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### Introduction: climate–debt linkage and paper purpose
- Climate vulnerabilities and fiscal risks are correlated across countries; sample evidence based on 128 low-and middle-income countries shows many countries with above-median climate risk also face higher fiscal crisis risk.
- Causation likely runs both ways:
  - Climate change can exacerbate debt vulnerabilities by reducing productive capacity and tax bases, creating fiscal reconstruction costs, and raising external borrowing costs.
  - Debt problems reduce fiscal space for mitigation and adaptation investments, worsening climate vulnerabilities.
- Paper objectives:
  - Assess whether there is an economic case for debt-climate swaps relative to other instruments.
  - If yes, examine whether and how swaps should be scaled and promoted.
- Key headline conclusions:
  - Qualified yes: a case exists but is sensitive to the swap definition.
  - If swaps are defined broadly (including comprehensive restructurings with climate commitments), they can be efficient when climate actions affect solvency.
  - If swaps are defined narrowly (conditional debt relief involving a single creditor or creditor class), the economic case is narrow:
    - When debt is sustainable, conditional grants are generally more efficient than debt swaps because some debt relief subsidizes non-participating creditors.
    - When debt is unsustainable, comprehensive debt restructuring generally dominates swaps.
    - Swaps can make sense when climate adaptation is efficient and fiscal risks are high but debt is not necessarily unsustainable — swaps can create fiscal space beyond financing the climate investment.
  - Pragmatic case: swaps may be useful when concessional finance or deep debt relief are unavailable or insufficient.

### Debt-for-climate swaps — structures and history
- Concept and common forms:
  - Debt-for-climate swaps derive from debt-for-nature and debt-for-development swaps: debt reduced in exchange for spending or policy commitments, with fiscal cost no higher than the debt reduction.
  - Two common forms:
    - Bilateral debt swaps: redirect previously committed official bilateral debt service to mutually agreed projects.
    - Tripartite swaps: buybacks of privately held debt financed by donors/new lenders, usually intermediated by an NGO; NGO lends to debtor at below-market rates conditioned on (1) buyback of commercial debt at a discount and (2) using a portion of resulting debt relief to fund climate actions.
- Illustrative tripartite steps:
  - NGO raises funding from ESG investors (loans and/or grants).
  - Funding on-lent to a special purpose vehicle (SPV).
  - SPV funds agreed-on projects and provides a loan to the government.
  - Government uses loan to buy back commercial debt.
  - Debt service flows back through SPV/NGO to original investors.
- Hybrid public–private examples:
  - Belize (2001) and Panama (2003): US government and The Nature Conservancy (TNC) shared swap costs; TNC provided a grant matching a portion of US debt reduction.
  - Belize (2021): US Development Finance Corporation provided political risk insurance for a “blue loan” by a TNC subsidiary, reducing credit risk of a “blue bond.”
- Historical scale and frequency:
  - At least 50 trilateral swaps and approximately 90 bilateral debt swaps involving about 15 official creditors and benefiting about 30 creditors (CRS 2018).
  - Includes 10 transactions between the United States and Latin American debtor countries under the 1990 Enterprise of Americas Initiative, and about 20 transactions under the 1998 US Tropical Forest Conservation Act.
  - Popularity waned in 2000s (shift to HIPC/MDRI comprehensive relief) but has seen a comeback (examples: French C2D with Democratic Republic of Congo 2019; TNC-led tripartite swaps in Seychelles 2015 and Belize 2021).

### Evidence on scale, fiscal mechanics, and conservation effects
- Aggregate scale and comparators:
  - Most swaps were small (two-digit US million-dollar range).
  - Largest recorded swap: $580 million (Poland, 1992).
  - Estimated totals (UNDP 2017): total value of debt treated by debt swaps = $2.6 billion; funded development/nature-related spending ≈ 1.2 billion.
  - Comparators: Brady Plan aggregate debt reduction = $65 billion; climate grants to developing countries in 2019 = $17 billion (OECD 2021).
- Fiscal mechanics and efficiency considerations:
  - Swaps often replace old debt with new debt of lower volume and often local currency, but do not always restore debt sustainability.
  - When debt is sustainable, conditional grants generally deliver climate finance more efficiently than debt swaps because swaps can yield debt relief that effectively subsidizes creditors that do not participate.
  - When debt is unsustainable, comprehensive debt restructuring (which could include climate conditionality) is typically preferable to swaps.
  - Swaps can expand fiscal space relative to conditional grants when climate investments are efficient and fiscal risks are high but debt not formally unsustainable.
- Evidence of conservation outcomes:
  - Some studies indicate debt-for-nature transactions are associated with lower deforestation.
  - Seychelles (2015 swap) increased protected marine area share to 30 percent as part of commitments.

### Box 1 — Recent transactions: Seychelles (2015) and Belize (2021)
- Seychelles (2015):
  - TNC bought back $21.6 million of public bilateral debt for $20.2 million (a discount of 6.5 percent).
  - Government issued promissory notes amounting to $21.6 million to pay off the TNC loan and to endow SeyCCAT.
  - Conservation commitments: protect 30 percent of waters; protect 15 percent of high-biodiversity areas; adopt a marine spatial plan.
  - Protected waters progress: from 0.04 percent to 30 percent since 2015.
- Belize (2021):
  - Sovereign bond face value: $553 million (about 30 percent of GDP).
  - Bond-for-cash exchange price: 55 cents per dollar of face value.
  - Bondholder acceptance: about 85 percent (collective action clause enabled full exchange).
  - Belize pre-funded a $23.4 million endowment supporting marine conservation.
  - Annual conservation spending commitment: $4.2 million per year.
  - Protected ocean area target: expand from about 16 percent to 30 percent by 2026.
  - Credit implications:
    - USDFC provided political risk insurance lowering credit risk for TNC subsidiary and reducing blue bond cost.
    - Standard & Poor’s upgraded Belize’s sovereign credit rating to B–.
    - IMF continued to assess Belize’s debt as unsustainable “in the absence of additional measures.”

### Box 2 — Example comparison: conditional grants vs debt-climate swaps
- Numerical example setup:
  - Initial sovereign obligation: country owes 100 units.
  - Available resources at repayment:
    - With probability 0.5: 115 units.
    - With probability 0.5: 90 units.
  - Market value of debt: 0.5∗100+0.5∗90=95.
  - Climate investment cost: 20 units.
  - Two support forms: grant of 20 or debt relief (swap) of face value 20.
- Key outcomes and implications:
  - In non-crisis (115): both grant and swap allow climate investment 20 and country retains 15 or repays reduced debt accordingly.
  - In crisis (90): realized climate spending depends on legal/de facto priority:
    - Climate spending priority → creditors worse off; swap can mirror grant.
    - Debt priority → climate investment may not occur or be partially funded.
    - Pro rata → creditors and climate spending share resources proportionally.
  - Three immediate implications:
    - Expected debt relief is generally less than face-value debt relief (example: expected debt relief = 15 when expenditure ranks below debt service).
    - To guarantee climate investment of 20 via swap when not ensured in crisis, donor may need to provide 30 units of debt relief (lowering debt to 70) so crisis resources 90 satisfy 90=20+70.
    - If climate expenditure is senior, swaps can be cheaper than grants because non-participating creditors bear part of the cost.
- Annex I extensions summarize continuous distributions, deadweight default costs, cases where relief exceeds spending needs, and buyback analyses.
- General analytical conclusions:
  - Debt-climate swaps where nominal debt relief ≥ climate spending requirement always lead to a non-negative fiscal transfer to the debtor, but the transfer is always less than the nominal decline in external payment commitments.
  - Grants are generally better for donors/creditors to ensure investment occurs unless expenditure commitments can be made senior.
  - Donor-conducted buybacks can be superior to debtor-conducted buybacks because donors can often purchase at lower secondary prices before markets anticipate forgiveness.

