Everyone is talking about carbon budgets (ourselves included). From British Prime Minister Kier Starmer’s carbon budget delivery plan to the International Panel on Climate Change’s net zero stabilization efforts, CO2 accounting is now mainstream. The Potsdam Institute for Climate Research’s Carbon Clock even offers a countdown to depletion (roughly 21 years). But Earth’s carbon budget isn’t the only budget that matters when it comes to climate action. Equally important are sovereign budgets … and these balance sheets look increasingly red.
Leaders at the World Economic Forum meeting in Davos in January were clear: There is a crisis of sovereign debt. In 2024, global public debt officially passed $100 trillion, an alarming milestone that underscores the scale of the challenge across countries, sectors, and regions. The outlook becomes even more concerning when projected climate damages are incorporated into future fiscal trajectories.
Overshooting carbon budgets will undoubtedly strain central government budgets, with the burden falling most heavily on countries confronting the dual pressures of climate vulnerability and debt distress. For the most exposed economies, there is an urgent need for innovative solutions that can alleviate fiscal constraints while supporting climate resilience.
Debt-for-nature swaps offer one such pathway.
What Is a Debt-for-Nature Swap?
Debt-for-nature swaps are not new. Thomas Lovejoy, then vice president for science of the World Wildlife Fund, published an op-ed in the New York Times first outlining the concept in 1982. His question, posed over 40 years ago, is just as relevant today: “Why not use the debt crisis—which seems to be nearing financial gridlock—to help solve environmental problems?”
Debt-swaps, also known as debt-conversions or debt buy-backs, transform external public debt obligations into domestic financing for environmental initiatives through a debt restructure or discounted purchase. Savings are then channeled into nature projects like the Aldabra Cleanup Project—which removed 25 tons of marine debris from the Seychelles’ Aldabra Atoll to protect coral reef biodiversity. Roughly 50 debt-for-nature swaps have occurred since 1987, taking place in countries ranging from Egypt to Indonesia to Ecuador. Although deal structures are diverse, past transactions can broadly be categorized along two dimensions: type of debt purchased (official vs. private creditor ) and deal participants (bilateral vs. multiparty).
The swap mechanism gained momentum in the late 1980s after the United States started the Enterprise for Americas Initiative (EAI) which unlocked roughly $177 million of local currency funding for environmental, natural resource, health protection, and child health in Latin American countries. Efforts were further solidified in 1998 when the US Congress passed the Tropical Forest Conservation Act, which empowered debt restructuring for forest conservation in eligible debtor countries.
These early swaps were largely bilateral between sovereigns and involved debt forgiveness in exchange for government commitments to environment goals. For example, the German government has initiated debt-for-climate swaps in Kenya, Egypt, and Tunisia through which debt repayments are waived after the completion of agreed upon projects, including sustainable energy and agricultural initiatives. More recent transactions have involved third parties, such as The Nature Conservancy in the Seychelles or the Pew Bertarelli Ocean Legacy Project in the Galápagos. The involvement of third parties has expanded the debt targeted in the transactions beyond official creditors. For instance, the Ocean Legacy Project bought eurobonds held by private creditors, differing from the traditional bilateral forgiveness model.
Debt-for-nature swaps are attractive because they jointly address the problems of sovereign debt and climate change. This is obvious in official creditor transactions as debt is explicitly waived or forgiven through restructuring. In third-party debt-for-nature deals, savings have been achieved through reductions of the principal, as was the case in Belize, which reduced the principal by $189 million and decreased Belize’s debt-to-GDP ratio by 12 percent. Others achieve debt reductions by lowering interest rates. The most successful example is the Galápagos transaction, which produced a lifetime forgiveness of $1.126 billion, a reduction in coupon to 5.64 percent (other coupons ranged from 17-26 percent), and the redirection of $450 million toward conservation activities.
Even though third-party swaps are becoming increasingly common, these deals still rely on development finance institutions, such as the US Development Finance Corporation (DFC) or Inter-American Development Bank, for credit enhancement. DFC has played a critical role in many past transactions by providing political risk insurance to parties in over half of deals since 2020. But under the Trump administration, DFC has indicated that it may be taking a step back from debt-for-nature swaps. DFC’s absence may jeopardize private market participation, but it also opens the door for other multilateral institutions, such as the African Development Bank or European Investment Bank, to assume a greater role in providing non-payment guarantees or credit enhancement to the deals.
