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This report outlines the challenges for developing countries and potential ways to overcome them.

 

*Climate and financial vulnerabilities of developing countries – and their solutions – lie mostly in factors outside their control

 

Recent devastating nature-related events, such as the flooding in Pakistan in 2022 or the Idai cyclone which ravaged Northern Mozambique in 2019, may likely be the symptoms of the intensification of climate change. The international scientific community is unified in its stand that developing countries in general will be the hardest hit relatively by climate change, both because adverse climate-related impacts tend to be concentrated in tropical regions and because developing countries have lesser resources than developed countries to cope with the economic, social and other environmental fall-outs from climate-related physical impact. This is despite their low historical contribution to global greenhouse gas emissions.

In addition to this climate challenge, developing countries face structural financial and macroeconomic constraints. One of the main reasons for this constraint lies in the fact that incomplete financial markets impede developing countries from borrowing abroad or long-term in their own currency. Most of their debt is therefore denominated in foreign currency, usually in US dollars, which exposes them to currency mismatch and volatility between their assets and liabilities. This has been coined an “original sin” in economic literature, because the reasons for such an inability to borrow in domestic currency lie in factors outside the control of developing countries.  

In this policy brief, we contend that both the climate and financial vulnerabilities of developing countries, particularly certain low and lower middle-income countries, can be deemed as “original sinS”: they have immense negative consequences for their development and stability but the root causes originate largely from variables independent of their actions and management.

The international community has recently launched several initiatives to catch up and try address some of these thorny and complex issues. On the climate adaptation side, COP 26 laid the ground for doubling climate change adaptation finance by 2025, and COP 27 resulted in the launch of the Sharm-El-Sheikh Adaptation Agenda. It also concluded with the creation of a Loss and Damage Fund to compensate vulnerable countries for climate change impacts. On the financial stability side, the temporary G20 Debt Service Suspension Initiative launched in 2020 aims at tackling liquidity shortage which developing countries have faced arising from the Covid-19 pandemic. The G20 extended it with a permanent initiative, the G20 Common Framework for Debt Treatments, which is aimed at improving the global framework for managing developing countries’ solvency. 

However, it would appear that many of these initiatives fall short of linking the international agenda for climate adaptation to the financial issues of developing countries, even though the strong nexus and the direct interaction between these two dimensions intrinsically make the case to warrant it. On the one hand, both the high exposure and lack of adequate resilience to the adverse impact of climate change can exacerbate the existing weak macroeconomic conditions of some of these developing countries. On the other hand, the constraints some of these developing countries face in accessing stable and long-term financial capital further impede financing for crucial adaptation measures necessary to strengthen resilience to the physical impact of climate change events. 

This policy brief explores these interactions and seeks to build the case for actively intertwining the international agenda for climate adaptation and financial stability of developing countries as a whole.

Section 1 lays out four arguments in favour of intertwining these agendas. 

Section 2 highlights debt-for-adaptation swaps and adaptation-linked debt restructuring as means to implement this approach, including to tackle the emerging debt crises which many developing countries face as of end of 2022. These instruments and interventions have already been analyzed and discussed by other institutions and authorities, including the IMF, the Heinrich-Böll Foundation and the Economic Commission for Latin America and the Caribbean. The main contribution of this policy brief regarding these instruments is to propose a workable methodology for identifying countries most in need of their application such that the roll-out can be speeded up. 

Section 3 opens up on whether a reform of the international monetary system may eventually be required for a complete integration to happen between the international agenda for climate adaptation and the financial stability of developing countries. It would be a fair assessment to state that, at the time of writing this policy brief, a full-fledged discussion of the vital deficiencies of the international monetary system when it comes to accelerating climate change – and the potential solutions to effectively remedy it – has not really started. Section 3 of this policy brief aims at triggering such a discussion, which we hope can be further developed in future research.

To make our above comments abundantly clear, we reiterate that this policy brief seeks to focus on low-income and lower middle-income countries, which are the country categories found to be the least resilient to the adverse impact of climate change and also relatively the most constrained in their ability to access financial capital efficiently and in a sustained manner. References are made to developing countries in general when supporting data and factual information for low income or lower middle-income countries cannot be adequately or reliably sourced.

