Debt-for-nature swaps

DEFINITION: Strategy for reducing foreign debt in developing nations by trading debt forgiveness or debt reduction for guarantees of environmental activities by debtor nations

Although some critics view debt-for-nature swaps as a form of cultural imperialism, these arrangements offer a way for environmental organizations to encourage developing nations to preserve ecosystems, conserve natural resources, and protect significant cultural sites.

An international finance crisis began during the late 1980s when many developing nations found that they had borrowed more from international lending institutions, mostly private banks, than they could repay. To recover some of the principal on the loans, banks began to sell the loans in financial markets, usually discounted to a fraction of their original value because of the threat of default. Several options to relieve this debt burden on developing nations were explored. One option was to refinance the debt to lower the interest rates and extend the time for repayment. Another strategy was to encourage domestic financial reforms in debtor nations by increasing domestic investment, expanding the domestic economy, raising taxes, reducing non-debt-related expenditures, or inflating the currency in order to pay the debt eventually. Finally, creditor nations and institutions could partially forgive the debt. Debt-for-nature swaps combine elements of all three of these options.

How Debt-for-Nature Swaps Work

In debt-for-nature swaps, environmental organizations buy discounted debt in the financial markets from the banks. Instead of collecting the full amount of interest and principal from the debtor nations, the environmental organizations agree to forgive all or a portion of the debt if the debtor nations invest amounts up to the principal value of the debt in local preservation efforts, often the purchase of land for national parks or investment in skilled staff and improvements for existing parks. In these arrangements, conservation organizations benefit through an increase in local funding for conservation, and banks benefit because they have a new market for the debt. The debtor nations benefit in several ways: They are able to invest their funds in their own nations rather than transferring funds to the lending nations; they use inflated local currency rather than high-value, scarce, dollar-based foreign exchange; and they reduce their outstanding debt and interest payments on that debt, which allows them to continue making payments on the remaining debt and maintain their international credit ratings.

Debt-for-nature swaps erase the “debt overhang,” that portion of debt that, if forgiven, allows the remaining debt to continue to be assumed by creditor nations or institutions with satisfactory levels of burden on the debtor nations and satisfactory debt payment risks for the creditor nations. Because environmental organizations purchase the debt at a discount, they are able to multiply their impacts on the environment. For example, in the first debt-for-nature swap in 1987, Conservation International purchased $650,000 in Bolivian debt for $100,000, then required the Bolivian government to establish a $250,000 endowment fund in local Bolivian currency to pay operating costs for a reserve in the Bolivian Amazon before erasing the debt.

In debt-for-nature swaps, debtor nations buy back a portion of their outstanding debt with an investment in a portion of their own natural capital. Natural capital includes caches of nonrenewable resources such as or oil reserves, natural resources such as old-growth forests or habitat, historical artifacts such as prehistoric ruins or fossil deposits, and cultural resources such as the homelands of primitive indigenous peoples or significant architectural sites. The preservation of this natural capital has positive benefits for the ecology, sustainable development, and biodiversity. A swap is also likely to improve the debtor nation’s economic ability to repay the remaining debt, because the preserved cultural and natural resources often serve as tourist attractions, cultural centers, and locations for academic and commercial research.

Participation of Financial Institutions

Because some private lending institutions will not voluntarily participate in debt-relief processes that reduce the financial institutions’ capital or potential profit from loans, governments in creditor nations either mandate financial institutions’ participation or provide financial incentives, such as tax deductions and tax credits, to encourage participation. Creditor governments justify these actions as a component of their foreign economic development programs, as a component of their environmental programs, as philanthropic support for preservation of the earth’s cultural and natural heritage, or as economically justifiable domestic self-interest. For example, encouraging nations in tropical zones to protect rain forests helps to reassure nations in the northern temperate zones that existing climate patterns supported by those rain forests will be maintained. Maintaining these climate patterns is necessary to prevent natural and human-made disasters, reduce the demands on industrialized nations to provide humanitarian relief from increased numbers of natural disasters, ensure continued rainfall in agricultural zones in temperate regions, prevent desertification, maintain good air quality and reduce the greenhouse effect, ensure global biodiversity, and improve the living conditions for every person on the planet.

Some nations, among them Costa Rica, welcome the opportunities presented by debt-for-nature swaps. Other nations—Brazil is an example—see the swaps as a form of environmental imperialism in which foreign environmental organizations shape domestic government policy. They argue that restricting large areas of land for parks and nature reserves reduces the amount of land available for economic production and access by poor subsistence farmers.

Nations throughout the world are hopeful that debt-for-nature swaps can help mitigate climate change. Experts believe that these swaps could probe $100 billion to help countries adapt to climate change and restore ecosystems. According to the International Monetary Fund (IMF), by 2050, it may cost as much as $6 trillion per year to combat climate change throughout the world. Developing nations may not be able to pay their share without debt-for-nature swaps.

In 2023, through the sale of a bond that will mature in 2041, Ecuador will help protect the plants and animals living on the Galapagos Islands. In 2024, the country was considering using debt-for-nature swaps to help protect the Amazon rain forest.

Bibliography

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Mulder, Monique Borgerhoff, and Peter Coppolillo. “Global Issues, Economics, and Policy.” In Conservation: Linking Ecology, Economics, and Culture. Princeton, N.J.: Princeton University Press, 2005.

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Whiting, Kate. "Climate Finance: What Are Debt-for Nature Swaps and How Can They Help Countries?" World Economic Forum, 26 Apr. 2024, www.weforum.org/agenda/2024/04/climate-finance-debt-nature-swap/. Accessed 17 July 2024.