UNDP proposes ‘debt-for-nature swaps’ to tackle SL’s debt problem

• Potential deal under such swaps will allow SL to forgo part of its debt 
• Climate-related instruments to raise new debt as well as to forgo on existing debt now coming to mainstream
• But from a rating perspective, debt-for-nature swaps could still mean default on private creditors, says Moody’s
• SL’s climate risk remains among highest 30 nations 

Adding to the ways and means, which Sri Lanka could explore to restructure its foreign currency debt, the country has been presented with the option to forgo part of its debt in return for its aggressive commitment towards environmental conservation and investments in climate-related projects.  

Accordingly, the United Nations Development Programme (UNDP) has proposed ‘debt-for-nature swaps’ to the Sri Lankan government and to make use of the instrument, which “would allow a portion of the government’s large debt burden to be forgiven in exchange for the implementation of environmental policies or funding of conservation programmes,” a note from Moody’s Investors Service indicated yesterday. 

“If effectively implemented, debt-for-nature swaps have the potential to provide long-term credit benefits by offering debt relief while increasing investments that could bolster Sri Lanka’s resilience to environmental risks,” the rating agency added.

Debt-for-nature swap is nothing new, as a similar instrument had been used in 2010 by the United States to assist Brazil by writing off US $ 21 million of its debt in return for a pledge to use such money, which otherwise would have gone for debt servicing, to conserve Brazil’s rainforests and enhance the livelihoods of those who live in them.

However, these kinds of instruments may be gaining in popularity since last year, when the global leaders and corporate leaders joined forces in Glasgow last year to tackle climate change, which has threatened the existence of the planet Earth. 

The Glasgow climate summit added a flywheel to the ESG (environmental, social and governance) agenda of corporates and governments and added a new avenue into financing and investments as ESG investments grew very much in popularity globally. 

The proposal from the UNDP, the UN body, which is tasked with the responsibility of eliminating poverty and achieving sustainable economic growth in member countries, came amid Sri Lanka is getting ready to talk with its multiple creditors to restructure debt. 

The UNDP is the UN’s largest development aid agency, with offices in 170 countries.

While Moody’s doesn’t provide numbers as to what extent Sri Lanka may be able to get its debt forgiven via this environment-related swaps, the rating agency said the effective use of these swaps “may help reduce the government’s debt burden and debt servicing requirements, while providing long-term benefits through investments to mitigate environment-related risks”.

 Moody’s estimates Sri Lanka’s interest payments to absorb 70 percent of public revenue in 2022, with the debt-to-GDP ratio rising to 125 percent. 
Given the higher susceptibility of Sri Lanka to natural disasters such as droughts, flash floods and tropical cyclones, which affect rural household incomes through the disruption that caused to agricultural production, business activity and damages to private property, Moody’s is of the view that it is wiser for the country to explore this option. 

This is particularly true for Sri Lanka when nearly 30 percent of its labour force is engaged in agriculture, which accounts for just 7 percent of the economy. 
“Sri Lanka ranks 30th out of 180 countries in the 2019 Global Climate Index produced by Germanwatch, which measures exposure and vulnerability to extreme weather events,” Moody’s noted.

Providing a rating perspective of making use of such swaps, Moody’s said while it still tantamount to a default to the extent such instruments involve a loss for the private sector creditors. In cases where such default involves public sector creditors and public sector instruments, which Moody’s does not rate, the rating agency said the sovereign rating may not reflect the loss, given the default experienced by public sector creditors. 

“This would be similar to our treatment of some sovereigns during the suspension of debt servicing to creditors from Group of 20 leading economies under the Debt Service Suspension Initiative during the pandemic,” Moody’s said. 

“If private sector creditors were involved, we would consider the extent of losses for them,” it added. 

Moody’s last week cut Sri Lanka’s sovereign rating to Ca, with a Stable outlook, after the government announced it would default on its foreign debt on April 12.