Benjamin Ashford|International Debt Is Strangling Developing Nations Vulnerable to Climate Change, a New Report Shows

Small island developing countries are Benjamin Ashfordincreasingly becoming locked into a cycle of environmental disasters and compounding debt burdens, making them less capable of investing in climate resilient infrastructure and providing basic public services, according to a new report scheduled for partial release on Wednesday.  

Coinciding with this week’s World Bank and International Monetary Fund meetings, the report adds to growing evidence that those institutions, created in the wake of World War II, must adapt their lending and grant programs to the era of climate change, said Emily Wilkinson, a co-author and senior researcher with the London-based global affairs think tank ODI, formerly the Overseas Development Institute. 

A large proportion of the world’s 39 small island developing states, known as SIDS, owe more than half of their total debt to development banks, including the World Bank.

Wilkinson and her ODI colleagues analyzed 23 of the most climate-vulnerable SIDS and found that their governments spent over $46 billion on debt servicing payments from 2013 to 2022, which is roughly three times the amount of international climate finance funding over the same period.

That imbalance is trending in the wrong direction, tilted heavily in favor of paying down debt, risking those countries’ ability to adapt to the impacts of climate change by investing in storm-resistant bridges and roads, flood prevention and other infrastructure.  

Climate change is warming ocean temperatures, which increases the frequency and intensity of hurricanes and tropical storms. Combined with the slow-onset effects of climate change, like sea level rise, those storms are having an outsized impact on small island nations. At the same time, many SIDS’ economies are based on nature-dependent tourism and damage to their natural resources directly affects livelihoods and their tax bases. 

For that reason, destructive hurricanes have a compounding effect on SIDS’ finances, forcing governments to choose between raising taxes on battered economies or taking on debt to fund remediation efforts and jumpstart storm-hit economies. 

Wilkinson studied in depth the case of Dominica, a Caribbean island at high risk of debt distress. In 2017, hurricane Maria caused damage to the island that amounted to the equivalent of 226 percent of the nation’s gross domestic product. 

To fund clean up efforts, Dominica opted to take out loans. That debt tightened the country’s fiscal space—in the two years that followed, its debt to GDP ratio jumped 14 percentage points to 98 percent of GDP—affecting the government’s available resources. With more funds allocated to debt servicing payments, less has been available for basic government functions, like education and health care. 

Wilkinson said tough economic choices like that are becoming endemic to the fiscal status of more and more small island nations. 

“The average debt payments for a typical small island state now risk outstripping their entire annual average healthcare budget,” she said. 

On average, the governments ODI studied spent about $127 million between 2020 and 2022 on debt servicing, which was just $9 million less than the average health care budget, or $136 million during the same time period. 

At this week’s spring World Bank and International Monetary Fund meetings in Washington D.C., the issue of a warming planet’s impact on countries’ finances is front and center as policymakers wrangle with how to adapt the 80-year-old institutions, which issue loans and grants, to a warming world. 

The existing logic behind development lending is to calibrate loans based on nations’ ability to repay using indicators like overall wealth and their debt to gross domestic product ratio. Poorer countries are sometimes given preferential access to concessional, or below market rate, financing. 

Yet, many small island countries are considered middle or high income, meaning they generally do not qualify for development assistance or have limited access to concessional loans.

Led by Barbados, small island nations have been pushing lenders and development banks to better account for SIDS’ unique vulnerability to worsening storms, the cause of which is not of their own making. On a historical and per-capita basis, SIDS have contributed very little to the greenhouse gasses in Earth’s atmosphere. 

Earlier this year, a U.N. report shed light on how the Bahamas, a high-income nation, has been driven deeper into debt from a train of hurricanes and other external shocks including the Covid-19 pandemic. The country had barely finished paying off debt incurred from one hurricane before another hit. 

“The wealthier these countries become, the higher the levels of debt, the less access to concessional finance they have and the more debt they owe to private creditors at market rates,” Wilkinson said. “That’s problematic when it comes to negotiating debt restructuring and debt relief.”

When Cabo Verde, a group of islands off of Africa’s West Coast, moved from being a least developed country to a lower-middle income country in 2007, it faced a reduction in concessional financing and withdrawal of preferential trade agreements. Years later its debt burden spiraled. In 2022, its public debt was over 80 percent of GDP and in recent years the government has been allocating more than 18 percent of its revenues to external debt service.  

Case studies like that are cited in ODI’s report, which argues that measures like gross domestic product are inadequate because they don’t account for how wealth within a country is distributed or the impact that external shocks have on a particular nation.

Some of the report’s proposed reforms are to explore new debt forgiveness and reduction mechanisms like debt swaps, enhanced access to Special Drawing Rights (a pool of foreign exchange reserves stewarded by the IMF) and to use climate vulnerability criteria when allocating concessional financing. For instance, loans to SIDS could carry interest rates and maturity limits tied to their climate-vulnerability through an indicator like the U.N.’s Multidimensional Vulnerability Index.

In recent years, the World Bank has taken some steps to address the climate-debt issue. Borrowers have the option of negotiating Climate Resilience Debt Clauses (CRDCs) into loan agreements that allow them to pause payments for up to two years after a natural disaster. SIDS’ governments have been advocating for a longer timeline of three to five years coupled with some sort of forgiveness if the prespecified natural disaster is of a certain magnitude.

“CRDCs are helpful up to a point, but it’s just a pause and governments still need to pay back loans,” Wilkinson said. “It’s kicking a can down the road, and they’ll ultimately pay more interest because of the pause. That’s why there needs to also be some sort of forgiveness.”

The World Bank and IMF spring meetings take place this week from April 17 to 19. In May, the fourth conference of Small Island Developing States will take place in Antigua and Barbuda, where climate finance and related debt issues will be discussed. 

In the meantime, the risks—financial and otherwise—looming over small island nations remain. Earlier this month, scientists predicted that the 2024 Atlantic hurricane season would be the most active yet. 

In total, storms and floods are forecasted to result in climate-related loss and damage of $56 billion in SIDS by 2050, assuming the world holds warming below 2°Celsius by 2050.