### When swaps make sense vs when they do not
- Not appropriate when the policy objective is primarily to restore debt sustainability — comprehensive restructuring is generally the superior instrument.
- Potentially appropriate conditions:
  - Climate adaptation or mitigation investments are efficient (positive social return).
  - Fiscal risks are elevated but debt is not officially unsustainable — swaps can create additional fiscal space.
  - Comprehensive debt relief or sufficient concessional climate finance is unavailable or insufficient.
  - Reputational or economic costs of comprehensive restructuring are high and can be avoided by targeted swaps.
- Narrow settings where swaps may be efficient:
  - When climate actions materially lower sovereign risk such that conditional debt restructuring is justified.
  - When a swap can be structured so climate investment commitments effectively rank above debt service.
  - When buybacks are donor-conducted and markets do not price in forgivability (type A tripartite swaps).

### Design and scaling considerations (barriers and remedies)
- Key constraints limiting scale:
  - High transaction costs (identifying projects, coordination, 2–4 years negotiation timeline).
  - High monitoring costs (fragmented project-level KPIs).
  - Commitment problems (future policy actions may be reneged on after shocks).
  - Limited suitable debt stock held by potential swapping creditors (aggregate figures for LICs end-2021: total external public debt = $245 billion; Paris Club-held debt to heavily indebted poor countries = $18 billion; non-Paris Club bilateral creditors = $55 billion; privately held bonded debt = $34 billion among those LICs).
- Measures to scale swaps (five non-mutually-exclusive sets):
  1. Bundling projects and policy reforms to raise transaction sizes and reduce reversal risk; use IFI conditionality as commitment device.
  2. Programmatic, budgetary approaches: finance climate-related budget expenditures (lower transaction/monitoring costs vs project-level swaps).
  3. Developing standardized KPIs and KPI-linked bond markets: reduce monitoring costs, support ESG/SLB issuance, and allow MDB credit enhancements.
  4. Using carbon credits to incentivize swaps: could offset creditor carbon footprints and make mitigation projects cost-effective; careful design to ensure additionality and avoid greenwashing.
  5. Multilateral initiative to mobilize official funding: coordinated donor initiative to identify beneficiaries, secure commitments, set minimum climate impact per dollar measured by KPIs, and set maximum support per beneficiary.

### Policy recommendations and pragmatic case
- Swaps should be promoted only insofar as they strengthen climate finance generally and ensure savings from reduced debt service are spent on intended climate investment.
- Recommended policies:
  - packaging climate projects and related policy reforms;
  - linking swaps to budgetary use of funds and climate-related policy reforms;
  - developing standardized climate performance indicators and KPI-linked debt markets;
  - using carbon credits to incentivize swaps;
  - providing official financial support and credit enhancements (partial guarantees, Brady-bond style collateral) to mobilize participation and reduce costs.
- Multilateral approach:
  - Official creditors and high-income countries could agree to identify beneficiary countries, negotiate creditor/donor commitments, agree on acceptable forms of support (climate-conditional grants, bilateral swaps, tripartite swaps), and set KPI-based minimum climate impact per dollar and maximum support per beneficiary.

### Annex highlights: fiscal transfer mechanics and LIC external debt composition
- Annex Figure 1.1 key definitions and properties:
  - Ỹ(D) ≡ E(Y | Y < D) = F(D)−1 ∫_0^D Y f(Y) dY.
  - Expected fiscal payments to creditors for debt D: [1 − F(D)] D + F(D) Ỹ(D) ≡ D − F(D) [D − Ỹ(D)].
  - Expected transfer from swap Tr ≡ [1 − F_0] D_0 + F_0 Ỹ_0 − [1 − F_s] D_s − F_s Ỹ_s = D_0 − D_s − { F_0 [D_0 − Ỹ_0] − F_s [D_s − Ỹ_s] }.
  - If D_0 − D_s ≥ 0 then D_0 − D_s ≥ Tr ≥ 0.
- Buyback insights (Bulow–Rogoff extensions):
  - Donor-conducted buybacks (type A) can achieve greater effective relief than debtor-conducted buybacks (type B) when markets do not price in forgiveness.
  - A debtor-conducted buyback can make sense for the debtor if either (i) a sufficient share γ of donor cash would have been available to creditors absent a buyback, or (ii) deadweight default costs L are sufficiently large.
- Annex Table 1.1 aggregate LIC external debt totals (end-2020 or latest available):
  - Total external debt: 245.0
  - Multilateral excl. IMF: 115.6
  - Paris Club: 17.8
  - Non-Paris Club: 55.3
  - Private creditors: 56.2
  - Bonds: 33.7
- Selected country-level figures (exact values preserved):
  - Afghanistan: Total external debt: 0.9
  - Benin: Total external debt: 4.4; Debt to GDP: 50.6; Sovereign spread**: 680
  - Ethiopia: Total external debt: 29.0; Debt to GDP: 53.0; Sovereign spread**: 1,807
  - Ghana: Total external debt: 23.3; Debt to GDP: 81.7; Sovereign spread**: 1,404
  - Kenya: Total external debt: 33.7; Debt to GDP: 69.8; Sovereign spread**: 573
  - Côte d'Ivoire: Total external debt: 20.0; Debt to GDP: 51.6; Sovereign spread**: 679
  - Senegal: Total external debt: 15.9; Debt to GDP: 74.7; Sovereign spread**: 513
  - Tajikistan: Total external debt: 3.1; Debt to GDP: 49.3; Sovereign spread**: 1,788
  - Tanzania: Total external debt: 11.2; Debt to GDP: 17.6; Sovereign spread**: 39.7
  - Uganda: Total external debt: 7.2; Debt to GDP: 11.3; Sovereign spread**: 49.7

*IMF Working Paper: “Debt-For-Climate Swaps: Analysis, Design, and Implementation” (Introduction, Box 1, Box 2, Conclusion, Annex excerpts).*

### Introduction ...........................................................................................................

### wpiea2022162-print-pdf - Introduction

### Introduction: climate–debt linkage and paper purpose
- Climate vulnerabilities and fiscal risks are correlated across countries: sample evidence based on 128 low-and middle-income countries shows many countries with above-median climate risk also face higher fiscal crisis risk (figures referenced).
- Causation likely runs both ways:
  - Climate change can exacerbate debt vulnerabilities by reducing productive capacity and tax bases, creating fiscal reconstruction costs, and raising external borrowing costs.
  - Debt problems reduce fiscal space for mitigation and adaptation investments, worsening climate vulnerabilities.
- Debt-for-climate swaps have been proposed to address climate and debt problems jointly; proponents include Picolotti and others (2020), Steele and Patel (2020), and Volz and others (2021).
- Paper objectives:
  - Assess whether there is an economic case for debt-climate swaps relative to other instruments.
  - If yes, examine whether and how swaps should be scaled and promoted.
- Key conclusions previewed:
  - Qualified yes: a case exists but is sensitive to the swap definition.
  - If swaps are defined broadly (including comprehensive restructurings with climate commitments), they can be efficient when climate actions affect solvency.
  - If swaps are defined narrowly (conditional debt relief involving a single creditor or creditor class), the economic case is narrow:
    - When debt is sustainable, conditional grants are generally more efficient than debt swaps because some debt relief subsidizes non-participating creditors.
    - When debt is unsustainable, comprehensive debt restructuring generally dominates swaps.
    - Swaps can make sense when climate adaptation is efficient and fiscal risks are high but debt is not necessarily unsustainable — swaps can create fiscal space beyond financing the climate investment.
  - Pragmatic case: swaps may be useful when concessional finance or deep debt relief are unavailable or insufficient.