 

Section 1: four arguments for linking climate change adaptation to the prevention and management of debt distress of developing countries

Debt-for-adaptation (DFA) swaps are voluntary-based agreements between a creditor and debtor to swap (sometimes part of) the creditor’s claim in exchange for the debtor’s pledge to implement certain corresponding adaptation investments. Adaptation-linked debt restructuring refers to a set of agreed actions and operations a debtor conducts, with several creditors or categories of creditors, to reduce and/or delay the terms of debt against a commitment by the debtor to implement adaptation investments. There are four principal arguments in favor of using these tools in the current context of developing countries. 

Argument 1: a debt crisis is looming in many low-income and lower middle-income countries

Many low-income (LICs) and lower middle-income countries (LMCs) are, as of 2022, at the edge of a public debt crisis. This can be approached in three contributing factors: a steady increase in debt and debt service levels before the onset of the Covid-19 pandemic, the negative shock it triggered, and the impact of the current macroeconomic situation characterized by geo-political tensions, commodity price inflation, rising interest rates and monetary contraction, among others. 

Factor 1: External public debt of LICs and LMCs increased by respectively 25% and 39% in absolute value from 2015 to 2019. While the service on this debt increased on par for LMCs, it increased by more than 60% for LICs. This led to close to a doubling of external public debt service to government revenue between 2015 and 2019 for LICs (Figure 1).

Factor 2: The Covid-19 pandemic led to a contraction of GDP growth, which totaled 0.1% in LICs and -3.3% in LMCs in 2020. The prevailing trend of increase in debt reimbursements and interest payments, which was already hardly serviced through growth, started putting strong pressure on government revenues when growth vanished.

14% (10%) of government revenue of LICs (LMCs) was dedicated to debt service in 2020, and this figure will plateau strongly above its pre-Covid level at least until 2024 for LICs (Figure 1).  

Factor 3: The global slowdown triggered by the crisis was further exacerbated by the Ukrainian war. It put pressure on already tense commodity prices, triggering inflation. The global slowdown triggered a flight to hard currencies (mostly to the US dollar), which created depreciation pressures on developing countries’ currencies and further fueled inflation. The response to it – interest rate hikes by central banks of developed economies – further enhanced depreciation pressures on developing economies (Figure 2). These developments contributed to enhancing the cost of external debt service of developing economies, usually denominated in US dollars. Since a significant share of the external public debt of developing economies has variable interest rates, it also contributed to increasing base interest rates and therefore absolute debt servicing costs. 

As of September 2022, as a consequence of these three factors, 37 developing economies are at high risk of debt distress or already in debt distress (Figure 3).   

 

Argument 2: climate change impacts are accelerating in low-income and lower middle-income countries 

Developing countries are at the forefront of climate impacts. As Figure 4 shows, the number of disasters which are enhanced by climate change is strongly accelerating since the early 1970s. It has been increasing faster in current LICs and LMCs than in upper middle-income and high-income countries, because of differentiated geographical exposures to climate change impacts but also less resilience to them compared to more developed countries. 

Moreover, as Figure 5 shows, climate change may have tremendous detrimental impacts on GDP. If most studies only anticipate a few percent decline in GDP growth by 2050/2100 due to climate change, they leave in the dark a significant share of the future impacts of climate change on the economy. This is simply because not all impacts and impact transmission channels to the economy can be modeled, but if taken into account, it may make the picture look a lot starker. Swiss Re, the leading global reinsurer, estimates that a 3.2°C temperature increase could lead to up to 25% of GDP reduction in Africa and Asia by 2050 relative to no climate change and when trying to account for unknown impacts and unknown impact channels, against “only” 3 to 5% when they are not (Figure 5)

 

Argument 3: adaptation finance needs in developing countries are substantial and unfulfilled

Required adaptation investments in developing countries are high. The United Nations estimates the annual cost of adaptation in developing countries to be $160 billion by 2030 and $315 billion by 2050 if global warming is contained below +2°C by 2100. These figures double to reach $340 billion and $565 billion respectively under a +4°C scenario (Figure 6).

