Climate finance needs to acknowledge the unmitigated debt crisis

Even before the pandemic, developing countries were spending 30–70% of their revenue on debt service in 2019 as the debt burden of least developed countries alone reached a record $744 billion. The steep cost of Covid-19 responses, combined with revenue losses, pushed many countries even deeper into debt.

With their fiscal space narrowed so much by debt, how can governments possibly make the investments needed to spur low-carbon development and build resilience to climate change? A recent report found that poorer countries spend five times more on debt than on climate action. Climate change impacts exacerbate development challenges, increasing loan and aid dependence.

Too often, climate finance adds to the problem. Of the $78.9 billion that developed countries reported mobilizing in 2018 – of which $62.2 billion was public finance – only $12.3 billion was grants. At the same time, the share of public climate finance given out as loans rose from 52% in 2013 to 74% in 2018 as the share of grants decreased from 27% to 20%. While the World Bank and other multilateral development banks provide low-cost concessional loans to the poorest countries, around half of total loans provided for climate finance are still not below market rates.

Speaking on behalf of the Climate Vulnerable Forum, former Maldives President Mohamed Nasheed summarized the situation of countries like this: “We are so threatened that we might not have an island or a country much longer, so it’s hardly possible for us to pay the debt if we are not around.”

In light of the Covid-19 crisis, the G20, supported by the International Monetary Fund and World Bank, temporarily suspended debt service payments until the end of 2021, but lasting solutions are needed. At the annual Science Forum in September, SEI researchers focused on climate finance, equity and justice issues gathered to discuss potential solutions that we plan to explore more deeply after COP26. There are three key opportunities for climate negotiators in Glasgow to start moving in the right direction.

Explicitly prioritize grant-based finance

The Parties are looking to set a new climate finance target for 2025 and beyond. As part of this, they could set a specific target for grant-based finance in absolute terms or as a share of the total, making it clear that it should be a majority. The latter would be similar to the Paris Agreement’s goal of achieving a balance between adaptation and mitigation finance. Although that target itself has yet to be met, it provides leverage for developing countries in the negotiations. A grants-based target could serve a similar purpose.

Scale up debt-for-climate swaps

Developed-country Parties could also agree to provide debt relief in exchange for developing countries meeting conditional pledges in their nationally determined contributions. Debt-for-climate swaps have already been put on the table by Argentina and South Africa ahead of COP26 as a way to open up fiscal space for much-needed climate action. They could benefit low- and middle-income countries alike and catalyse green investments by spurring new projects.

Pledge grant-based bilateral climate finance:

Individual Parties can take the lead by pledging to provide a majority, if not all, of their bilateral climate finance as grants. Canada recently pledged to increase its grant share from 30% to 40%, but this is nowhere near the scale of change required. Announcing substantial commitments to grant-based bilateral climate finance would inspire others to follow suit and help build momentum for more grants-based finance under the $100 billion target.

Climate finance is a key means by which the principle of “common but differentiated responsibilities and respective capabilities”, a foundation of the climate policy regime, is fulfilled. Meeting finance pledges is therefore essential to protecting the legitimacy of the negotiations. The growing share of finance delivered as loans, not grants, raises troubling questions around the extent to which countries are honouring their historical responsibility. By recognizing and starting to address the debt crisis at COP26, Parties can show they are truly committed to climate finance and climate justice.