### Debt-For-Climate Swaps: a primer — structures and history
- Concept:
  - Debt-for-climate swaps derive from debt-for-nature and debt-for-development swaps: debt reduced in exchange for spending or policy commitments, with fiscal cost no higher than the debt reduction.
  - Two common forms:
    - Bilateral debt swaps: redirect previously committed official bilateral debt service to mutually agreed projects (nature, climate).
    - Tripartite swaps: buybacks of privately held debt financed by donors/new lenders, usually intermediated by an NGO; NGO lends to debtor at below-market rates conditioned on (1) buyback of commercial debt at a discount and (2) using a portion of resulting debt relief to fund climate actions.
- Illustrative tripartite steps (as depicted in figure):
  - NGO raises funding from ESG investors (loans and/or grants).
  - Funding on-lent to a special purpose vehicle (SPV).
  - SPV funds agreed-on projects and provides a loan to the government.
  - Government uses loan to buy back commercial debt.
  - Debt service flows back through SPV/NGO to original investors.
- Hybrid public–private examples:
  - Belize (2001) and Panama (2003): US government and The Nature Conservancy (TNC) shared swap costs; TNC provided a grant matching a portion of US debt reduction.
  - Belize (2021): US Development Finance Corporation provided political risk insurance for a “blue loan” by a TNC subsidiary, reducing credit risk of a “blue bond.”
- Historical scale and frequency:
  - Well over 100 debt swap transactions since late 1980s:
    - At least 50 trilateral swaps and approximately 90 bilateral debt swaps involving about 15 official creditors and benefiting about 30 creditors (CRS 2018).
    - Includes 10 transactions between the United States and Latin American debtor countries under the 1990 Enterprise of Americas Initiative, and about 20 transactions under the 1998 US Tropical Forest Conservation Act.
  - Popularity waned in 2000s (shift to HIPC/MDRI comprehensive relief) but has seen a comeback (examples: French C2D with Democratic Republic of Congo 2019; TNC-led tripartite swaps in Seychelles 2015 and Belize 2021).

### Evidence on scale, fiscal mechanics, and conservation effects
- Modest aggregate volume:
  - Most swaps were small (two-digit US million-dollar range).
  - Largest recorded swap: $580 million (Poland, 1992).
  - Estimated totals (UNDP 2017): total value of debt treated by debt swaps = $2.6 billion; funded development/nature-related spending ≈ 1.2 billion.
  - Comparators: Brady Plan aggregate debt reduction = $65 billion; climate grants to developing countries in 2019 = $17 billion (OECD 2021).
- Fiscal mechanics and efficiency considerations (overview in paper and detailed in Annex):
  - Debt swaps often replace old debt with new debt of lower volume and often local currency, but do not always restore debt sustainability.
  - When debt is sustainable, conditional grants generally deliver climate finance more efficiently than debt swaps because swaps can yield debt relief that effectively subsidizes creditors that do not participate.
  - When debt is unsustainable, comprehensive debt restructuring (which could include climate conditionality) is typically preferable to swaps.
  - Swaps can expand fiscal space relative to conditional grants when climate investments are efficient and fiscal risks are high but debt not formally unsustainable.
- Evidence of conservation outcomes:
  - Some studies indicate debt-for-nature transactions are associated with lower deforestation (Shandra and others 2011; Sommer, Restivo, and Shandra 2020).
  - Seychelles: as part of its 2015 debt swap commitment, the country increased the share of its protected marine area to 30

### Why swaps have remained a niche instrument
- Size constraints: majority of swaps have been small in nominal terms (two-digit millions).
- Composition and fiscal impact:
  - Swaps typically involve replacing existing debt rather than providing net external finance at scale.
  - The distribution of benefits across participating and non-participating creditors can reduce efficiency.
- Historical shifts in debt relief architecture (HIPC/MDRI) reduced relative attractiveness in 2000s.

### When do debt-for-climate swaps make sense? (summary)
- Potentially appropriate conditions:
  - Climate adaptation or mitigation investments are efficient (i.e., have a positive social return).
  - Fiscal risks are elevated, but debt is not officially unsustainable—swaps can create additional fiscal space.
  - Comprehensive debt relief or sufficient concessional climate finance is unavailable or insufficient.
  - Reputational or economic costs of comprehensive restructuring are high and can be avoided by targeted swaps.
- Limitations:
  - If the policy objective is primarily to restore debt sustainability, comprehensive restructuring is usually the superior instrument.
  - If the objective is to fund climate actions in a cost-effective manner where debt is sustainable, climate-conditional grants are generally more efficient.

### Policy directions to scale swaps (overview)
- Paper argues swaps should be promoted only insofar as they strengthen climate finance generally, noting overlap in monitoring and verification infrastructure between swaps and climate-conditional lending.
- Areas for policy action discussed in the paper (detailed sections follow in full text):
  - Bundling projects and policy reforms to raise transaction sizes and impact.
  - Ensuring budgetary expenditures support adaptation and/or mitigation.
  - Developing KPIs and creating KPI-linked bond markets to align incentives.
  - Using carbon credits to incentivize swaps.
  - Mobilizing official funding for swaps or grants linked to climate action.

*IMF Working Paper: “Debt-For-Climate Swaps: Analysis, Design, and Implementation” (Introduction section).*

### Box 1. Recent Debt Swaps in Seychelles (2015) and Belize (2021)

### Box 1. Recent Debt Swaps in Seychelles (2015) and Belize (2021)

### Overview
- Describes two recent debt-for-nature / debt-for-climate style transactions: Seychelles (2015) and Belize (2021).
- Highlights transaction structures, financing sources, conservation commitments, and implications for sovereign risk and credit ratings.

### Seychelles (2015) transaction — structure and outcomes
- Transaction parties:
  - Government of Seychelles and TNC (The Nature Conservancy).
  - SeyCCAT (Seychelles Conservation and Climate Adaptation Trust) was newly established as part of the transaction.
- Financial terms and mechanics:
  - TNC bought back $21.6 million of public bilateral debt for $20.2 million (a discount of 6.5 percent).
  - The government issued two promissory notes amounting to $21.6 million to pay off the TNC loan and to endow SeyCCAT.
  - Funding sources included private philanthropic funding and loan capital raised by TNC’s NatureVest conservation investment unit.
- Fiscal and cash-flow effects:
  - SeyCCAT became the new owner of the debt; the government pays back over a longer tenure, providing cash-flow relief on repayments.
- Conservation commitments and results:
  - Government commitments:
    - Protect 30 percent of its waters.
    - Protect 15 percent of its high-biodiversity areas.
    - Adopt a marine spatial plan to guide updates of coastal zone management, fisheries, and marine policies.
  - Outcome since 2015:
    - Progressed from protecting 0.04 percent to 30 percent of national waters.

### Belize (2021) transaction — structure and outcomes
- Transaction parties:
  - Government of Belize, TNC, US Development Finance Corporation (USDFC), commercial creditors holding a sovereign bond, and providers of new market finance.
- Financial terms and mechanics:
  - Sovereign bond involved had face value of $553 million (about 30 percent of GDP).
  - A subsidiary of TNC arranged a “blue loan” to finance a bond-for-cash exchange at 55 cents per dollar of face value.
  - About 85 percent of bondholders accepted the offer; collective action clause enabled full exchange of the bond.
  - Belize agreed to pre-fund a $23.4 million endowment supporting marine conservation.
  - Belize committed to spending $4.2 million per year on marine conservation.
  - Belize committed to expand protected ocean area from about 16 percent to 30 percent by 2026.
- Risk mitigation and credit implications:
  - A critical element was USDFC-provided “political risk insurance” that substantially lowered credit risk taken by the TNC subsidiary and reduced the cost of the blue bond.
  - Although Belize’s credit rating remained below investment grade and IMF continued to assess Belize’s debt as unsustainable “in the absence of additional measures,” the risk insurance earned TNC’s blue bond an investment grade rating.
  - As a result of the transaction, Standard & Poor’s upgraded Belize’s sovereign credit rating to B–.