Current adaptation investments in developing countries are at best minimal or low if not virtually non-existent compared to the level needed. The Climate Policy Initiative estimates that adaptation investments currently amount to $49 billion globally (Figure 6). Current global adaptation investments are therefore only a quarter of what would be required by 2030 in developing countries. Moreover, official development assistance is falling short of the needs of developing countries with an estimated bilateral public flow channeled to adaptation projects of $20 billion in 2019, and multilateral flows from development banks of $15 billion that same year.  

 

Argument 4: a climate liability of Global North to Global South mirrors a financial liability of Global South to Global North

Cumulative and overshot emissions are mostly accounted for by Global North countries. Hickel (2020) shows that two-thirds of cumulative greenhouse gas (GHG) emissions from 1850 to 2015 were accounted for by Global North countries, and another third by Global South countries (Figure 7.a). But what matters more for identifying responsibilities in the climate breakdown are GHG emissions above a certain threshold from which climate starts changing significantly. Hickel (2020) came up with a method to do so. Its methodology relies on the idea that each person is entitled to an equal amount of GHG emissions, and emissions above this threshold are considered overshot emissions. To identify this threshold, it uses a carbon budget equivalent to 350 parts per million (ppm) of atmospheric CO2 concentration, the CO2 atmospheric concentration threshold above which climate is significantly altered, and allocates it evenly across the global population, using population average from 1850 to 2015. These are then broken down at national levels. Results indicate that as of 2015, the Global North was responsible for 92% of historical overshot emissions (Figure 7.b). It can therefore be argued that (at least some) Global North countries have a “climate liability” to (at least some) Global South ones, because of their overuse of the atmosphere

This “climate liability” mirrors a financial liability from South to North. For instance, as of 2022, LICs, which are all Global South countries, owed $18 billion to Paris-club members on their external public debt, which are all Global North countries, and $90 billion to private creditors (loans or bonds), which a significant share is likely to be owed to creditors from Global North countries

 

The combination of strong financial vulnerability (argument 1), the negative impact of climate change on GDP (argument 2) and high adaptation investment needs (argument 3) potentially worsens the financial outlook of developing countries. Figure 8 shows that, on average for LICs and LMCs, the higher the risk of external debt distress, the lower the resilience to climate change as expressed by the ND-GAIN index (the lower the GAIN index, the less the country is resilient to climate change). The countries most impacted by climate change, which have the highest adaptation investment needs relative to their financial resources, are facing aggravated financial constraints. The lack of investments in adaptation will likely further worsen this constraint and fuel debt distress, potentially triggering doom loops of climate change adverse events and financial crises. 

Therefore, the approach of linking the prevention and management of debt distress of developing countries with climate adaptation makes sense. A way to do this is by acknowledging the notion that developed (Global North) countries have a pent-up climate liability owed to developing countries (argument 4), which can be justified as the moral basis for the former to provide debt relief to the latter in the form of debt-for-adaptation swaps and adaptation-linked debt restructurings.

 

 

Section 2: linking climate change adaptation to the prevention and management of debt distress of developing countries

1. Implementing debt-for-adaptation (DFA) swaps

DFA swaps pursue strengthened debt sustainability and adaptation to climate impact. The case for DFA swaps lies where strengthened debt sustainability is needed to create fiscal space for adaptation investments and when adaptation investments enable strengthened debt sustainability. However, countries at the edge of defaulting should undergo debt restructuring, which gathers a larger number of creditors than debt swaps and therefore allows a stronger impact on debt sustainability (cf. section 2.2). Therefore, as the International Monetary Fund (IMF) argues, DFA swaps are relevant when (i) fiscal space is constrained but debt is not unsustainable and (ii) adaptation investments are efficient in fostering long-term debt sustainability. DFA swaps can therefore be thought of as precautionary actions with regard to debt sustainability and adaptation to climate change. 

