Converging debt and the climate crisis are hammering countries in the Global South, which have contributed far less to climate change than those in the Global North.
Egypt, the host of COP27, this year’s flagship UN climate conference, claims debt obligations are limiting its climate action, as 45% of its revenue is directed towards paying off loans. The country is far from alone – 53 others are also in need of immediate debt relief, according to the UN. The International Monetary Fund (IMF) also claims that about 60% of low-income countries are in or near ‘debt distress’.
Recent measures imposed by central banks in advanced economies are making these debt burdens even more acute. As countries such as the US hike interest rates to reduce inflation at home, it becomes even harder for lower-income countries to pay back their foreign debts, let alone invest in climate action.
But the IMF has one powerful tool it can use to assist this debt distress: special drawing rights (SDRs) – sometimes described as the ‘IMF’s currency’. These are international reserve assets, whose value is based on a basket of major currencies – including the US dollar, Japanese yen, euro, pound sterling and Chinese renminbi – which are allocated during times of global economic hardship.
While SDRs are not themselves money – they cannot be used to buy things and private entities are not allowed to hold them – they are the IMF’s unit of account: member states can use SDRs to pay off loans they owe to the IMF or exchange them with other IMF members for hard currencies.
SDRs are meant to provide additional liquidity. Once allocated, they automatically supplement a country’s foreign exchange reserves, potentially obviating the need to issue more expensive debt in order to obtain hard currency.
Crucially, unlike IMF loans, countries do not have to agree to implement certain policies in order to receive their SDR allocation. IMF members can exchange SDRs for a currency in the SDR basket to pay for, say, oil imports or Covid vaccines, as was the case in August 2021, when the IMF allocated $650bn worth of SDRs to help countries in the Global South pay for vaccines and ride out restrictions.
Now, a year later, another issuance of SDRs could help countries both adapt to climate change and avert debt defaults.
From Covid to the climate crisis
It was not just countries in the Global South that received SDRs during the pandemic. In fact, those in the Global North received the lion’s share: the US, for example, received $71bn worth – compared to $310m for Afghanistan.
This is because SDRs are allocated on the basis of members’ quotas, or shares, in the IMF, rather than by financial need.
But since rich countries are generally able to manage liquidity challenges on their own or by swapping currencies among themselves, they mostly left their 2021 SDRs unused, sitting on their central banks’ books.
Many Global South countries, on the other hand, faced urgent financial problems and quickly used their proportionately lower amounts. Fifty-five countries used SDRs to reduce their debts owed to the IMF, while others converted their SDR allocations into hard currency to purchase imports or to back public spending.
In fact, more countries have drawn on the 2021 allocation of SDRs than in the last round in 2009, when $250bn of SDRs were given out in the wake of the financial crisis.
Now, as the climate crisis forces many countries to choose between paying off their debts and making necessary climate investments, climate advocates are calling for SDRs to be used more aggressively to fill the climate finance gap.
An IMF working paper found that only seven of 29 low-income countries examined had the fiscal space to make necessary investments to safeguard against climate impacts. Already, debt distress and climate change have fueled unrest from Sri Lanka, where citizens stormed the presidential palace after the country ran out of foreign reserves to pay for fuel, to Ghana, where citizens took to the streets to protest new taxes implemented by a government seeking an IMF bailout.
At COP26, Barbados’s prime minister, Mia Mottley, proposed a regular allocation of $500bn a year for the next 20 years to help countries meet their climate goals and the UN 2030 Sustainable Development Goals. This would help to reduce the cost of capital for Global South countries seeking to finance climate investments and could also depoliticise the climate finance debate, limiting the regular haggling that has often stifled it.
The pros and cons
Reallocating SDRs is admittedly not straightforward, and some IMF members have varied concerns about doing so. Some argue that since the IMF is not a central bank, it should not determine how much liquidity is available.
Others worry that regular allocations could lead to moral hazard, or that recipients would use these no-strings-attached reserves not on vital climate investments, but on wasteful subsidies or ‘white elephant’ projects (financial endeavours that fail to live up to expectations).
The US, which opposed an SDR allocation in 2020 under the Trump administration, argued at the time that boosting the emergency reserves was an inefficient way to aid poor countries, pointing out that most SDRs would accrue to advanced economies that did not need the help, or geopolitical competitors like China and Russia.
Three key points must be underscored in response to these criticisms.
First, the $650bn SDR allocation last year has unequivocally proven to be successful in providing crucial policy space at a moment of need for Global South countries.
Second, the international community must use all available tools to meaningfully address the climate crisis, including SDRs. Global South countries already face impossible choices – like deciding whether to increase spending on healthcare or build seawalls to protect themselves from climate change – and these decisions will only get more difficult as climate crises grow in intensity and frequency.
Third, countries in the Global North have collectively failed to keep their pledge to provide $100bn annually in climate finance to lower-income countries for years, leaving them unable to make investments that benefit people everywhere. This broken promise poisons the atmosphere at international climate talks.
Most immediately, the IMF should make another SDR allocation to help countries manage imminent or ongoing liquidity challenges. As 2021 shows, SDRs are immensely useful for countries that need access to hard currency or want to reduce IMF debt, making space to spend more elsewhere.
Ultimately, injections of SDRs let governments decide what investments and public services to prioritise, rather than kicking the can down the road.
It is fair for governments to hold varying positions on the right balance between providing direct climate finance aid, allocating SDRs, and using public resources to ‘derisk’ projects and attract private investment. What is clear though, is that the current model, wherein poor countries forego climate investments for debt payments and in turn experience greater climate disasters and debt, isn’t working for anyone.
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