Using debt-for-nature swaps

Debt-for-nature swaps were developed to transform commercial debt of developing countries into finance for the environment. The transactions have appeal in principle because they can meet two objectives: financing worthwhile environmental activities with substantial leverage for donor funds, while helping to manage developing country debt. In practice, the transactions are complex, and the instances in which both objectives can best be served with a single instrument are few.

Since the first debt-for-nature swap was completed (for Bolivia, in 1987), a further 16 swaps in eight countries have retired nearly US$100 million in external debt, using original donations of $16 million. Although this represents only a small fraction of the commercial debt of these countries, it paid for significant conservation efforts, in some cases vastly expanding existing expenditures.

For non-governmental organizations, swaps demanded a new financial expertise. These organizations have also had to build up relationships with local non-governmental organizations and government agencies. For the recipient government, the conversion of external to local-currency obligations has several implications for economic and debt management. First, debt-for-nature swaps imply greater domestic spending by the debtor government. To avoid stimulating inflation, most such swaps have been not for cash but for government bonds, with payments spread out over a number of years. Second, many severely indebted countries have serious budgetary problems that may preclude converting a foreign debt into a domestic obligation.

A recurring issue is the amount of local-currency bonds the government issues in exchange for the external debt. If the new bonds are close to the face value of old debt the financial leverage of the donor is maximized, but so too is the financial obligation of the local government. In three quarters of the swaps the new 'conservation bonds' have a value of about 90% or more of the original debts.

Debt-for-nature swaps financed by non-governmental organizations are likely to be small in relation to both the overall needs of environmental funding and to foreign debts. National aid agencies in a number of countries, notably the Netherlands, Sweden and the USA, have made grants available for some outstanding debt. These debt-for-nature swaps have been valuable for some countries, but their effect has been more to reallocate aid than to generate additional resources. Some official debts are now eligible for swaps. Part of eligible Paris Club debts can now be exchanged for local-currency funding of agreed environmental activities. The USA Enterprise for the Americas Initiative provides for local-currency payments on reduced official debt, to be used to fund eligible environmental projects in Latin America and the Caribbean.

The US Tropical Forest Conservation Act, approved by Congress in 1998, authorizes the reduction of official debt owed to the USA by countries with significant tropical forests in exchange for conservation measures. US $13 million has been allocated for the year 2000.