Debt-for-Nature Swap after IMF Extended Fund Facility?
Posted on November 29th, 2022

By Asiri Fernando The Sunday Morning

Colombo, November 27 (The Sunday Morning): The Sri Lankan Government is planning to explore alternative funding means such as the announced $ 1 billion ‘Debt-for-Nature Swap’ (DNS) programme in late 2023, following the approval of the anticipated $ 2.9 billion Extended Fund Facility, The Sunday Morning learns.

It is understood that the Government is keen to pursue the DNS programme after Sri Lanka’s debt has been restructured and made sustainable following negotiations with creditors.

Presidential Advisor on Climate Change Ruwan Wijewardene confirmed to The Sunday Morning that the Government was of the belief that DNS should be explored following the IMF programme and debt restructuring.

Meanwhile, according to the Ministry of Environment, the Government is slowly progressing with drafting a framework for the DNS programme with the Treasury taking the lead, aided by stakeholder consultations.

The development of the framework for a possible DNS programme comes in the wake of Sri Lanka’s commitments to global climate change and related issues at the recent United Nations Climate Change Conference (COP27) which was held in Egypt.

Sri Lanka, which declared bankruptcy earlier this year and holds over $ 50 billion in external debt, is struggling to find funding, with many lenders not forthcoming due to the economic crisis the country is facing and the ongoing debt restructuring programme.

As such, along with an ambitious reform and restructuring agenda, the Sri Lankan Government has indicated its keenness to explore alternative forms of funding and investment to help stabilise the economy and move towards recovery.

 What is Debt-for-Nature Swap?

According to former Director of Development Economics of the World Bank (WB) and Professor of the Practice of International Development at Georgetown University, Prof. Shanta Devarajan, a Debt-for-Nature Swap (DNS) is a transaction whereby a debtor country has part of its debt burden reduced in exchange for the country investing in protecting its environment.

In the case of commercial debt, the transaction involves a third party, usually an NGO such as the Nature Conservancy, which buys the country’s bonds at a reduced price and then ensures that the country undertakes the environmental investment. In the case of official debt, the government of the creditor country typically undertakes the transaction directly. These have been used by several countries, most recently Belize,” Prof. Devarajan told The Sunday Morning.

DNS programmes began in the 1980s, with Ecuador being the first country to try out the concept. A number of countries – such as the Philippines, Bolivia, and Uganda – have also used DNS in the past to manage debt and improve their environmental protection and resilience in the process.

According to Prof. Devarajan, while there would be interest from international financial institutions and conservation groups for such a programme, he pointed out that such a programme may not be best initiated in the present economic environment that Sri Lanka finds itself in.

When asked if a DNS programme would help Sri Lanka at present, Prof. Devarajan opined that while in principle such a programme could benefit Sri Lanka, it may not be what is needed on a priority basis.

In principle, such a programme can help a country like Sri Lanka, which has a high and unsustainable debt and a lot of environmental resources that the world is interested in preserving. In practice, the programme may not be the best thing for Sri Lanka at this time. The reason is that Sri Lanka needs debt relief in order to buy imports (fuel, food, medicines) and that is what the money saved should be used for. With a DNS, Sri Lanka would have to spend the money saved on environmental conservation which, although important, is not the highest priority at the moment when people are starving, and the economy is declining,” Prof. Devarajan explained.

Government’s thinking

Sri Lanka as a debtor, its creditors, and the globe can benefit from a well-planned DNS programme, Ministry of Environment Secretary Dr. Anil Jasinghe told The Sunday Morning.

According to him, both the lender and debtor have to agree to take part in a DNS programme.

There has to be a willingness from the lender to reduce some debt in exchange for some of the debt in place of some conservation work. That could be conservation of a forest, a reef, or a renewable energy programme,” Dr Jasinghe said, adding that a DNS programme could also include carbon credits in the future.

According to Dr. Jasinghe, the framework for the DNS is now being drafted by the Treasury, with the Environment Ministry’s assistance. As the framework is drafted, the Government will have to conduct nature capital assessments of Sri Lanka’s land and marine eco-space.

This will take some time; the Government’s focus at present is on getting the IMF programme approved. Whatever we do about the DNS, we will do it with the concurrence of the IMF, ” Dr. Jasinghe said.

Responding to a question, he said that innovative financial tools such as ‘green bonds’ and ‘blue bonds’ could only come after a framework was put in place and national debt was made sustainable. It is hard to imagine a bankrupt nation being able to issue bonds,” he said.

According to Dr. Jasinghe, the $ 1 billion amount reported in relation to the proposed DNS programme is what is envisaged for the framework that is being drafted.

President’s Advisor on Climate Change Ruwan Wijewardene told The Sunday Morning that although the Government would work in parallel with the IMF programme to develop a framework for DNS, it would only be implemented after Sri Lanka’s debt had been restructured and the four year-long EFF agreements had commenced.

We will look into all the renewable energy projects that can be taken up with a DNS framework once the debt restructuring is done. After that, we can explore other alternatives like blue bonds and green bonds, which was a topic that was discussed extensively at COP27. Many agencies have spoken to us about the DNS,” Wijewardene said.

According to him, the Government plans to analyse possible projects to be included in the DNS framework next year, including those in food security, agriculture, forestry, conservation, and renewable energy. 

We can start listing the projects. I think by the end of next year our debt will be restructured, and hopefully sustainable. The IMF also suggested that we wait till the assistance programme goes through for us to begin the DNS. Even the United Nations has discussed DNS with us and there are other parties who are also interested, including international banks,” Wijewardene explained.

When is the right time?

When asked if Sri Lanka could pursue alternative funding measures such as DNS before an IMF agreement was reached and debt restructured, Prof. Deverajan said Sri Lanka should not pursue such alternative financing before the IMF agreement because the IMF agreement would permit Sri Lanka to spend both the IMF’s loan and the money saved from debt reduction on essential imports to revive the economy and get essential imports to the people.

There is an additional risk in that Sri Lanka is currently in discussions with both official and commercial creditors about debt restructuring. If Sri Lanka discusses a DNS with the same creditors, that may disrupt the current negotiations and delay the reaching of an agreement,” he added.

Belize DNS

According to the IMF, the Government of Belize signed a debt-for-nature swap with The Nature Conservancy (TNC), an environmental organisation, which reduced the country’s external debt by a striking 10% of GDP.

Under the agreement, a TNC subsidiary lent funds to Belize to buy back a $ 553 million ‘superbond’ – the Government’s entire stock of external commercial debt, equivalent to 30% of GDP – at a discounted price of 55 cents per dollar. It financed this by issuing $ 364 million in ‘blue bonds’ in a sale arranged and underwritten by Credit Suisse, a bank. The US Government’s development bank, the International Development Finance Corporation (IDFC), provided insurance. This allowed the loan to have a low-interest rate, a 10-year grace period during which no principal is paid, and a long maturity of 19 years. In return, Belize agreed to spend about $ 4 million a year on marine conservation until 2041. It will double its marine-protection parks – spanning coral reefs, mangroves, and the seagrasses where fish spawn – from 15.9% of its oceans to 30% by 2026. An endowment fund of $ 23.5 million will finance conservation after 2040,” the IMF Country Focus of May 2022 said.

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