### Design features and comparative implications
- Distinction drawn in the paper between four types of climate-conditional financial operations:
  1. Loans (including on concessional terms).
  2. Grants.
  3. Debt swaps.
  4. Comprehensive debt restructurings.
- Differences between (3) debt swaps and (4) comprehensive debt restructurings:
  - Comprehensive restructurings aim to restore sustainability when debt is unsustainable; debt swaps generally do not.
  - Comprehensive restructurings involve a broad restructuring perimeter including most creditor categories; debt swaps typically involve one creditor or one class of creditors (as in Belize 2021).
- When debt-climate swaps can make sense:
  - Depends on the economic problem causing underinvestment in climate:
    - Climate externality (benefits accrue to parties/countries not paying for it).
    - Borrowing constraint (credit risk raises borrowing cost).
    - Lack of fiscal space even when debt would be sustainable without the climate investment.
    - Debt that is unsustainable regardless of the investment.
  - If the cause is a climate externality or borrowing constraint, concessional loans (possibly conditional) can address the problem via concessionality and conditionality.
  - Many developing countries lack fiscal space even for concessional financing; example measure cited:
    - Fiscal space proxy: difference between present value of debt as a share of GDP at end-2021 and the threshold present value debt share that would put countries at high risk of debt distress under the LIC-DSF.
    - Of 64 countries shown, 43 have fiscal space of less than 20 percent of GDP and 33 below 10 percent of GDP; in 28 cases, fiscal space is negative.
    - Among 29 LICs that submitted estimates of adaptation needs, only 7 have sufficient fiscal space by this measure to meet those needs.

### Debt-climate swaps versus climate-conditional grants
- Efficiency comparison:
  - Climate-conditional grants (or grant/loan combinations) are generally more efficient than debt-climate swaps because:
    - Grants can be designed so they are impossible to be diverted to debt service or other spending; they are targeted to the climate investment and are disbursed only if the investment occurs.
    - Debt-climate swaps redirect spending from debt service to agreed public investment, implying greater sovereign risk for donors/creditors unless expenditure commitments are de facto senior to remaining debt service.
- Circumstances where swaps can be relatively more efficient:
  - If the expenditure commitment is de facto senior to debt service, the swap can support climate expenditure at lower cost to the creditor/donor since part of the climate expenditures will be indirectly financed by other creditors who would suffer greater losses in a crisis.
  - Debtors may prefer swaps if they provide debt relief in excess of what is needed to finance the climate investments (i.e., swaps typically produce some net debt relief).
- Cost-efficiency conclusion:
  - Generally, from the creditor/donor perspective, it is more cost efficient to combine a climate-conditional grant that exactly pays for the climate investment with some additional, unconditional debt relief than to deliver the same net fiscal transfer via a debt-climate swap.

### Key numeric facts and commitments (verbatim from source)
- Seychelles:
  - Debt bought back: $21.6 million.
  - Purchase price: $20.2 million.
  - Discount: 6.5 percent.
  - Conservation targets: protect 30 percent of waters; protect 15 percent of high-biodiversity areas.
  - Protected waters progress: from 0.04 percent to 30 percent since 2015.
- Belize:
  - Sovereign bond face value: $553 million (about 30 percent of GDP).
  - Bond-for-cash exchange price: 55 cents per dollar of face value.
  - Bondholder acceptance: about 85 percent (collective action clause enabled full exchange).
  - Pre-funded endowment: $23.4 million.
  - Annual conservation spending commitment: $4.2 million per year.
  - Protected ocean area target: expand from about 16 percent to 30 percent by 2026.
  - Credit rating outcome: Standard & Poor’s upgraded Belize to B–.
- Fiscal space statistics for 64 LICs (as reported):
  - 43 countries have fiscal space of less than 20 percent of GDP.
  - 33 countries have fiscal space below 10 percent of GDP.
  - 28 countries have negative fiscal space.
  - Among 29 LICs with submitted adaptation needs, only 7 have sufficient fiscal space to meet those needs (by the cited measure).

*Source: Box 1. Recent Debt Swaps in Seychelles (2015) and Belize (2021), wpiea2022162-print-pdf*

### Box 2. Comparing Climate-Conditional Grants and Debt-Climate Swaps: An Example

### Box 2. Comparing Climate-Conditional Grants and Debt-Climate Swaps: An Example

### Example setup and state-by-state outcomes
- Initial sovereign obligation: country owes 100 units of real resources to creditors.
- Available resources at repayment:
  - With probability 0.5: 115 units.
  - With probability 0.5: 90 units.
- Market value (expected payment) of debt: 0.5∗100+0.5∗90=95.
- Climate investment cost: 20 units (unaffordable without external support).
- Two forms of conditional fiscal support considered:
  - A grant of 20 (must be spent on climate investment).
  - Debt relief (debt-climate swap) of face value 20.

Outcomes when no crisis (resources = 115):
- Grant: climate investment paid (20), creditors repaid 100, country keeps 15.
- Debt relief: debtors repaid 80, country implements climate investment (20), keeps 15.

Outcomes when crisis occurs (resources = 90) — differences depend on legal/de facto priority ranking between climate investment commitment and debt service:
- If climate investment ranks above debt service:
  - Outcome mirrors conditional grant: climate investment undertaken (20), creditors receive 70, creditors lose 10.
- If climate investment ranks below debt service:
  - Climate investment may not occur or is partially funded. Examples:
    - If debt service has precedence: creditors repaid 80, leaving only 10 for climate investment.
    - If resources allocated pro rata: creditors receive 0.8∗90=72 (losing 8 rather than 10), resources for climate investment are 0.2∗90=18.

Additional considerations abstracted from this simple comparison:
- Administration and timing/phasing differences (e.g., debt swaps may match cashflow of climate expenditures).
- Swaps often replace hard-currency debt repayments with local expenditures, strengthening balance of payments; similar benefits could follow from a foreign-currency grant spent locally.

### Three immediate implications from the example
- Expected debt relief is generally less than face-value debt relief (20) unless climate expenditure is senior:
  - If climate expenditure ranks below debt service:
    - Expected payments to creditors = 0.5∗80+0.5∗80=80.
    - Expected debt relief = 95−80=15.
  - If debt service ranks pro rata with climate expenditure:
    - Expected payments to creditors = 0.5∗80+0.5∗72=76.
    - Expected debt relief = 95−76=19.
  - If climate expenditure ranks above debt service:
    - Expected payments to creditors = 0.5∗80+0.5∗70=75.
    - Expected debt relief = 95−75=20.
- If the creditor/donor providing debt relief cannot guarantee that the 20 units of climate investment happen even in a crisis (as a climate-conditional grant would), then to ensure the 20 units of investment the donor would need to provide 30 units of debt relief (lowering debt to 70). Rationale: with debt lowered to 70, crisis resources 90 would satisfy 90=20+70.
  - Implication: achieving a desired guaranteed level of climate expenditure via a debt-climate swap can be more costly than via a conditional grant; extra cost partly subsidizes non-participating creditors.
- If the climate expenditure commitment can be made senior, debt-climate swaps can have a cost advantage relative to conditional grants:
  - Example: face-value debt write-down of 20 financed by a swap costs the participating creditor the market value of that debt, namely 19 (=20*0.95). The residual financing is effectively borne by non-participating creditors who receive less in the crisis state (70 rather than 72 in the example).

