By Stephanie Lai, Head of Research at King’s Commercial Awareness Society
Debt for nature swaps have become re-popularised among banks as they provide a solution for developing nations that are economically weak to lower their debt, which is important amidst the current global inflation. Meanwhile, they are also improving these developing nations’ environmentalism, which is instrumental given that many developing nations host vast biodiversity.
Debt for nature swaps are financial transactions that forgive an amount of the foreign debt of developing countries in exchange for investments in environmental projects. It has been suggested that up to 2 trillion USD of debt in developing nations can be included in debt for nature swaps, greatly alleviating the debt burden which has beenexacerbated by the tumultuous economic climate. The popularity of debt for nature swaps has been evident in numerous developing nations, many of which are known to default. This includes Belize, which has vast biodiversity in their coral reefs and rainforests, and has planned $553 million in debt for nature swaps with Credit Suisse. Other developing countries that are planning substantial debt for nature swaps include: Gabon which has proposed $700 million, Ecuador has organized for $800million in debt for nature swaps and Sri Lanka, which recently defaulted in April 2022, has signaled a $1 billion deal in debt for nature swaps. This conveys the rising popularity of these schemes in developing nations which involve substantial sums of capital.
For developing nations
While debts are rising in developing nations and the debt for nature swaps can alleviate these financial struggles, doubts are forming about their impact on developing nations as they carry high transaction costs. Further, suspicion has arisen around the schemes since they were first introduced in the 1980s. Doubts are raised by non governmental organizations, such as Greenpeace, about debt for nature swaps to be removed due to the uncertainty they bring as to financial considerations and regarding the domestic issues of developing nations. Financial uncertainty may occur from developing nations hiding the extent of their debt in order to obtain funding. Hence if their debts continue to substantially increase despite the debt for nature swaps, these nations will be susceptible to financial challenges and a damaged reputation if they are unable to follow through in their promises to invest money into environmental projects. This is a common theme as research has found that 18,000 marine protected regions fail to reach their environmental goals due to inadequate finances. Further, many developing nations, such as Brazil, are rejecting aid from developed nations as they perceive it as a form of intervention to their sovereignty, while they question the morality of such large funds being involved in environmental issues as opposed to social ones, such as regarding health care.
For banks
Banks are betting that the debt for nature swaps will be successful as they intend to use public funds to de-risk private investment and capital to finance developing nations. These are often considered risky to invest in, especially in environmental projects which often fail to be finalized. Further, banks are likely very keen to be involved in debt for nature swaps as they are always seeking to have a high amount of capital invested in ESG-related projects in order to meet their green investment targets. However, often the amount of capital that goes toward green investments is substantially smaller than the transaction size, suggesting that even though the sums paid for the debt to nature swaps are large, the amount invested into the environment by developing nations will likely be significantly smaller. For example, from the debt for nature swaps in Belize, only $84 million went towards their reef out of the $553 million they received.
Banks may also be susceptible to high levels of risk from their debt for nature swaps in the instance that one of these nations defaults from their debt increasing, which may occur given the tough economic climate globally. Hence, whilst the debt for nature swaps attempt to make investments in these nations less risky, rapid inflation and economic uncertainty may put this in jeopardy. For example, Sri Lanka experienced surging inflation of 30% in April coupled with domestic unrest, causing their nation to default for the first time ever. At the same, during the past few years, there has been severe turbulence in the market from inflation and exchange rates which may impede the success of the debt write-off in exchange for the investment in environmental projects.
Future
The debt for nature swaps have the chance to be successful and aid nations struggling with debt financially and also environmentally strengthen biodiverse regions of the world. However, the economic uncertainty, coupled with the commonality of greenwashing and environmental malpractice suggests they may not be as successful as big banks are portraying them to be.