Debt Cancellation: No Quick Fix for the Climate Funding Crunch

At the 27th Conference of the Parties to the United Nations climate change negotiations (COP27), taking place in Egypt from November 6 to 18, there will be renewed urgency to support vulnerable countries. The Paris Agreement forged in 2015 recognizes the need to “avert, minimize and address the adverse consequences of climate change”. But while “averting” and “minimizing” seem covered by mitigation and adaptation action, developing countries argue that the “addressing” part is missing and not defined.

Worse, additional text in the decisions in 2015 exclude any type of finance or compensation for loss and damage. However, developing nations have been fighting fiercely for a loss and damage fund with push back from developed nations. The latest discussion of a dedicated financial mechanism to address loss and damage was again postponed at COP26 in Glasgow in 2021, amid heightened economic uncertainty, despite the growing climate change-related destruction around the globe, particularly in developing economies.

A fresh alternative

This year, an alternative option to fund loss and damage has emerged: debt cancellation. Developed economies could write off a developing economy’s debts, unburdening them of repayments and interest, allowing them to redirect the money towards supporting their own loss and damage costs.

The idea and its practice are not new. Debt relief, partial or full, can be provided to eligible developing countries through the Heavily Indebted Poor Countries Initiative of the International Monetary Fund (IMF). Among other criteria, it requires a “poverty reduction strategy paper” and the amount of debt cancellation then needs to be re-invested into initiatives that benefit the most vulnerable and alleviate poverty. Similarly, the World Bank set up a debt-suspension initiative during the pandemic, which allowed developing economies struggling in the Covid-19 pandemic to reinvest into social, health or economic spending.

Supporting the countries reeling from the impacts of climate change seems like a win for everyone – developed economies wouldn’t need to find new funding and countries in need would have more agency once relieved of their debt obligations. The reality is more complicated, dogged by challenges of feasibility, capacity, transparency and equity.

There is still no guarantee that debt cancellation would provide developing economies with the resources and capacity needed to withstand climate change. Several small developing island countries such as Fiji and Vanuatu are in the process of strengthening their internal processes to manage their climate finance. Significant challenges such as cyclones and floods continue to derail their budget and fiscal position. It is difficult to forecast how the split of freed-up money would help all aspects of loss and damage. So-called non-economic losses such as culture, displacement, health or territory could pose a particular problem as money cannot replace them.

These challenges do not mean debt cancellation is unworkable. It just means the complicated, increasingly urgent path to financing loss and damage will not be solved simply. Nuanced proposals that can deliver a solution to the loss and damage question are out there. On a national scale, trust funds, for example, that manage the money spent on initiatives to address loss and damage have been formed including one in Bangladesh.

With any solution, in the absence of a universally agreed definition, it still requires elaboration on what it means to “address” loss and damage and a simple call for debt cancellation without a strategy for reinvestment is not as straightforward as it sounds. Debt cancellation could only solve part of the puzzle but should not dominate discussions on finding a comprehensive and overarching solution to loss and damage finance. Prioritizing debt cancellation as a simple form of compensation could hinder negotiations and agreement on mitigation pledges and increased adaptation efforts that avoid more loss and damage in the future.

Debt cancellation mechanisms may bring relief to developing nations that are struggling with the impacts of climate change, in addition to external shocks such as the Covid-19 pandemic. Rushing into such an ambitious policy, however, could be ill fated without a rigorous feasibility study and careful planning.