### Extensions and general results (Annex I)
- Annex I extends the example with:
  1. Continuous probability distribution for resources used to service debt and pay investment commitments.
  2. A “deadweight cost” of default for debtors.
  3. Cases where debt relief and grants may exceed the climate spending they are meant to support.
  4. Analysis of debt buybacks and tripartite debt swaps with tradable debt in a secondary market.
- Key results derived using that setup:
  - A debt-climate swap where nominal debt relief ≥ climate spending requirement always leads to a non-negative fiscal transfer to the debtor (equal to the expected change in external payment commitments), but this transfer is always less than the nominal decline in external payment commitments.
  - From a donor/creditor perspective, a grant is generally a better way to support investment spending in a country with risky sovereign debt than debt relief, because a grant can be structured to ensure the investment occurs regardless of debtor resources. For the same reasons, a debtor generally prefers the grant unless the swap yields debt relief exceeding what is needed to finance the climate investment.
  - When climate investment has priority over debt service, a debt-climate swap is a cheaper financing method than a grant, because part of the swap financing comes from curtailing debt service when resources are insufficient.
  - A debtor-conducted debt buyback can be efficient if the cost of default and/or the share of cash going to creditors in a restructuring is sufficiently high (buybacks are more attractive if, in default, most cash goes to creditors).
  - A donor-conducted buyback (donor buys debt in secondary market and then swaps it against a loan of equal or smaller face value than the cash used) is better for donor and debtor than a debtor-conducted buyback, because the donor can purchase at a lower secondary price.

### Debt-climate swaps versus comprehensive debt restructuring
- Debt swaps are partial debt relief instruments and are generally not the right tool for unsustainable debt situations, which typically require comprehensive restructuring across a broad perimeter of outstanding debt.
- Optimal approach when debt is unsustainable and climate needs are large depends on whether climate actions materially affect sovereign risk:
  - If climate actions do not materially lower sovereign risk:
    - Restore debt sustainability first via comprehensive debt restructuring; then support climate investment through climate-conditional grants/loans. Rationale: debt-climate swaps subsidize non-participating creditors; comprehensive restructurings generally include mechanisms to ensure wide creditor participation.
  - If climate actions materially lower sovereign risk:
    - There is an economic case for climate-conditional debt restructuring. In narrow cases (e.g., some small island states where climate risks exacerbate debt vulnerabilities), linking debt relief to mandated climate adaptation may be essential to avoid moral hazard and to secure creditor buy-in.
- Debt-climate swaps may be efficient in narrow settings with both high risk of debt distress and large costs associated with comprehensive restructuring—if the swap’s partial relief substantially reduces debt risk. If probability of distress remains high after a swap, comprehensive restructuring would be preferable.
- Pragmatic case for debt-climate swaps:
  - When unconditional debt relief is unavailable and climate-conditional grants are insufficient, linking debt relief to climate action can expand fiscal space for climate investments.
  - This may be particularly relevant for middle-income countries less likely to receive grants.

### Design and scaling considerations
- Tripartite swaps with donor-financed purchases: donor-conducted purchases before market realization of forgiveness may secure lower prices; purchased debt can then be swapped against a loan of equal or lower face value than the cash used in the buyback.
- Key constraints that have kept debt swaps a niche instrument:
  - High transaction costs: identifying suitable projects, coordination, and time-consuming negotiations (2-4 years noted).
  - High monitoring costs: fragmented, project-specific performance measures increase administrative burden and limit participation by financial institutions.
  - Commitment problems: future policy actions required by swaps create incentives to renege or inability to meet obligations after fiscal shocks.
  - Limited suitable debt stock held by potential swapping creditors (e.g., among LICs with medium/high debt risks, total external public debt = $245 billion end-2021; Paris Club-held debt to heavily indebted poor countries = $18 billion; non-Paris Club bilateral creditors = $55 billion; privately held bonded debt = $34 billion among those LICs).
- Measures that could scale up debt-climate swaps and related instruments (five non-mutually-exclusive sets):
  1. Bundling projects and policy reforms: package related projects (mitigation/adaptation) and link to policy reforms to reduce reversal risk and commitment problems; use IFI conditionality as commitment device.
  2. Programmatic, budgetary approaches: finance climate-related budget expenditures (lower transaction/monitoring costs versus project-level swaps); link to country development strategies and green budgeting practices.
  3. Developing standardized KPIs and KPI-linked bond markets: standard KPIs reduce monitoring costs, support issuance of ESG/Sustainability-Linked Bonds (SLBs), and potentially widen the “greenium” over time; MDBs could provide credit enhancements (partial guarantees, collateral) to boost market development.
  4. Using carbon credits to incentivize swaps: credits could offset creditor carbon footprints and make more cost-effective mitigation projects feasible; careful design required to avoid greenwashing and ensure additionality (example: 2005-2007 Spain–Uruguay debt-for-wind-power swap under CDM).
  5. Multilateral initiative to mobilize official funding: coordinated, multiyear donor initiative to identify beneficiary countries (based on climate-related fiscal gap and climate risk), secure donor commitments (e.g., share of GDP), agree on acceptable support modalities, minimum climate impact per dollar (measured by agreed KPIs), and maximum support per beneficiary (the climate-related fiscal gap). Modalities could include bilateral debt-climate swaps, conditional grants, and tripartite swaps; multilateral institutions/NGOs could intermediate.
- Participation and free-rider concerns:
  - To minimize free riding and share fiscal costs, participation should be broad—at minimum include main official bilateral creditors (Paris Club and non-Paris Club) and advanced economies.
  - Without broad participation, incentive mismatches arise for both non-creditor donors and major official creditors.

*IMF Working Paper — Box 2 summary.*

### Conclusion

### Conclusion

### When debt-climate swaps are useful
- Debt-climate swaps can be useful instruments when the main constraint to climate investment is lack of fiscal space.
- When fiscal space is binding, standard climate finance (green loans or bonds) will not solve the problem because they would raise debt to unsustainable levels. Promoting climate investments will require fiscal transfers in the form of:
  - climate-conditional grants,
  - debt-climate swaps (defined as climate-conditional debt relief by one creditor or a strict subset of creditors), or
  - comprehensive debt restructuring (which could be combined with climate conditionality).

### Relative efficiency and limitations
- Debt-climate swaps are generally a less efficient form of fiscal support than conditional grants and/or broad debt restructuring.
- Conditional grants and plain debt restructuring are usually better at ensuring that transferred resources finance climate investment and/or reduce the debt burden rather than benefiting other creditors.
- Climate-conditional grants can be structured to disburse only if climate action is implemented; this is more difficult for debt-climate swaps because swaps lower debt service to participating creditors conditional on a public investment commitment that typically remains subject to sovereign risk.
- Comprehensive debt restructuring, by definition, seeks to involve a broad set of creditors; as a result, debt-climate swaps are generally dominated by climate-conditional grants, coupled with comprehensive debt restructuring in unsustainable debt cases.

### Two settings where debt-climate swaps may be as good or better
- When a debt-climate swap can be structured so that the recipient country’s climate investment commitment de facto ranks above its commitment to service debt. In this case, a debt-climate swap may have an advantage over a conditional grant.
- When a comprehensive debt restructuring is expected to produce large economic dislocations and the partial debt relief associated with a debt-climate swap is expected to materially reduce the probability of debt distress (including by restoring debt sustainability in unsustainable debt cases). These conditions were rarely met by past debt-nature swaps but could be met if debt swaps are “scaled”.

