2023-Public-Sector-Perspectives

What are the benefits of executing a debt-for-sustainability swap? Debt-for-sustainability swaps have attractive characteristics for both debtors and creditors. • Provide Fiscal Space: The debt relief and reduced debt service helps to improve the public finances; • Decrease External Risks: The instrument can help a debtor from drawing down foreign currency reserves when external debt is due; • Support Economic Growth: The improved fiscal space provides a government with capacity to stimulate economic growth, while debt service savings are typically invested back in the country toward sustainable and environmental commitments; • Provide Potential Credit Rating Enhancement: In the case of a partial/ full guarantee from an investment grade institution as part of the structure, the issued debt-for-sustainability instrument may obtain a credit rating better than the sovereign resulting in lower pricing or market access for issuers otherwise blocked from the markets; • Improve Debt Sustainability: Debt relief along with improved finances helps to improve debt sustainability; • Delivering on International Commitments: The swap can support the government’s national sustainability and climate agenda as well as accelerate the implementation towards international commitments such as NDC/Paris Agreement; • Replicable and Scalable Solution: If the government were able to achieve targeted outcomes/KPIs from the debt-for-sustainability swaps, this could lead to additional and sizable transactions in the future. Barriers and challenges for scaling debt-for-sustainability swaps Besides the Belize transaction, most of the debt-for-sustainability swap deals were executed in small sizes for several reasons. • Sovereigns’ commitment: The main factor necessary for a successful debt swap program is the debtor country’s commitment to deliver on the targeted outcomes. For a successful debt-for-sustainability swap transaction, the debtor country should be willing to deploy significant resources for implementation, monitoring and reporting. • Debt trading levels: Over the past 30 years, external sovereign bonds were trading close to face value and yields were low. Therefore, the incentive to engage in such debt-for-sustainability transactions was minimal given that they could be costly. Therefore, sovereigns would resort to conventional debt refinancing rather than seek to enter into a long-term debt swap transaction. But the growing likelihood that more sovereigns will face distressed debt conditions makes this option more feasible, and while it can seem costly, it can offer debt relief for a sovereign and enable it to allocate resources to the necessary investments supporting a transition to the green economy or to other ESG projects. • Transaction Cost: A debt swap transaction involves multiple stakeholders such as the debtor sovereign ministries, the creditor government, NGOs and bond holders which can be a time-consuming process that entails costs. • Monitoring Cost: The debt service savings generated from the debt swaps are channeled to predetermined projects, and the implementation of these projects is usually carried out over the long term (for example, 10-15 years) which requires ongoing monitoring of the deployed funds to ensure the delivery of the intended results. From Citi’s role as advisor to Belize, we know that a good project can be the key in terms of negotiating debt relief with creditors. In Belize, we shared the government’s projects for marine conservation identified by TNC with the creditors; this transparency enabled the creditors to reach a settlement that they recognized would help the country while still enabling them to make good on part of their initial investment, and in the end they accepted the tender offer. This experience provided proof that such deals can be done, and Citi can work effectively with both sovereign debtors and their creditors to negotiate successful outcomes acceptable to both parties. Recent developments Given current market conditions that make it difficult for highly indebted sovereigns to access capital markets at a reasonable cost of financing, alongside the rising concerns about social and environmental risks, Citi expects debt-for-sustainability swaps to be executed more frequently. In 2021, the IMF’s Managing Director Kristalina Georgieva commented: “When we are faced with this dual crisis — the debt pressures on countries and the climate crisis, to which many low-income countries are highly, highly vulnerable — it makes sense to seek this unity of purpose, in other words, green debt swaps have the potential to contribute to climate finance. They have the potential to facilitate accelerated action in developing countries.” 74 Debt-For-Sustainability: Addressing Debt Pressures and Achieving SDG Goals