The two conditions put forward by the IMF can be estimated using data from the World Bank Debt Sustainability Analysis (DSA) and the ND-GAIN index. The DSA framework is a framework allowing to measure developing countries’ debt distress and classify them into different categories of debt distress risk: low, moderate, high and in distress. A moderate to high external debt distress risk as per the DSA framework is an approximate indication of countries with sustainable debt but with a lack of fiscal space. The ND-GAIN index – already introduced in section 1 – is a measure of countries’ vulnerability to climate change and readiness to face its impacts. Countries with high vulnerability and low readiness have “a great need for investment and innovation to improve readiness and a great urgency for adaptation action”. Figures 9 and 10 map the 41 LICs and LMCs which are considered at moderate or high risk of external debt distress with regard to their vulnerability and readiness profiles. 34 countries in this sample are highly vulnerable to climate change and poorly ready to adapt to it. 

       

Countries in the upper left quadrants of Figures 9 and 10 above which have a relatively high share of external debt owed to Paris club members may be considered for DFA swaps. To maximize debt relief and climate adaptation, DFA swaps must be done on a significant portion of the debt. In the short term, the most relevant option is to implement DFA swaps on debt owed to Paris club members. These creditors are the most prone to grant debt relief in a relatively timely manner. Moreover, debt-for-nature swaps have usually been done by Paris club members in the past, and they can leverage this experience for DFA swaps. Mobilizing private and other public creditors would obviously strengthen the efficiency of DFA swaps. 

Using a threshold of 10% of external public debt owned by Paris club members, Vanuatu, Senegal, Afghanistan, Cameroon, Papua New Guinea and Kenya appear relevant for implementing DFA swaps in the short term (Figure 11). A swap of 75% of the debt these countries owe to the Paris club would concern $7.5 billion. This would cover more than 50% of Senegal’s declared total adaptation investment needs, and 40% of Papua New Guinea’s

 

Best practices for implementing Debt-For-Adaptation swaps1/ DFA swaps should rely, as much as possible, on existing adaptation plans of developing countries. Projects financed by DFA swaps should be relevant to the adaptation plan of the country. This would allow to foster country ownership of the investment funded by the swap. Adopting an adaptation plan and reflecting it in Nationally Determined Contributions or National Adaptation Plans (two documents under the UNFCCC framework) reveals a country’s awareness of its adaptation challenges. It can send a positive signal for potential creditors to implement DFA swaps. 

2/ DFA swaps must be transparent, programmatic and long-term. Transparency in adaptation investments and fiduciary management systems of the debtor countries and adopting an open and democratic management approach will incentivize creditors to implement DFA swaps. It is also necessary for the debtor country to establish management systems that show the efficient use of financial support, and to establish monitoring and document-based reporting systems. Such monitoring should be implemented over the long term since adaptation investments usually deliver benefits in the medium to long term.

3/ Creditors can provide capacity building to make the implementation of the underlying adaptation projects easier and hassle-free. The Green Climate Fund and Global Environmental Fund offer capacity building and technical assistance to local adaptation initiatives, which could be leveraged for adaptation projects financed through DFA swaps.

 

2. Including an adaptation component in debt restructuring

When a country is already in distress, a restructuring process is needed to which adaptation measures could be attached. Attaching adaptation conditions to a debt restructuring program is efficient when adaptation investments have a significant impact on the solvency of the borrower. All LICs and LMCs currently in external debt distress are highly vulnerable to climate change and inadequately prepared to handle the impact (Figure 12). For a number of these countries, debt restructuring is already underway or terminated, but as Figure 12 shows, it would likely have been relevant to include adaptation conditions in their restructuring processes. Adaptation investments must be financed by additional debt relief compared to a baseline restructuring, to acknowledge the climate liability of developed countries to developing countries. 

Zambia provides a good example of a country currently in debt distress because of accelerating environmental degradation. The country defaulted on its external debt in 2020 and has been struggling to get a restructuring of its debt until the end of 2022. The country’s default has been driven by poor economic performance directly stemming from two severe droughts since 2015 and the Covid-19 pandemic in 2020, two types of events which are favored or caused by environmental degradation.

