Increased public spending and reduced income has constrained governments’ ability to respond to, and recover from, COVID-19. This has led to an urgent need to secure liquidity and has piled immense strain on many developing country governments struggling to service their mounting debts.
About the Author
Ashley Gorst is a Senior Economist at Finance for Biodiversity (F4B) and Vivid Economics, specialising in the economics of natural capital and biodiversity. He currently leads F4B’s work on sovereign debt. He holds a PhD in Environmental Economics from the London School of Economics and Political Science.
As shown in Figure 1, external debt in developing countries has climbed steadily in the last decade, reaching US$8 trillion at the end of 2019. In these economies, external sovereign debt stocks amounted to US$3.1 trillion in 2019, with debt service payments due in 2021 and 2022 amounting to US$676 billion.[i] The relative size of debt stocks has also increased in several countries, notably in 19 sub-Saharan African countries where debt to GDP ratios reached 71% in 2020 compared with 26% in 2012.[ii] Debt restructurings in Angola, Argentina, Belize, Ecuador, Kenya, Lebanon, Suriname and Zambia highlight the growing pressure, with the IMF warning that half of low-income countries are either at high risk of, or in, debt distress.[iii]
Figure 1: Total external debt stock for 135 low- and middle-income countries 1999-2019
The global debt crisis has been particularly severe in countries with greater economic dependence on nature, who are also more vulnerable to climate change. Studies show a substantial overlap between deterioration in debt terms and areas of critical biodiversity and climate vulnerability.[iv] This is significant: nature’s health and climate change impacts pose immediate and long-term risks to economic growth, particularly in developing economies where ‘natural capital’ makes up on average 47% of total wealth. The United Nations Food and Agriculture Organisation estimates that 95% of agriculture relies on soil productivity[v], while nature-based tourism contributes between 10-20% of GDP to the economies of Kenya and Namibia.[vi]
Nature’s health and climate change impacts pose immediate and long-term risks to economic growth, particularly in developing economies where “natural capital” makes up on average 47% of total wealth.
Yet nature conservation efforts and climate action have, to date, fallen far short of what is needed, with global COVID-19 recovery programmes largely failing to contribute towards more sustainable outcomes. Estimates suggest US$2.8 trillion of the US$14.9 trillion injected is estimated to leave large and lasting impacts on carbon emissions and nature.[vii] International pledges to mobilise US$100 billion of climate finance in developing nations annually until 2025 have also not materialised.[viii]
Forthcoming international negotiations on both climate and biodiversity will set global ambition for the next decade, and will seek to lay foundations to mobilise resources to meet those ambitions.
While there is growing recognition of the urgency of stemming decades of loss in the natural world and addressing climate change, global sovereign debt markets have so far failed to provide governments with the means to fund green fiscal policies at scale. Not accounting for the state and management of natural capital means that debt markets do not price in the risks posed by destroying a nation’s natural assets, offering little or no opportunity for the issuers of debt to capitalise on improvements in their natural capital, or for investors to seek better nature and climate performance to reduce sovereign risk.
Now, a new generation of debt instruments offers governments the opportunity to fund their liquidity needsand support green fiscal policies that enable better long-term and sustainable growth.[ix] These instruments provide various ways of structuring debt, including:
- KPI-linked or sustainability-linked bonds, which allow issuers to raise funds for general purposes but incentivise performance through debt payments liked to achievement of nature-based outcomes.
- Use-of-proceeds bonds, such as green bonds,which link the funds raised to specific nature-based projects.
The deployment of these debt instruments at scale is now realistic, building on the recent growth of sustainability-aligned debt that now exceeds US$1.5 trillion, and is expected to make up 10% of global issuance in 2021. So far, 22 governments have issued green bonds in the last four years[x], including France, Germany, South Korea, Indonesia, Nigeria and the Seychelles.[xi] Governments including Pakistan have pledged to drive a green recovery through the adoption of a new class of nature performance bonds, mirroring rapidly increasing issuance of sustainability-linked bonds in corporate debt markets.[xii]
While many opportunities for innovation exist, uncoordinated efforts will result in confusion, inefficient use of resources, and slow progress. The knowledge and capacity required to engage with these new forms of finance is also lacking in many low- and middle-income countries, adding additional barriers to the organic uptake of these instruments. Decision-makers urgently need a set of developed options to meet these challenges head on.
A Nature and Climate Sovereign Bond Facility proposed by Finance for Biodiversity, in close coordination with multilateral development finance institutions and nature experts, would provide a practical mechanism to do this. It would support sovereign issuers and investors in addressing the short-term sovereign debt crisis in ways that drive a green, inclusive recovery. It would also enable governments to factor nature- and climate-related risks and opportunities into sovereign debt markets over the longer-term, allowing public and private investors to engage at scale.
To do this effectively, the facility will need to perform the following functions:
- Catalyse the use of innovative sovereign debt instruments to integrate nature and climate into performance, the cost of capital and use-of-proceeds instruments, for both new issuance and debt restructurings.
- Coordinate the integration of nature into debt markets with international financial organisations, and promote developments with sovereigns, investors, and market actors such as credit rating agencies.
- Manage performance assessment by developing nature and climate metrics and standards, and support this with monitoring, reporting and verification to oversee performance outcomes, linked to national commitments on nature and climate.
- Leverage the balance sheets of many public and private financial institutions to mobilise ‘green-linked’ concessional and blended financing from diverse sources e.g. development finance institutions.
- Promote standardisation of nature and climate performance outcomes through systematic data collection, analysis, and reporting protocols, drawing on existing green and sustainable bond initiatives and standards.
- Promote institutional knowledge sharing and capacity building, including enhancing coordination across governments and the financial sector.
- Reduce transaction costs to issuers and investors by bringing together counterparties to make investments; increasing standardisation; and providing authoritative nature and climate performance-linked data and assessment protocols.
The implementation of such a facility is now being actively discussed by the World Bank and its partners. These efforts need to be supported and amplified through the G20 and G7, and at forthcoming meetings on climate and biodiversity. Development finance institutions, sovereigns and private financial institutions, and environment and development organisations, all have a role to play. Now is the opportunity to be ambitious. It is time to create the right architecture to rapidly mobilise public and private finance to support economic recovery while scaling up investments in nature and climate.
[ii] Fitch Ratings, 2020. Sub-Saharan Africa Sovereigns See Record Downgrades in 2020, Pressures Remain
[iii] IMF, 2020. Joint World Bank-IMF Debt Sustainability Framework for Low-Income Countries. IMF and World Bank, 2020
[v] FAO (2020). State of knowledge of soil biodiversity – Status, challenges and potentialities
[vi] World Bank (2015). Harnessing the Potential for Nature-Based Tourism for Poverty Reduction.
[vii] Finance for Biodiversity Initiative. 2021. Greenness of Stimulus Index.
[x] Climate Bonds Initiative. 2021. Sovereign Green, Social, and Sustainability Bond Survey 2021.
[xi] OECD. Growing momentum for sovereign green bonds 2020.