### Broader case for climate conditionality in debt restructuring
- When climate risks are a contributing cause of debt risk, conditioning debt relief on debtor actions that lower exposure to climate risk (such as adaptation investment) makes sense.
- Most present-day debt problems in developing countries are not caused by climate change, but this argument is relevant for economies with unsustainable debt and high climate risks and will gain relevance as more economies feel climate impacts.
- The IMF’s new Sovereign Risk and Debt Sustainability Framework (IMF 2022b) includes modules that analyze the impact of climate adaptation and mitigation on debt sustainability and requires IMF staff to apply the adaptation module in all debt restructuring contexts.

### Pragmatic case for debt-climate swaps
- Climate finance falls short, particularly climate-conditional grants. Creditors’ willingness to provide debt relief may be enhanced if the debtor commits to climate conditionality in addition to standard macroeconomic conditionality, even when climate conditionality has no direct impact on credit risk.
- Debt-climate swaps are worth promoting if they:
  1. expand the fiscal resources of debtor countries that cannot shoulder climate investments based on loans alone, and
  2. are designed to maximize benefits to the debtor (ensuring savings from reduced debt service are spent on the desired investment rather than general debt service).
- Example: the recent debt swap targeted to marine conservation in Belize demonstrates how to structure swaps to ensure funds generated by reduced debt service are spent on the intended investment.
- If the debt swap involves a buyback of commercial debt in the secondary market, the buyback should be conducted by a donor/creditor rather than the debtor, since a third party may be able to purchase the debt at a lower price than the debtor country.

### Policies to encourage and scale debt-climate swaps
- Recommended policies to encourage and raise the scale of debt-climate swaps (and to benefit other forms of climate finance) include:
  - packaging climate projects and related policy reforms;
  - linking debt-climate swaps to the budgetary use of funds and climate-related policy reforms;
  - developing standardized climate performance indicators and markets for debt instruments whose financial terms are linked to these KPIs;
  - using carbon credits to incentivize debt swaps from both private and official sources.
- These policies would reduce the transactions and monitoring costs that currently impede debt-climate swaps, encourage the use of scarce resources to reduce emissions in the most cost-effective way, and increase the fiscal benefits of debt-climate swaps and other forms of climate finance (the “greenium”) for developing countries.

### Official financial support and credit enhancements
- Debt-climate swaps and related climate finance instruments deserve official financial support.
- One form of support is credit enhancements, such as partial guarantees or Brady-bond style collateral. The purpose of such enhancements should not be to eliminate credit risk but to address climate externalities that cannot be internalized through other means (for example, regulation favoring KPI-linked bonds or institutional investor responses to public opinion).

### Ambitious multilateral approach
- Official creditors and high-income countries could agree to alleviate fiscal constraints to climate investments in developing countries by:
  - identifying a set of potential beneficiary countries;
  - negotiating commitments of participating creditors/donors;
  - agreeing on acceptable forms of support, including a minimum climate impact per dollar of financial support measured by agreed KPIs and a maximum support level per beneficiary country.
- Subject to agreed conditions, donors would be free to choose which countries to support and the modality of support, including climate conditional grants, bilateral debt-climate swaps, and purchase of commercial debt followed by swap with climate-conditional loans or KPI-linked bonds.

### Annex I — Fiscal transfers associated with a debt swap: overview
- The annex studies fiscal transfers associated with three types of debt swaps:
  1. Bilateral debt swap: official bilateral creditor swaps a debt claim 퐷0 for a debt claim 퐷1 plus an incremental spending commitment 푆. 퐷푠 ≡ 퐷1 + 푆 denotes total external expenditure commitments after the swap. Assume 퐷푠 ≤ 퐷0.
  2. “Type A” tripartite debt swap: a donor raises cash 퐶, purchases government bonds from commercial creditors at price 푝퐴 < 1, and swaps them for a debt claim 푙퐴 ≤ 퐶, conditional on incremental spending commitment 푆 > 0. After the swap: 퐷1 = 퐷퐴 ≡ 퐷0 − 퐶푝퐴 + 푙퐴. Since 푝퐴 < 1 and 푙퐴 ≤ 퐶, 퐷1 < 퐷0.
  3. “Type B” tripartite debt swap: like type A but the debtor conducts the buyback. Donor provides cash 퐶 to debtor in exchange for (1) a new debt claim 푙퐵 ≤ 퐶, (2) commitment to use the cash to buy back debt at price 푝퐵 < 1, and (3) incremental spending commitment 푆 > 0. After swap: 퐷1 = 퐷퐵 ≡ 퐷0 − 퐶푝퐵 + 푙퐵 < 퐷0.
- The annex answers four questions:
  1. Under what conditions on 퐷0, 퐷1, and 푆 do these operations provide a fiscal benefit (net transfer) to the debtor? If 푆 is serviced from the same pool of resources as debt (so the country may not deliver the full expenditure in bad states), then 퐷0 − 퐷1 > 푆 guarantees a fiscal transfer. The expected reduction in external payment commitments is always smaller than the nominal reduction in payment commitment (nominal debt relief net of the spending commitment).
  2. From the perspective of a donor/creditor, is it better to support climate investment through a conditional grant or a debt-climate swap? The grant is generally preferable unless the expenditure commitments are senior to the remaining debt claims—in which case a swap may be preferable.
  3. In operation 3 (type B), does it make sense to force the debtor to use the cash 퐶 to buy back debt, or let the debtor keep the cash? The answer depends; the buyback may make sense when it helps reduce the chances of a default that is costly for the debtor.
  4. For a donor (NGO) with cash budget 퐶, which tripartite swap is better: type A or type B? If the donor can conduct purchases before the debt market realizes that the purchases will be forgiven, type A is better.

### When do debt swaps expand fiscal space?
- It is important to account for the riskiness of the debt—some debt might not have been repaid absent a swap.
- Minimal structure: defaults determined by ability to pay. Debtor resources to repay debt (including debt service and possible incremental spending commitment 푆) denoted 푌, with density f(푌) and cumulative F(푌). f(푌) and F(푌) are assumed independent of 푆 (ignoring potential output benefits of climate investment).
- If 푌 ≥ 퐷, debt 퐷 is repaid in full; else the debtor defaults. The probability of default is hence F(퐷).

*Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022162-print-pdf.pdf*

### Annex Figure 1.1

### Annex Figure 1.1

### Expected payments and properties of Ỹ(D)
- Definition: Ỹ(D) ≡ E(Y | Y < D) = F(D)−1 ∫_0^D Y f(Y) dY.
- Derivative (using Leibniz rule): Ỹ′(D) = f(D)/F(D) (D − Ỹ(D)).
- By definition Ỹ(D) < D, hence Ỹ′(D) > 0.
- Expected fiscal payments to creditors associated with debt D:
  - [1 − F(D)] D + F(D) Ỹ(D), equivalently D − F(D) [D − Ỹ(D)].
  - Interpretation: expected payments are smaller than promised repayment D; the shortfall depends on default probability F(D) and debtor’s ability to pay in default Ỹ(D).
- Monotonicity:
  - Using Ỹ′(D) = f(D)/F(D) (D − Ỹ(D)) > 0, both F(D)[D − Ỹ(D)] and D − F(D)[D − Ỹ(D)] are increasing in D.
  - Also, d{D − F(D)[D − Ỹ(D)]}/dD = 1 − F(D) > 0.

### Notation simplification for swaps
- Simplified notation: F(D_0) ≡ F_0, F(D_s) ≡ F_s, Ỹ(D_s) ≡ Ỹ_s.
- Ỹ_s is expected payments available in the default state to service both debt and climate spending when both cannot be repaid in full.