The newly created G20 Common Framework for Debt Treatments should foster enhanced adaptation investments. This framework has been created in 2020 to ensure that, in the event a debt relief of a LIC is required, all G20 members contribute jointly to the negotiations. The Framework also seeks equal treatment of private creditors – which means that they should apply debt relief on comparable conditions – which are usually not taking part in sovereign debt restructuring and therefore benefit from a de facto senior debt position compared to bilateral creditors. The Framework can be implemented along with an IMF-supported program, which provides creditors with information on the required debt treatment to restore debt sustainability.

The Framework could be further enhanced by introducing adaptation investment conditions, which can then be financed through write-offs, two features it currently leaves aside. The role of the IMF could be extended to providing creditors, in coordination with the concerned country and the World Bank, with information on the adaptation investments which would best foster long term debt sustainability of the country, and the required debt write-offs to finance them. This can be beneficial in the long term to both debtors and creditors since strengthened adaptation investments tend to improve the macroeconomic outlook for debtor countries. 

 

 

Section 3: will a reform of the international monetary system be eventually needed?

DFA swaps and adaptation-linked debt restructuring can prove very useful to tackle the intertwined climate and financial vulnerabilities of countries. However, they remain crisis management tools and can by themselves hardly be sufficient to provide the full means for climate adaptation and long-term financial stability of developing countries. Structural financial constraint, and increasingly climate vulnerability, cross over from and into the deficiencies of the international monetary system which DFA swaps and adaptation-linked debt restructurings do not address. A reform of the international monetary system may eventually be needed. This section explores this hypothesis, but deeper research is needed to refine and make a compelling case for it. 

1. Why is the current international monetary system not fit for tackling the challenges associated with climate change impacts?

The current international monetary system suffers from deficiencies which hamper adequate business cycle management by developing countries. The international monetary system features strong procyclical tendencies which are a factor of macroeconomic volatility in developing countries. Developing countries often feature liberalized capital accounts, which favor the pro-cyclicality of capital inflows and outflows (overheating in booms and drying up of financing in busts). It severely limits the effectiveness of governments and central banks’ countercyclical policies in developing countries. 

Moreover, the existing international financial safety net available to developing countries to manage crises resulting from busts is thin. For instance, many developing countries are excluded from swap networks between central banks, which are restricted to developed and some emerging countries. This favors the accumulation of reserve currencies (so-called hard currencies), especially the US dollar, by developing countries to face down cycles: they use their reserves to maintain liquidity of the local currency in times of crisis. This can fuel global imbalances: reserves in hard currencies are reinvested in hard currency countries instead of being exchanged against local currencies, maintaining exchange rate undervaluation of countries accumulating hard currency reserves and fueling potentially unsustainable capital inflows in hard currency countries.

Finally, there is no institutionalized international debt workout mechanism. Debt restructurings of countries in debt distress rely on voluntary participation of creditors and incentives to take part are thin. This results in an insufficient restructuring of developing countries’ debts when they are in distress. Debt restructurings are also often implemented in an untimely manner, after a crisis already had a significant detrimental impact on economic and social outcomes

Yet, climate change impacts will strengthen the macroeconomic instability of developing countries. They will put weight on growth, reducing the size of upward cycles, and will trigger strong negative macroeconomic shocks. The case of the 2022 flood in Pakistan – largely attributable to climate change – provides an interesting example of what we are likely to see more and more in the future. It resulted in a loss of $40 billion (12% of GDP) and destructions triggered created a weight on long-term growth, aggravating an already unsustainable debt situation. Destructions of crops have forced the country to increase its trade deficits to import food, pressuring down hard currency reserves and the rupee. Government spending increased to face the adverse effects of flooding. This pushed up external debt levels, which eventually led the country to call its creditors for a debt relief plan. 

