The debts of developing countries were at the highest level on record before the great lockdown. Since the COVID-19 pandemic began, the fiscal space for most of these countries has narrowed sharply: foreign direct investment has cratered, tourism and commodity-based revenues have plummeted, remittances from citizens abroad have dropped and trade protectionism has risen.
One indicator of the deepening financial crisis in developing countries is that 103 countries the largest number ever have asked the International Monetary Fund (IMF) for emergency financing to help address rising poverty and crises in health care and other sectors. Yet longer-term and structural solutions are needed to minimize debt defaults by these countries. Surely some official creditors will write off some debt. But for a much larger portion of the existing loans, complex, often divisive debt restructuring negotiations between debtor governments and their multiple creditors are about to begin.
Debt restructuring deals may include a variety of features, including extending debt service repayment schedules, lowering interest rates and exchanging or swapping debt. In a debt swap, the original value of the loan is discounted, because it is clear that the debtor will not be able to pay the full amount, and the discounted debt is sold to another creditor, who takes on the debt in exchange for various commitments by the debtor.
Debt swaps that benefit nature or promote action on climate change have played a modest role in past debt-restructuring deals. In 2020, as the world faces another unfolding debt crisis for developing countries, coupled with the current global climate emergency and the decline of biodiversity and ecosystems, debt swaps can become more important instruments.