Time Lag Troubles
Climate change and sovereign debt share a central characteristic: The harms of both are disproportionately borne by future generations. From job loss in polluting industries to total decarbonization of the transportation sector, the short-term versus long-term tradeoffs associated with climate policy are well documented. Indeed, the unwillingness to incur the full costs of mitigation by today’s leaders has slowed the green transition, ultimately shifting the burden of climate damages to subsequent generations.
The same intertemporal commitment challenge is true of sovereign debt; future generations are obligated to repay loans they did not take out. Theoretically, the indebted future generations are the beneficiaries of such loans, but that assumption holds only if gains from the projects (financed through debt) have been realized before amortization. However, corruption, mismanagement, and clientelism can interfere with the realization of such gains, undermining efforts to increase national wealth while passing the buck to a country’s youth.
The COVID-19 pandemic forced many countries to assume significant debt, ultimately contributing to the defaults of both Suriname and Zambia. Since the pandemic, additional exogenous shocks—including hikes in advanced economy interest rates, the war in Ukraine, increased cost of foreign capital, and the globalization of inflation—have accentuated the risks of debt distress in many low- and middle-income countries. This pressure is compounded in borrower countries that have experienced depreciation, but hold debt obligations in foreign currency. Despite many having higher average growth rates than advanced economies, the greater perceived sovereign risk and higher financing costs can restrict low- and middle-income countries’ access to capital markets. This limits the fiscal space of the 54 of 172 countries whose debt to GDP ratios exceed the International Monetary Fund sustainability thresholds.
Although climate change and public debt pose independent challenges, the complexity is magnified by their interaction. Many climate vulnerable countries already carry significant debt burdens. Consider the debt profiles of Small Island Developing States (SIDS); in 2021, 40 percent of SIDS were either highly indebted or in debt distress. This can be attributed, at least in part, to the increased frequency of disaster events as well as the increased cost of recovery. Early evidence finds that borrower countries in areas with a history of tropical cyclones, on average, exhibit a higher cost of debt. High borrowing costs limit access to up-front capital needed for adaptation, which means that damages are catastrophic when disasters strike, as was the case in Dominica after Hurricane Maria caused damages worth 226 percent of GDP in 2017.
This breeds a vicious cycle. Instead of financing long-term infrastructure projects to spur in-country growth, loans are now needed for reconstruction after extreme weather events. Countries must borrow at higher interest rates to rebuild, which makes repayment more expensive and subsequently limits access to the capital needed to minimize damages caused by the next storm. Expensive repayments further strain public expenditure on much needed development activities. Between 2021 and 2023, over 3.4 billion people lived in countries whose governments spent more on servicing the interest of existing loans than on health or education programs—let alone conservation or climate adaptation.
Debt-for-nature swaps therefore have the ability to alleviate, albeit not eliminate, harms associated with the long-term challenges of both sovereign debt and climate change. Through this mechanism, money once borrowed from future generations is instead spent on projects for them, simultaneously addressing the twin crises.
A Modest Tool for Two Massive Problems
While novel, debt-for-nature swaps are still an imperfect solution to the looming sovereign debt and climate crises. The first challenge is scale. The sums swapped in debt conversions represent a fraction of total sovereign debt. Many older swaps, such as the 2007 swap in Costa Rica ($26 million) or the 2015 swap in the Seychelles ($29.6 million), were relatively modest in volume. Recent debt swaps, such as the 2023 Ecuador ($1.6 billion) and 2024 El Salvador swaps ($1 billion), have been more ambitious, but they treat only a fraction of the countries’ outstanding public obligations ($39.9 billion and $31.6 billion government debt respectively).
The second critique pertains to restrictions on the use of proceeds as funding activities are often specified prior to the transaction; this is true of bilateral deals and those with third-party participants. In countries grappling with pressing development challenges, such as infrastructure improvement, critics argue that debt-for-conservation swaps can be a distraction. While this concern holds merit, the funding unlocked from prior sovereign obligations effectively represents an additional contribution to government spending. This is because money that should have flowed to external creditors is re-spent within the country.
