Debt swaps provide opportunities for raising capital in low-income countries to address environmental and other policy challenges and support green growth. There are also a range of risks and management issues that need to be addressed if debt swaps are to achieve their objectives.
The rationale of debt swaps is that debt can be acquired at a discount. When creditors do not expect to recover the full nominal value of debts, they may be willing to accept less. In exchange for (partial) cancellation of the debt, the debtor government is prepared to mobilise the equivalent of the reduced amount in local currency for agreed purposes on agreed terms.
Debt swaps are normally negotiated in the context of debt restructuring of public and publicly guaranteed long-term debt to official bilateral creditors, such as the members of the Paris Club. Debtor countries qualify if they are heavily indebted (according to IMF standards), if they have exhausted other more favourable debt relief instruments (e.g. unconditional debt relief), and if they can convince creditors that they are capable of allocating a sustainable part of the resources that have been budgeted for debt repayment to finance domestic projects which will yield significant environmental benefits at national, regional, or global level.
As experience shows, arranging debt-for-environment swaps (DFES) is not an easy task. It requires the concerted efforts of the whole government and very thorough preparations, including robust pre-feasibility studies, strong fiscal capacity, commitment to transparency and international credibility of the domestic spending and expenditure programme that is attractive to the whole government. With caution and determination, DFES is a realistic option for some countries and can play a significant role in mainstreaming the environment in government policies and in domestic environmental financing.
During the first half of the 2000s, two Eastern Europe, Caucasus and Central Asia (EECCA) countries – Georgia and the Kyrgyz Republic – qualified for debt swaps, including DFES, under the Paris Club rules. Both countriers requested the Environmental Action Programme (EAP) Task Force co-operation in analysing options for the transaction structure of the DFES arrangement, its institutional set-up, the expenditure programme that can be covered from the swap resources and the overall negotiations strategy with potential creditors.
The analysis demonstrated that such arrangements in the two countries were feasible and, if properly designed, could generate additional environmental expenditure for the countries as well as benefits for the international community, including creditors. Unfortunately, neither Georgia nor the Kyrgyz Republic succeeded in carrying through the negotiations to a successful completion.
The lessons learnt from the experience with designing, negotiating and implementing DFES in Georgia and the Kyrgyz Republic as well as in other (mostly Central and East European countries which implemented successfully such swaps - Poland and Bulgaria) were further summarised and could be of interest to other countries that may consider entering into such swaps.