remain insufficient despite a COP29 commitment to increase climate finance for emerging markets. Pledges to the Adaptation Fund and the Loss and Damage Fund, in particular, fell far below what’s required in the context of ongoing indebtedness across emerging markets and developing economies.
The good news is efforts are aligning in response. In early December, South Africa set climate finance and debt relief as its G20 presidency focus; in October G20 Finance Ministers reaffirmed commitment to act swiftly to tackle global debt vulnerabilities and create fiscal headroom for investment in fighting inequality and addressing climate change. The former builds on the path set by the G20 through the “Common Framework” on debt relief which, whilst not without its challenges, has achieved significant steps in four cases by advancing the coordination between G20 and Paris Club (PC) official bilateral creditors.
Innovative blended finance models, such as debt conversions, can be triple win, playing an important role in addressing emerging market debt burdens whilst channelling capital towards sustainable outcomes. The completion of the recent Bahamas Debt Conversion Project for Marine Conservation – in which Standard Chartered acted as sole lender, underwriting a USD300 million loan – will see the country refinance its debt and channel savings towards marine conservation and to support economic growth. Similar models can be applied to solve for a range of issues, from health to climate adaptation.
But we will only succeed in solving at scale if these multi-stakeholder approaches are mirrored elsewhere. The Global Sovereign Debt Roundtable, upon which Standard Chartered sits as one of two private sector members, is one important way in which International Financial Institutions, debtor countries, official bilateral creditors, private creditors and others are creating the space to focus on and identify breakthrough solutions to the issues identified as affecting sovereign debt restructuring.
This is a model of engagement which government and business leaders can bring to bear next week at the World Economic Forum, as they convene to discuss how ‘Collaboration for the Intelligent Age’ can help shape a more sustainable, inclusive future. It is also a model the G20 must apply later this year as it seeks to drive forward its ambitious agenda on climate and sovereign debt in 2025.
Indeed, financing models like debt conversions have given us a glimpse of what we can achieve when different stakeholders apply an innovative mindset and come together to find a path through difficult and uncharted waters. Now, we must harness the integrated power of these different perspectives to address the twin crises of debt affordability and climate change impacts, at scale.
