International Monetary Fund can help developing nations by helping planet

By Mark Malloch-Brown and Jean-Paul Adam

Financial negotiators descending on Washington for the International Monetary Fund-World Bank spring meetings this week will again attempt to resolve the escalating debt crisis in emerging markets.

Tackling the issue requires a long-term vision for sovereign financing to achieve greater stability and resilience in developing economies. One route forward lies in the burgeoning sustainability-linked debt movement.

Major creditor groups facing a wave of potential sovereign debt defaults are locked in disagreement over who should cast the lifeline of short-term debt relief, meaning there is currently no real pathway for addressing the problem beyond emergency response.

 

Despite this, the link between the loss of nature and creditworthiness in developing nations is well documented. A recent report by NatureFinance and a team of economists led by Cambridge University warns that “nature collapse” — severe environmental degradation and a massive loss of biodiversity — would increase annual interest payments on debt by up to $53 billion a year, leaving many developing nations at high risk of sovereign debt default — in effect, a form of  bankruptcy.

This is why, given the rising tide of vulnerability and the associated economic and political uncertainty, substantive discussion and consideration of scaling up sustainability-linked debt should be strongly embraced at the spring meetings and solidified through ambitious new commitments from multilateral development banks.

There is growing consensus around the use of performance-based sovereign financing solutions for both middle- and low-income countries. Increasingly, public and private lenders and major multilateral development banks are waking up to the vast potential of this approach. They have partnered to issue sustainability-linked sovereign debt, where countries explicitly target sustainable climate and nature outcomes in return for financing. Critical to these structures is a set of key performance indicators, or KPIs, that track country performance against predefined commitments, and transparent protocols around the measurement, reporting and verification of progress.  

The sustainability-linked debt market could well form the backbone of a new sovereign financing architecture that internalizes the increasing interlinkages between the triple threat of sovereign, climate and nature risks. Estimates put the market in emerging markets and developing economies at between $250 billion to $400 billion by 2030. Yet this is a vast underestimate once advanced economies and local markets come on board.

Two sustainability-linked sovereign bonds in 2022, by Chile and Uruguay, provided a crucial proof of concept. Unlike so-called green bonds, where strict limits apply to the “use of proceeds,” sustainability-linked bonds give countries complete autonomy over how they spend resources. They rely instead on financial incentives to spur performance.

In the context of the escalating nature and climate crisis, this kind of fiscal flexibility is like gold dust for low- and middle-income countries. And unlike the “conditionality” imposed by creditors under policy-based sovereign financing, these targets are chosen by the issuing sovereigns according to their own needs and priorities.  

To date, ad hoc relief has been provided through the Debt Service Suspension Initiative, a new issuance of Special Drawing Rights, and more “user friendly” long-term concessional loans through the IMF’s new Resilience and Sustainability Trust. The hope remains that the G-20 Common Framework for debt payments will overcome its dysfunctionality — which was recently demonstrated by the significant delays in support for Chad — to help debtor countries and creditors work out bespoke restructuring agreements. The new Global Sovereign Debt Roundtable, set up to deal with this stalemate, is a promising initiative — but has yet to indicate that it will succeed in bridging longstanding geopolitical divisions.

And there is still the huge challenge of getting private creditors to the table. Currently, all this group can see is a future of one-off debt swaps with massive haircuts and no reassurance of country-led Sustainable Development Goal investment strategies on the horizon. Enticing creditors will take a more durable win-win solution for the future of the $88 trillion sovereign debt market beyond the current crisis.

One critical pathway to scale this approach is for multilateral development banks to establish a coordinated pool of funding to underwrite credit enhancement for sustainability-linked debt. This would enable distressed and lower-income countries to tap deeper and more liquid pools of capital than they currently have access to.  

Creating a new credit enhancement facility for sustainability-linked bonds should be at the top the list for stakeholders at the IMF, World Bank and G-20 — particularly in considering how to move forward on the Capital Adequacy Framework review’s call to expand lending for critical challenges like climate change. Collectively providing guarantees, insurance and reinsurance at scale for sustainability-linked instruments in debt-distressed countries is exactly the kind of development-aligned “risk” capital that multilateral development banks should deploy as part of Bretton Woods 2.0.

This approach is also aligned with the spirit of the Bridgetown Agenda, spearheaded by Prime Minister Mia Mottley of Barbados, the Sustainability-linked Sovereign Debt Hub and the Sustainable Debt Coalition, both launched at the COP27 climate change conference last year. It offers concrete means to leverage greater multilateral development bank and private investment at scale to support financing for adaptation and resilience, while also speaking directly to the global debt crisis, increasing fiscal headroom and generating employment in growth sectors.

It is an approach that would not only take countries out of triage: It would significantly decrease the need for treatment in the first place. The potential upsides to building up this set of tools warrant discussion, and the IMF spring meetings are the perfect forum to do so.

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