### Expected fiscal transfer from a debt swap
- Transfer definition:
  - Tr ≡ [1 − F_0] D_0 + F_0 Ỹ_0 − [1 − F_s] D_s − F_s Ỹ_s     (equation 2)
  - Rewritten: Tr ≡ D_0 − D_s − { F_0 [D_0 − Ỹ_0] − F_s [D_s − Ỹ_s] }.
- Properties when D_0 − D_s ≥ 0:
  - Since F(D)[D − Ỹ(D)] is increasing in D, F_0 [D_0 − Ỹ_0] − F_s [D_s − Ỹ_s] ≥ 0.
  - It follows that D_0 − D_s ≥ Tr ≥ 0.
- Implications:
  - If the swap weakly lowers total spending commitment (D_0 ≥ D_s ≡ D_1 + S), it yields a non-negative fiscal transfer.
  - The expected transfer Tr is always weakly less than the nominal decline in external payment commitments D_0 − D_s because part of nominal relief would not have benefited the debtor in states where default would have occurred.

### Debt swaps versus conditional grants (financing a climate investment S)
- Two forms considered:
  - Conditional grant G = S that exactly covers climate investment S.
  - Conditional debt relief D_0 − D_1 ≡ S in same nominal amount.
- If both cover the investment exactly, external obligations remain D_0 and default probability remains F(D_0); hence no net fiscal transfer (D_s ≡ D_1 + S = D_0 implies Tr = 0).
- Which form is better depends on:
  - (1) Creditor/donor vs debtor perspective.
  - (2) Assumed priority between climate spending and debt repayment.
  - (3) Presence or absence of inefficiency (deadweight loss) in restructurings.
- Grants can be structured to pay only for the expenditure (e.g., escrow), so realized climate spending s = S under a grant.
- Under debt relief, realized climate spending s depends on Y and priority rules:
  - (a) Debt service priority: creditors receive Y; s = max{Y − D_1, 0}.
  - (b) Pro-rata sharing: creditors receive (D_1/(D_1 + S)) Y; s = (S/(D_1 + S)) Y.
  - (c) Climate spending priority: creditors receive max{Y − S, 0}; s = min{S, Y}.
- Key conclusion:
  - Unless debt relief is structured so climate spending enjoys priority, realized s will be higher with a conditional grant than with debt relief.
  - Even with priority, if Y < S then s < S under debt relief, so grants remain safer.

### Effect on non-participating creditors
- Non-participating creditors unaffected by conditional grants.
- Under debt-climate swaps:
  - They do better when debt service enjoys priority.
  - They do worse when climate spending enjoys priority.
  - They are the same if commitments rank equally and shortfalls are distributed pro rata.
- Recovery value per unit of debt in default (Y < D_0):
  - Grant financing: Y/D_0.
  - Conditional debt relief:
    - (a) Debt priority: Y/D_1.
    - (b) Pro-rata: (D_1/(D_1 + S)) (Y/D_1) = Y/D_0.
    - (c) Climate priority: (Y − S)/(D_0 − S) if Y ≥ S, or 0 if Y < S.
- Comparison:
  - Case (a): creditors recover strictly more than under grant financing since D_1 < D_0 implies Y/D_1 > Y/D_0.
  - Case (b): creditors recover exactly the same as under grants.
  - Case (c): creditors do worse than under grants when Y ≥ S because Y/D_0 > (Y − S)/(D_0 − S); if Y < S they recover 0.

### Donor/participating creditor perspective
- A donor/creditor seeking to support climate investment should normally prefer grant financing because it ensures the investment S happens regardless of Y.
- Exception: if climate commitment has priority (case (c)) and Y > S for any realization of Y, and the donor is not the sole creditor, then a debt-climate swap can be preferred since remaining creditors partly finance the climate spending, making the swap cheaper for the donor.
- Illustrative example:
  - Donor has cash C ≥ S and debt claim equal to S < D_0; remaining debt D_1 = D_0 − S held by others.
  - If grant-financed: donor spends S and keeps debt claim worth S; expected repayment to donor:
    - [1 − F(D_0)] S + F(D_0) S (Ỹ(D_0)/D_0).
  - If debt-climate swap: donor keeps cash C, reduces debt claim to zero, expected debt repayment = 0.
  - Swap is better for donor if S > [1 − F(D_0)] S + F(D_0) S (Ỹ(D_0)/D_0), which holds because Ỹ(D_0) < D_0.

### Debtor perspective
- If the debtor values the climate investment, and net transfers are zero with unchanged default probability F(D_0), the debtor prefers grants over debt relief because grants are safer (guarantee the investment).
- This conclusion holds even when the debtor cares about default costs (output, reputational, political).
- However, historically debt-nature swaps have sometimes delivered debt relief exceeding investment requirements, so swaps can provide net fiscal transfer and reduce default probability—making them attractive to the debtor.
- From donor cost-effectiveness: combining a conditional grant to cover S with additional debt relief is generally more cost-effective than a debt-climate swap that dilutes funds by subsidizing non-participating creditors.

### Would the debtor be better off keeping donor cash rather than buying back debt? (Bulow-Rogoff discussion)
- Model setup:
  - Default involves non-pecuniary deadweight loss L ≥ 0 borne by debtor; l_B = 0 (cash C is a grant).
  - Without buyback:
    - Country keeps cash C, of which γ C becomes available for debt repayment.
    - Expected payment to creditors: [1 − F(D_0 − γ C)] D_0 + F(D_0 − γ C) [Ỹ(D_0 − γ C) + γ C].
    - Debtor expects loss L with probability F(D_0 − γ C).
  - With buyback:
    - Government pays C to buy back debt.
    - Debt service becomes D_B ≡ D_0 − C p_B if no default, or Ỹ(D_B) in default.
    - Expected payment: [1 − F(D_B)] D_B + F(D_B) Ỹ(D_B) + C.
    - Debtor expects loss L with probability F(D_B).
- Buyback benefits the debtor iff:
  - [1 − F(D_B)] D_B + F(D_B) [Ỹ(D_B) + L] + C < [1 − F(D_0 − γ C)] D_0 + F(D_0 − γ C) [Ỹ(D_0 − γ C) + γ C + L]     (equation 8)
  - Rewritten as:
    - D_B − F(D_B)[D_B − Ỹ(D_B)] + C < D_0 − F(D_0 − γ C)[(D_0 − γ C) − Ỹ(D_0 − γ C)] + [F(D_0 − γ C) − F(D_B)] L     (equation 9)
  - Using p_B D_B = D_B − F(D_B)[D_B − Ỹ(D_B)] and D_B ≡ D_0 − C p_B, becomes:
    - p_B D_0 < D_0 − F(D_0 − γ C)[(D_0 − γ C) − Ỹ(D_0 − γ C)] + [F(D_0 − γ C) − F(D_B)] L     (equation 10)

### Special cases for buyback effectiveness
- (i) γ = 1, L ≥ 0:
  - Buyback always makes sense (even if L = 0).
  - Substituting γ = 1 into (9) yields inequality (11) and monotonicity arguments show it holds regardless of L.
- (ii) γ = 0, L = 0 (Bulow-Rogoff case):
  - (10) becomes p_B D_0 < p_A D_0 where p_A D_0 = D_0 − F(D_0)[D_0 − Ỹ(D_0)].
  - Since D_0 > D_B implies p_B > p_A, (11) never holds and a debtor-financed buyback makes the debtor worse off.
- (iii) γ = 0, L > 0:
  - (10) becomes p_B D_0 < p_A D_0 + [F(D_0) − F(D_B)] L     (12)
  - Because p_B > p_A and F(D_0) > F(D_B), for given D_0, C and F(.), (12) could hold if L is sufficiently large — i.e., buyback could benefit the debtor if deadweight default costs L are large enough.
- General trade-off:
  - For 0 ≤ γ < 1 and L ≥ 0, there is a trade-off between γ and L: buybacks can be beneficial if γ is sufficiently high or if L is sufficiently large.