The additive funding mobilized through debt-service savings requires myopic governments to spend on projects with long-time horizons. All countries will face the costs of climate change with unevenly distributed exposure to damages, but climate policy is rarely a top government priority. This is attributable to climate policies’ perverse political incentives; benefits are seldom realized in a single electoral cycle. But it is precisely because climate adaptation and environmental protection initiatives are considered a “distraction” that the debt-swap mechanism is well-suited to funding low-priority but high-importance projects. In both the Seychelles and Galápagos, the debt-swaps were designed to sustain program activities into perpetuity by investing a portion of proceeds in an endowment. This trust fund mechanism generates long-term capacity that guarantees environmental projects can be sustained whilst being resilient to the volatility of the electoral calendar.
To ensure that programs are effectively tailored to country needs, extensive consultation with domestic governments and affected stakeholders is critical to project implementation. In the Galápagos deal, four representatives from the Ecuadorian government sit on the board—clearly signaling domestic participation. Tailoring project activities to have pro-environmental outcomes, while supporting government priorities was evidenced in the Seychelles deal which was a debt-for-adaptation swap that promoted nature-based solutions, rather than a debt-for-conservation swap. It’s also worth noting that the mechanism is highly portable and should be used for other pressing humanitarian issues, such as the debt-for-food swap currently under negotiation in Kenya with the World Food Program.
Finally, critics argue that, rather than restructuring through debt-for-nature swaps, sovereign debt in low- and lower-middle income countries should be wholly forgiven. This school of thought points to histories of colonialism, environmental exploitation, and predatorial interest rates as the true causes of sovereign debt distress. The injustice that those least responsible for climate change are often the most vulnerable and now forced to incur significant debt to finance recovery should not be ignored. No one can deny that there are significant problems in global lending patterns, such as the home bias of credit rating agencies that disadvantage emerging markets by offering preferential decisions to their domiciled country.
Although debt-for-nature swaps do not eliminate sovereign debt entirely, they remain attractive because reductions in principal or interest payments can ease long-term government budget constraints and create immediate space for development spending when loan maturities are extended. By redirecting funds to domestic projects that would otherwise have gone to out of country creditors, the swaps can increase fiscal capacity, offer domestic employment opportunities, and finance initiatives that promote resilience in the face of climate change. Unlike widespread forgiveness, debt-for-nature swaps do not risk introducing shockwaves into the private market that could force commercial investors to abandon current projects or avoid future investments, which, ultimately, impairs a country's integration into global financial markets.
Imperfect, but a Good Complementary Strategy
Climate budgets and carbon budgets are intertwined. Unfortunately, the policies needed to manage both burdens remain highly unpopular, and yet delaying action leaves youth especially vulnerable. While climate change and sovereign debt are intergenerational problems, mobilizing capital through debt swaps can fundamentally reconfigure both of these relationships. Reducing principal loans or interest rates decreases the tax burdens associated with debt repayments—ultimately an expense incurred by future generations. And leveraging the finance unlocked through the transactions for climate goals can improve community resilience for today’s youth.
Debt-for-nature swaps are imperfect. The transactions pale in comparison to absolute sovereign debt obligations and should not be considered a substitute for robust climate finance. That said, they offer a complementary strategy to address two of the most pressing inter-generational challenges. When well structured, these arrangements can reduce debt service pressures while directing resources toward conservation and climate resilience, offering fiscal relief for vulnerable economies. Their significance lies less in magnitude than in design: They create a mechanism through which debt management and environmental objectives can be pursued in tandem.
Given the intergenerational stakes embedded in both sovereign debt and environmental protection, this structural symbiosis warrants attention. After all, in a world running fiscal and carbon deficits, innovative approaches to alleviate pressures on both budgets are increasingly necessary.
Emily Hardy co-writes IPQ’s Carbon Critical column and is an environmental, social, and governance consultant at Aqua Blue Investments.
Dan Helmeci co-writes IPQ’s Carbon Critical column and is a master’s student at Columbia University.
Conflict of Interest Statement: Emily Hardy works on debt-for-nature swaps in a professional capacity, which is disclosed for transparency. The views expressed in this article are the author’s own and do not reflect the positions of any affiliated institution.
