Debt crisis undermines climate action in the Global South, report finds

But precisely at this moment, a debt crisis is emerging in the Global South. According to recent World Bank estimates, 61 developing countries — representing 40 percent of the world economy — face debt distress.

In a report published on Tuesday (2 May), a group of researchers have collected evidence showing that without significant debt relief, many developing countries will not be able to invest in a green future, risking another "lost decade" for those countries.

According to the Debt Relief for Green and Inclusive Recovery Project (DRGR), — a collaboration between multiple universities, including the Boston University Global Development Policy Center — external debt levels and service payments have more than doubled since the 2008 global financial crisis.

Between 2008 and 2021, developing and emerging economies' sovereign debt increased by 178 percent, from €1.3 trillion to €3.5 trillion. In Pakistan and Egypt, 50 percent of the annual revenue goes to foreign creditors. After debt servicing, Nigeria was left with only 4 percent of its budget last year, according to the World Bank.

Many countries suffering debt distress are also most acutely confronted with the destructive effects of climate change. Following the worst flood in its history, Pakistan now faces reconstruction costs estimated at €30bn — costs exceeding the country's annual budget.

Looking at the big picture, the DRGR researchers find that the 61 countries at high risk of debt distress will need at least €735bn of their arrears restructured—jargon for written off— to achieve "sustainable levels" of debt.

It is a response to efforts already underway that have not reached meaningful results. Crucially, the Group of 20 wealthy countries initiated debt relief reform following the Covid-19 pandemic — the so-called "common framework."

This was supposed to offer clarity to all creditors and debtors and speed up the debt relief process. But it has become clear the effort has failed due to a limited buy-in from creditors and because middle-income countries were excluded.

The DRGR proposal suggests rapid reform could be made around three pillars.

Three pillars

First, public and multilateral creditors like the World Bank, the African Development Bank and the International Monetary Fund (IMF) should agree to reduce debt by up to €212bn — a sum these institutions have so far not been willing to accept.

Secondly, private and commercial creditors — a group that includes US asset giants Blackrock and Vanguard and many other institutional investors like pension funds and insurers —should restructure up to €257bn.

Additionally, up to €55bn is needed to fund newly issued 'green and inclusive recovery' bonds that private and commercial creditors can swap against old debt at a significantly lower interest rate. Finally, for those countries not in immediate debt distress but lacking the money to invest in the green transition, international financial institutions should help lower the cost of capital.

Debt relief alone "is not a panacea," the authors write but should be part of a package of measures that increases access to cheap finance, for example, by funnelling €500bn in unused IMF reserves towards developing countries. However, this would require 85 percent of the voting power of the IMF board of governors.

Climate frontline

Although politically not yet within reach, the proposal has already been endorsed by the Group of Vulnerable 20 finance ministers, representing 58 finance ministries, indicating significant support across the Global South.

Implementation would especially help the countries on the climate frontline, as the authors find a correlation between debt distress and vulnerability to environmental destruction.

Climate risks increase the cost of capital paid by climate-vulnerable developing countries, which in turn deepens both the debt problems and hampers the ability to adapt and prevent environmental destruction.

Cash-strapped Pakistan suffered a flood last year and is now dealing with a devastating drought. Argentine farmers face losses of €18bn following the worst drought in 60 years. By 2050 drought losses could account for 4 percent of Argentina's GDP, the World Bank recently reported.

If debt problems are not addressed, these countries could sink ever deeper into a downward spiral of financial and environmental distress. The authors explain debt relief can free up the space necessary to achieve sustainable development and climate goals.

The next significant global financial negotiation meeting will occur at the New Global Financial Pact Summit in Paris on 22-23 June.