### Annex Figure 1.2 illustration (specific example)
- Example parameters: Y ∼ Uniform(0,1), D_0 = 0.5, C = 0.2.
- Results:
  - When γ = 0, buybacks make sense for L ≥ 0.25.
  - As γ increases, the threshold L for buybacks to make sense declines.
  - For γ > 0.66, buybacks make sense even if L = 0.
- Note: γ is share of debtor cash creditors can seize in default; L is non-pecuniary default cost. The blue line in Annex Figure 1.2 represents L(γ) making debtor indifferent between keeping cash and buying back debt under the uniform distribution assumption.

### Donor-conducted versus debtor-conducted buybacks
- Interest parity / buyback price (risk-neutral investors, safe rate = 0):
  - p(D) = [1 − F(D)] ∗ 1 + F(D) ∗ Ỹ(D)/D = 1 − F(D) [1 − Ỹ(D)/D]     (equation 7)
  - p′(D) < 0, so p(D) is decreasing in D.
- If donor buys back (market does not realize forgiveness), market price based on unchanged outstanding debt D = D_0, denote p_A = 1 − F(D_0)[1 − Ỹ(D_0)/D_0].
- If debtor buys back and retires debt, D = D_B ≡ D_0 − C p_B + l_B < D_0, p_B = 1 − F(D_B)[1 − Ỹ(D_B)/D_B].
- Since D_B < D_0 implies p_B > p_A, type A (donor-conducted) swaps achieve greater debt relief than type B (debtor-conducted) swaps, provided the market does not realize the bought-back debt will be forgiven.
- Consequences:
  - Remaining creditors benefit from greater reduction in credit risk under type A swaps.
  - The benefit that would have accrued to creditors selling the debt is captured by the debtor in type A swaps, unlike type B swaps.

*Source: Authors, Annex Figure 1.1, IMF Working Paper "Debt-For-Climate Swaps: Analysis, Design, and Implementation."*

### Annex Table 1.1 External Debt of Low-Income Countries by Creditor Type

### Annex Table 1.1 External Debt of Low-Income Countries by Creditor Type

### Table scope and data sources
- End-2020 or latest available; billions of US dollars, unless otherwise noted.  
- Sources: Bloomberg Finance L.P.; World Bank, International Debt Statistics 2021; and IMF staff.  
- Notes included in table:
  - *H = high, M = medium.  
  - **“Weighted-average spread” is the par-value-weighted spread across all of a country’s bonds with more than one-year remaining maturity.  
  - ***Non-Paris club debt end-2020 is approximated by using non-Paris club share of total external official debt in 2019, multiplied by total official external debt in 2020.  
  - ****Small developing state.

### Key columns and definitions (as presented)
- LIC-DSF Risk of debt distress* (H = high, M = medium)  
- Sovereign spread**  
- Debt to GDP  
- Total external debt  
- Multilateral excl. IMF  
- Paris Club  
- Non-Paris Club***  
- Private creditors (non-bonds)  
- Bonds

### Aggregate totals (table totals, end-2020 or latest available)
- Total external debt: 245.0  
- Multilateral excl. IMF: 115.6  
- Paris Club: 17.8  
- Non-Paris Club: 55.3  
- Private creditors: 56.2  
- Bonds: 33.7

### Selected country-level entries (values taken exactly from table)
- Afghanistan
  - LIC-DSF Risk of debt distress*: H
  - Sovereign spread**: 2.0
  - Debt to GDP: 1.0
  - Total external debt: 0.9
  - Multilateral excl. IMF: 0.1
  - Paris Club: 0.0
  - Non-Paris Club: 0.0
- Benin
  - LIC-DSF Risk of debt distress*: M
  - Sovereign spread**: 680
  - Debt to GDP: 50.6
  - Total external debt: 4.4
  - Multilateral excl. IMF: 2.7
  - Paris Club: 0.1
  - Non-Paris Club: 0.4
  - Private creditors: 1.2
  - Bonds: 0.6
- Ethiopia
  - LIC-DSF Risk of debt distress*: H
  - Sovereign spread**: 1,807
  - Debt to GDP: 53.0
  - Total external debt: 29.0
  - Multilateral excl. IMF: 14.0
  - Paris Club: 1.1
  - Non-Paris Club: 7.4
  - Private creditors: 6.5
  - Bonds: 1.0
- Ghana
  - LIC-DSF Risk of debt distress*: H
  - Sovereign spread**: 1,404
  - Debt to GDP: 81.7
  - Total external debt: 23.3
  - Multilateral excl. IMF: 6.0
  - Paris Club: 0.9
  - Non-Paris Club: 2.2
  - Private creditors: 14.1
  - Bonds: 10.2
- Kenya
  - LIC-DSF Risk of debt distress*: H
  - Sovereign spread**: 573
  - Debt to GDP: 69.8
  - Total external debt: 33.7
  - Multilateral excl. IMF: 15.2
  - Paris Club: 3.6
  - Non-Paris Club: 7.5
  - Private creditors: 7.4
  - Bonds: 6.1
- Côte d'Ivoire
  - LIC-DSF Risk of debt distress*: M
  - Sovereign spread**: 679
  - Debt to GDP: 51.6
  - Total external debt: 20.0
  - Multilateral excl. IMF: 4.0
  - Paris Club: 0.7
  - Non-Paris Club: 3.2
  - Private creditors: 12.1
  - Bonds: 8.5
- Senegal
  - LIC-DSF Risk of debt distress*: M
  - Sovereign spread**: 513
  - Debt to GDP: 74.7
  - Total external debt: 15.9
  - Multilateral excl. IMF: 5.7
  - Paris Club: 3.0
  - Non-Paris Club: 2.0
  - Private creditors: 5.2
  - Bonds: 4.2
- Tajikistan
  - LIC-DSF Risk of debt distress*: H
  - Sovereign spread**: 1,788
  - Debt to GDP: 49.3
  - Total external debt: 3.1
  - Multilateral excl. IMF: 1.3
  - Paris Club: 0.0
  - Non-Paris Club: 1.3
  - Private creditors: 0.5
  - Bonds: 0.5
- Tanzania
  - LIC-DSF Risk of debt distress*: M
  - Sovereign spread**: 39.7
  - Debt to GDP: 17.6
  - Total external debt: 11.2
  - Multilateral excl. IMF: 1.3
  - Paris Club: 2.8
  - Non-Paris Club: 2.3
  - Bonds: 0.0
- Uganda
  - LIC-DSF Risk of debt distress*: M
  - Sovereign spread**: 49.7
  - Debt to GDP: 11.3
  - Total external debt: 7.2
  - Multilateral excl. IMF: 0.9
  - Paris Club: 2.7
  - Non-Paris Club: 0.5
  - Bonds: 0.0

### Visual breakdown (as presented)
- Annex Figure 1.3: External Public Debt of LICs by Creditor Composition (Percentage of GDP) — shows country-level stacks of: Paris Club; Non-Paris Club; Multilateral excl. IMF; Bonds; Private creditors, non-bonds.
- The figure lists countries in descending order by total external public debt as percent of GDP (labels include Cabo Verde****, Djibouti****, Senegal, Maldives****, Samoa****, Dominica****, Rwanda, etc., through Solomon Islands****).

*Source: IMF staff compilation from Bloomberg Finance L.P.; World Bank, International Debt Statistics 2021; and IMF staff.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022162-print-pdf.pdf_