Why Multilateral Development Banks Must Step Up on Debt Relief

By Rishikesh Ram Bhandary, PhD, Assistant Director of the Global Economic Governance Initiative at the Boston University Global Development Policy Center and Sara Jane Ahmed is the founder of the Financial Futures Center and Finance Advisor to the V20 Group of Finance Ministers

With a third of Pakistan under water, millions displaced and commodities like cotton at the heart of Pakistan’s economy destroyed, the existential impact of climate change on vulnerable economies could not be clearer.

A recent report on loss and damage from the Vulnerable Group of Twenty (V20) Finance Ministers, a group of 55 economies vulnerable to climate change, showed warming-induced economic losses among its members reaching USD 525 billion over the last two decades, or a staggering 20% of their gross domestic product (GDP). For six of its country members, climate losses wiped out all economic gains made over the same period. Climate change is not a distant challenge; it has set aflame national budgets here and now.

Amidst a pandemic and the ripple effect of the Ukraine conflict, climate change is further compounding existing fiscal stress. Rising interest rates in advanced economies are making it more challenging for countries to pay their debt while rising energy and food prices are draining national budgets. This summer, the International Monetary Fund (IMF) sounded alarm bells indicating 60% of low-income countries are at risk of debt distress. Thirteen of these countries are members of the V20.

Equally alarming, countries not currently in debt distress are also not spared. Last month, the IMF released a new working paper showing only seven of 29 low-income countries have the fiscal space to realise investments necessary to protect themselves from climate impacts. When scarce public resources are mostly channelled to service debt instead of spending to build a more resilient economy, vulnerable countries will get locked into a cycle of unsustainable debt fuelled by worsening climate impacts.

Comprehensive debt restructuring is vital, and it will require all parties working together with a sense of urgency at the negotiating table.

A new policy brief from the V20 and the Boston University Global Development Policy Centre assesses the V20’s debt profile, identifying the creditors, their relative salience and trends in debt servicing costs.

Its findings are disconcerting. The report found the V20 holds USD 686.3 billion in external public debt, with private creditors and multilateral development banks (MDBs) as the major lenders. Private creditors comprise 36% of the debt stock, with the World Bank holding 20% and other MDBs holding another 20%. Paris Club nations hold 13% and China holds 7%. The brief also showed how, by 2028, MDBs will become the largest class of creditors for V20 members. The largest shareholders of the World Bank are the United States, Japan, China, Germany, the United Kingdom, France, India, Russia and Canada.

The report makes clear why MDBs must accelerate comprehensive debt relief to disrupt the cycle of climate disasters and unsustainable debt.

Newly released data from the World Bank seems encouraging. The institution mobilised USD 31.7 billion in the last fiscal year, exceeding its target of orienting 35% of lending towards climate change between 2021-2025. However, the sheer scale of climate investments needed and the perilous fiscal space among climate vulnerable economies means far more fundamental changes are required.

Holding a tremendous share of V20 debt and receiving nearly USD 70 billion in debt service payments from V20 countries alone, MDBs are no bystanders. They must play a proactive and essential role in realising durable, positive debt negotiation outcomes, which the V20 intends on reminding MDBs at the upcoming 2022 Annual Meetings of the IMF and the World Bank.

As creditors are often reluctant to participate in a debt restructuring unless other creditors participate, a guarantee facility hosted by the MDBs could secure payments to private creditors. This would incentivise the private sector to join the debt relief effort while reducing what countries owe. The Group of 20 (G20) appointed an independent expert group on capital adequacy frameworks for MDBs that has reaffirmed the amount of headroom – USD 500 billion to USD 1 trillion – that MDBs have to scale up their lending programmes.

While providing guarantees on freshly issued bonds would be a major step forward, the impact would nonetheless be dulled until MDBs themselves take a debt haircut, a move that is not necessarily unprecedented. In 2016, the IMF sold its gold to support a multilateral effort for Highly Indebted Poor Countries. Major economies also contributed to the MDBs while banks used their own investment incomes to provide haircuts. MDBs and their shareholders must display similar ambition now for climate vulnerable countries. Climate change is a central concern to the World Bank’s shareholders and as well as its client countries. The World Bank leadership needs to reflect and build on this ambition.

Warming impacts will continue to exact an increasingly severe cost on climate vulnerable nations. The international community has a fundamental obligation to step in and break the cycle of climate damages and debt, and if a stable global economy is to be realised, this must be seen as the fundamental fiscal responsibility of all.