On 22 and 23 June, Paris is hosting a summit for a “New Global Financing Pact” at the Palais Brogniart. Heads of state, international organisations and representatives of civil society will be gathering to discuss ways to boost solidarity toward the Global South. The aim is also to contribute to the international agenda on development and climate financing, a few months after the UN climate summit, COP27, left a mixed record.
The summit comes at a time when the budgetary margins and debt sustainability in a number of countries have been undermined by a succession of crises: pandemics, Russia’s war on Ukraine, inflation, rising global interest rates, etc. Yet the need for funds that promote low-carbon development, as well as adaptation to increasing climate disruption, is as pressing as ever. Many developing countries are having to reckon with an ever-growing number of natural hazards, at a time of acute socio-economic vulnerability.
However, the financial situations of developing countries vary: some, such as Sri Lanka, Ghana and Suriname, already have unsustainable public debt that needs to be restructured. Others can still access cash without compromising their sustainability, such as Egypt.
A study carried out by the International Monetary Fund (IMF) in 2022 on 128 low- and middle-income countries revealed a strong correlation between exposure to climate risks and limited budgetary capacity. The climate crisis and the budget crisis have a habit of feeding each other: coping with a crisis puts a strain on public finances, and new funding is needed to adapt to climate change. Taking on more debt also means taking on more debt at higher costs. Developing countries are therefore in danger of entering into a vicious circle.
Increasingly complex debt restructuring
On top of ad hoc restructuring for countries facing particular constraints, several debt restructuring or suspension initiatives were launched in 2000 in response to more widespread debt situations. The Heavily Indebted Poor Countries (HIPC) initiative, established in 1996 by the IMF and World Bank, and the 2005 Multilateral Debt Relief Initiative (MDRI) are notable examples. Broadly speaking, these schemes aim to cancel a share of public debt in return for a commitment that the sums released will go toward beneficiaries’ development goals, in areas such as health, education and poverty reduction.
During the Covid-19 pandemic, the G20 countries also adopted the Debt Suspension Initiative (DSI), which sets out to suspend the debt repayments of 73 of the world’s poorest countries.
At the origin of the HIPC initiative and the DSI was the Paris Club (CDP). Composed of 22 bilateral creditors, mainly from developed countries, the informal group worked with the IMF and World Bank to establish rules to renegotiate the external public debt of over-indebted countries. However, CDP creditors are no longer the most important players, dwarfed by “new”, non-member bilateral creditors, such as China and India.
Beyond budgetary capacity, it is developing countries’ public debt structure that has gradually changed. By doubling over the last decade, the debts of developing countries have also opened up to new creditors from the private sector and emerging countries such as China, India, Russia, Turkey and the countries of the Middle East. The restructuring process has thus become even more complex.
In response to this new international context, the G20 countries have set up a “Common Framework for Debt Treatment”, enabling countries eligible for the DSI to request a restructuring of their debt in case of persistent financing deficits. This new body paves the way for better coordination between bilateral creditors who are members and non-members of the CDP.
However, the global framework for debt restructuring has so far had little impact on climate issues, with climate investment often an afterthought.
Vulnerable countries in demand
Innovative financial instruments for combining finance and climate change are on the rise. Debt-for-climate swaps (such as Debt for Climate Swap have been back in the spotlight in recent years, focusing not only on the fight against global heating, but also on protecting nature. The idea is that the government of the debtor country undertakes to spend the equivalent of the cancelled debt on projects to fight climate change, under conditions agreed between the creditors and the debtor country. A growing number of research groups, civil society groups and, to a lesser extent, international institutions, are advocating similar solutions to combat both climate change and rising public debt.
Recent global shocks have led to a certain consensus that the international financial system may no longer be equipped to handle current global challenges. Many are unimpressed by efforts to finance the decarbonisation of the economy and climate adaptation. As a result, several countries called for reform of this financial architecture at the UN General Assembly in 2021, in particular by asking for debt restructuring to be linked to climate objectives.
This call was echoed at COP26 in Glasgow in November 2021, notably by the V20 countries (vulnerable twenty group). Now comprising 58 nations, the group accounts for 5% of global greenhouse gas emissions, and yet are at the receiving end of climate change. They have called for large-scale debt relief.
The prime minister of Barbados has also presented the Bridgetown Agenda for Reform of the Global Financial Architecture, with a view to directing global funds toward low-carbon, climate-resilient development, in a way that would also tackle developing countries’ sovereign debt.
Even more complexity?
The richest countries have also proposed ideas. At the end of the 76th annual meetings of the World Bank and IMF in October 2022, the G7, joined by Australia, the Netherlands and Switzerland, set out its proposals for reforming the World Bank.
Much indicates 2023 will be a year of reform for development finance, with many events slated to reflect on these issues.
Calls for reform of the global framework have been around since the globalisation of financial markets, however – no single institution is responsible for global financial movements. Institutions, both international (IMF, World Bank, World Trade Organisation, etc.) and regional (OECD, European Commission, Bank for International Settlements, etc.), are numerous, while the private sector is expanding.
Beyond the debate over the role these institutions should play and whether or not it is useful to introduce international standards and controls, it would be wise to bear in mind that any new development finance initiative will remain vulnerable to changes in the international financial architecture, which is forever subject to negotiation and regulation. The challenge is also to ensure that the introduction of new instruments does not add yet more complexity to the management of developing countries’ debts.