The impact of climate change will therefore put more pressure on developing countries, and the above-mentioned deficiencies of the international monetary system are likely to be felt even more

  • Strengthened macroeconomic volatility due to climate change will likely be enhanced by financial procyclicality. Relatively small financial markets make developing countries highly vulnerable to sudden capital outflows – so-called capital flights. A negative climate event could trigger a capital flight, leading to a drying up of financing and causing a liquidity crisis. 
  • Increased macroeconomic instability due to such impacts will likely result in developing countries trying to accumulate more hard currencies, which would further fuel global imbalances. 
  • Increased climate change impacts will likely be a catalyst of debt distress, through both their negative impacts on GDP and the need of developing countries to borrow and invest to rebuild infrastructures after a negative climate event and to adapt to climate change. Consequently, the lack of an efficient debt workout mechanism is likely to be felt even more. 

The international monetary system also hampers adaptation investments in developing countries. Adaptation investments are characterized by their public good characteristic. They mostly feature non-appropriable benefits which make the government, as opposed to the private sector, the main institution to implement such investments. But government finance of developing countries is inhibited by the deficiencies of the international monetary system:

  • Hard currencies are highly liquid and stable as they are considered safe by investors (mostly the US dollar, but also the euro, the British pound or the yen). On the contrary, soft currencies of developing countries are rarely accepted internationally and are highly volatile and illiquid. This results in the need for developing countries governments to borrow in hard currencies and compensate for the risk associated with the volatility of their currency by offering higher interest rates on their debt. High interest rates are particularly detrimental to adaptation investments, which feature indirect and long-term benefits and may therefore appear insufficiently profitable. 
  • Capital flows to developing countries are mostly driven by exogenous factors, such as the interest rate set by the US federal reserve, and largely disconnected from domestic economic conditions. As a consequence, developing countries lack the financial autonomy to implement long-term development plans, including climate adaptation strategies, and focus on short-term export-led strategies to acquire hard currencies in order to sustain liquidity in the event of an economic crisis. 
  • Hard currencies accumulated as reserves are re-invested in hard currency-denominated assets (for instance in US Treasury bonds) and are thus unavailable to be traded against the developing country’s currency to finance adaptation investments locally.

The current international monetary system is therefore not fit for properly navigating the climate crisis. Drivers of macroeconomic instability of developing countries will be further strengthened while the international monetary system performs poorly in enabling developing countries to manage up and down cycles. Moreover, strong adaptation investments are needed but are structurally hampered by the international monetary system, some of the factors explained above. In a forward-looking sense, climate impacts will likely make a reform of the international monetary system more pressing.

2. Potential avenues for reforming the international monetary system at a time of accelerating climate change

Numerous reforms to alleviate the deficiencies discussed above are already widely discussed by experts and the scientific community. Among other options, the following set of reforms – which have been proposed by others but (some of) which we link more explicitly than previous authors to adaptation requirements of developing countries – would prove particularly useful to favor the adaptation of developing countries to adverse climate events increasing in frequency and scale. The following proposals are meant to engage the discussion, but more research is required to better explore how and what reforms of the international monetary system can contribute to foster the adaptation of developing countries to climate change. 

  • Strengthen the role of the Special Drawing Rights (SDR) as a reserve currency

SDRs are an international reserve asset managed by the IMF and aimed at playing the role of a reserve currency along with national hard currencies. SDRs are allocated to IMF members on an ad hoc basis, usually in times of economic crisis such as in 2021, in the midst of the Covid-19 pandemic. Higher SDR allocations to developing countries would reduce the need for developing countries to hold precautionary reserves in hard currencies. This would require delinking the allocation of SDRs from IMF country quotas to enable developing countries to receive a significant share of SDRs and use them as a reserve asset.

Developing countries would be able to use the proceeds of exports not as reserves but to finance local development projects, such as adaptation projects. It would also enable developing countries to focus less on short-term, export-led development strategies aimed at acquiring hard currencies, and rather embrace development strategies centered on diversification, which is a central driver of long-term macroeconomic stability which will be more and more at risk due to climate change impacts.

  • Enable the use of SDRs for the financing of adaptation-related projects in developing countries

Several authors already proposed to use SDRs to finance climate-related projects, but rather focusing on climate change mitigation. SDRs allocated to countries but unused by them could be channeled to development banks, such as the Green Climate Fund, the World Bank or the African Development Bank, to finance adaptation projects. SDRs would therefore contribute to macroeconomic stability both as a reserve asset and a source of funding for climate change adaptation.

