Mitigating the Debt-Climate Trade-off
Rising interest rates are pushing low-income, climate-vulnerable countries into debt distress, making it even more challenging for their governments to invest in conservation and decarbonization. But innovative financial solutions like debt-for-nature swaps could help alleviate debt burdens while strengthening climate resilience.
CAIRO – The sharp, almost synchronized, pivot by most of the world’s major central banks in raising interest rates has highlighted the growth-inflation trade-off that most countries now face. But it has given rise to another significant macroeconomic challenge – the Herculean task of balancing debt sustainability with climate-change mitigation and adaptation. The challenge is especially formidable in the Global South, where the rising cost of servicing external debts has reduced countries’ fiscal space and ability to pursue climate action.
Global warming is intensifying, and its negative spillovers are disproportionately felt in low-income, climate-vulnerable economies. Although these countries have contributed the least to the looming climate catastrophe, they find themselves on the frontlines of a crisis that, by increasing the frequency and likelihood of large economic contractions, represents a major long-term development risk. For example, the economic and social costs of the floods suffered by Pakistan in 2022 resulted in an estimated output loss of 2.2% of GDP.
As aggressive monetary tightening pushes more developing countries into or close to debt distress, addressing climate change becomes even more daunting. Fortunately, innovative nature-based financial solutions that can help avert both climate and debt crises have emerged. Debt-for-nature swaps, for example, enable countries to restructure their debt at a lower interest rate or longer maturity, with the proceeds being channeled to carbon-abatement projects.
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