A widening climate debt trap

With over $7.2bn in so-called concessional loans failing to address poverty in poorer countries like Nepal, the pressure is now on the West to shift toward debt relief or grants. Meanwhile, climate change has become a convenient pretext to impose additional loan burdens on vulnerable LDCs like Nepal. This is already evident in Nepal through initiatives like the Green, Resilient and Inclusive Development (GRID). Multilateral lenders like the World Bank and the IMF, exploiting the greed of Nepali finance bureaucrats for petty benefits, have secured blind approvals for millions in loan agreements in the name of disaster resilience.

This looks like the most likely scenario given the ongoing discussion in COP29 at Baku. A new climate finance goal is up for discussion, which may scale up to $1trn every year by 2030. This was a replacement for an unrealized $100bn target. The funding gaps relating to mitigation, adaptation and clean energy transition need to be addressed. These include diversification of funding through non-grant elements of grants and concessional loans, private sector involvement, and predictability and accessibility to developing nations of funds. Other innovative mechanisms in contemplation for mobilizing additional resources include the Climate Finance Action Fund.

The recent report of the Change Initiative details how the ‘Climate Debt Risk Index 2024’ says Least Developed Countries fall into debt because of climate financing practices. Though they contribute less than 3.3 percent of the global emissions, their countries suffer the most drastic impacts of climate change and are persistently entangled in a web of debt from loans issued for climate resilience and adaptation.

It also highlights the ‘climate debt trap’, where LDCs are forced to borrow extensively in order to combat the vagaries of climate. “The current reliance on  loan-based climate finance,” the report says, “is leaving many countries exposed to debilitating debt, taking money away from vital investments such as health care and infrastructure.” Ironically, this framework has undermined the resilience it was designed to foster by keeping LDCs near financial bankruptcy.

This report states, “LDCs are among those most vulnerable to the impacts of climate change and yet bear the highest financial burden through unsustainable loan practices.” Debt related to climate in these countries has risen significantly, constraining their potential for effective application of sustainable climate strategies and, generally speaking, their development.

Climate Debt Risk Index (CDRI) measures countries' risks regarding climate debt for the next decade and projects a likely increase or stability in the levels of debt. The CDRI spotted many high-risk zones, mainly located within South Asia, East Africa and Southeast Asia, showing striking regional differences in vulnerability and loan dependency.

Within South Asia, Sri Lanka and Bangladesh emerge as displaying a very high risk. The former will witness its risk score reach up to 74.17 points by 2030. Bangladesh also emerges as a very high risk because it has signed loans worth $14.31bn, and on account of heightened vulnerability across climate and loan dependence, Bangladesh will emerge as a country slipping from high to very high risk. On an average, East Africa bears the highest risk levels, as already witnessed by record CDRI scores of Mozambique and Madagascar.

The score for Madagascar will peak in 2030 at 81.41, a debt risk category classified as ‘very high’. Meanwhile, in Rwanda, the risk jumps significantly from high to very high risk in light of increased climate challenges.

In Southeast Asia, Myanmar still has one of the highest climate debt risks, with an estimate of 78.87 by 2030, whereas Cambodia and Laos remain high-risk countries due to increased dependence on loans arising from climate finance. The Philippines has demonstrated only a moderate level of debt risk, but many challenges persist. It also categorizes West Africa and the Caribbean as vulnerable zones, while climate-related loans are driving countries like Senegal and Haiti toward high risk by 2030.

Dependence on loans

One disquieting trend reflected in the index is that though climate finance continues to flow in LDCs, much of this is loan-based. In the case of Bangladesh, it has received a total climate finance of $14.31bn, with a Loan-Grant Ratio of 8.34, indicating that loans are highly predominant over grants. Whereas Sri Lanka has a Loan-Grant Ratio of 12.13, one of the highest in the report. Afghanistan relied on grants only and received $0.42bn with no loans, suggesting an absolute breach between debt-burdened and debt-free countries. This creates loan dependency that increases their vulnerabilities, as they have to pay these debts while staring at climate disasters.

According to the report, such financial burdens are unsustainable and divert countries from investing in very important aspects necessary for building resilience against climate impacts.

Adaptation vs mitigation

The second most striking pattern is the differential adaptation and mitigation funding across LDCs. Countries such as Pakistan, a country that received $1.84bn for climate finance in the first instance decided to spend on mitigation at $1.45bn, hence having a low Adaptation and Mitigation Ratio of 0.29. Cambodia has spent more on a balanced approach, with an Adaptation and Mitigation Ratio of 2.07, having equal efforts in both areas.

This means, in practice, mitigation will have a role of reducing the emissions, whereas adaptation measures are core to the LDCs, whose current impacts of the climate change-related events such as flooding, hurricanes, and droughts are already felt. Indeed, it has been suggested that without proper financing of adaptation, these countries will continue to suffer significant economic and social damages. According to the report, a more balanced financing model is important in strengthening resilience.

Sustainable climate finance

The findings of the Climate Debt Risk Index 2024 bring forth actionable solutions on how to mitigate the climate debt crisis the LDCs find themselves in. First, it advocates for a shift from loan-heavy climate finance toward grant-based financing, especially for projects targeting adaptation and loss and damage. This would involve more grants and less loans, hence enabling the LDCs to reduce their debt burdens while building resilience sans increased financial burdens.

The report also recommends debt-for-climate swaps as a method to transform outstanding debts into climate resilience funds, easing burden off the national budget while pursuing climate objectives. In such a deal, part of the country’s debt would be written off in exchange for spending on climate resilience, adaptation, or biodiversity protection. Having proven potentially workable in the past, it is therefore recommended as a means of pursuit for countries at high risk.

Besides the debt-for-climate swaps, the report prescribes innovative financing mechanisms in the form of climate resilience bonds and carbon taxes. Climate resilience bonds would raise funds dedicated to adaptation, while carbon taxes would represent a new revenue stream, keeping off the burden of national debt for climate projects. According to the report, such mechanisms could be decisive in bringing the global climate finance paradigm into the realm of sustainable solutions.

Global policy reforms 

The Climate Debt Risk Index 2024 report includes several remedies regarding the climate debt burden on LDCs. First and foremost, it calls for grants over loans in adaptation and loss and damage to reduce dependence on debt-heavy financing structures that result in a growing financial burden on these countries. It also calls for ‘debt-for-climate swaps’ that would allow part of the debt to go toward building resilience to climate change, thereby reducing fiscal burdens on those economies.

The report calls for global policy reforms to ensure due transparency in the allocation of climate finance, hence backing these financial shifts. It also sets out a clear, standardized set of metrics under the UNFCCC to track the effective delivery and verification of climate finance, hence ensuring equitability and efficiency in its use. These solutions together contribute toward the paradigm shift that needs to take place for the delivery of climate finance in a more sustainable, transparent and equitable manner for LDCs.