Private funding to developing countries may become scarcer and more expensive as climate change accelerates. Climate change, especially if left unchecked, will entail “unhedgeable risks” and therefore strongly restrain an already limited access of developing countries to international capital. Public capital, may it be national or international, will therefore be called upon to play a more important role in the financing of these economies, and mobilizing SDRs would allow to do so while limiting the constraints on governments’ balance sheets. 

  • Promote the use of capital account regulations (CARs) as a tool to foster macroeconomic resilience to climate change impacts

CARs are measures to control international transactions in which a country’s residents are involved. They have been found to strongly favor macroeconomic stability. Stronger and wider use of CARs would contribute to the resilience of developing countries to climate change impacts. It can enable to limit the scale of capital flights in the event of a negative climate impact. 

  • Build an efficient sovereign debt workout mechanism

The absence of an efficient debt workout mechanism incentivizes both debtors and creditors to delay restructuring and forces debtors to adopt contractionary adjustment policies during a debt crisis. This results in strengthened liquidity and solvency issues, and delayed, insufficient debt restructuring. 

As already shown, there is a strong correlation between the lack of resilience to climate change impact and the risk of external debt distress of developing countries (cf. Figure 8). If the causality link between the former and the latter is, up to now, unclear, climate-related shocks will likely fuel sovereign debt risk in the future. This will make more pressing the need to adopt efficient debt restructuring processes. If the integration of aggregation clauses to sovereign bond contracts can help, the creation of an “International Debt Restructuring Court” seems the most efficient way to address this issue. It should foster debt restructurings based on internationally agreed norms “regarding the priority of claims, necessary overall write-downs, and sharing of ‘haircuts’”. The Court should have the power to halt ongoing negotiations between creditors, if they cannot agree, and impose its decisions on them, allowing for a pre-determined timescale to be defined in order to avoid lengthy restructuring processes which are strongly detrimental to the debtor.   

Lack of adaptation to climate change and the financial vulnerability of developing countries – particularly LICs and LMCs – strengthen each other in a doom loop. The financial vulnerability of these countries is exacerbated by the destabilizing impact of climate change. Reducing the destabilization potential of climate change in these countries require strong adaptation investments, which are hampered by the financial constraint they face. The case for bringing together the international agendas for climate adaptation and financial stability of developing countries, therefore, appears strong, and strengthens as climate change accelerates.

Bringing these agendas together can be done through debt-for-adaptation swaps and adaptation-linked debt restructurings. Such tools would allow to link debt relief of a debtor developing country to adaptation investments, and therefore concurrently address its climate and financial vulnerabilities. The easiest way to implement such tools is to leverage developing countries’ debt owned by developed countries members of the Paris club. A partial reallocation of the debt owned by such countries to adaptation investments in debtor developing countries can fulfill a significant share of adaptation investment needs, as would be the case for instance for Senegal and Papua New Guinea. Swapping a developing country’s debt owned by a developed country against adaptation investments or granting additional relief on such debt as part of a debt restructuring process to enable adaptation investments would also contribute to greater global climate justice, as it would allow balancing financial liabilities of developing countries with ecological debts of developed countries.

Despite their usefulness, debt-for-adaptation swaps and adaptation-linked debt restructurings do not address the structural deficiencies of the international monetary system. Such deficiencies hamper the management of up and down cycles of developing countries, which will be enhanced by climate change impact, and constrain their investment capacity, limiting their ability to finance adaptation investments. Eventually, a reform of the international monetary system will be needed to address the challenge of adapting to climate change. As part of such a reform, several changes could be envisioned. Special Drawing Rights could be granted a greater role, through their enhanced use as reserve assets but also as a source of funding for climate adaptation. A strengthened use of capital account regulations and the rollout of an efficient global debt workout mechanism would also contribute to greater financial resilience of developing countries in an age of climate change-induced macroeconomic instability.