By Adil Ababou
Over the past three years, debt swaps have experienced a remarkable revival. They have transitioned from relying on donor debt cancellation efforts to being applied on a large scale for commercial debt, leveraging credit enhancement mechanisms. The initial reaction to this revival was a mix of circumspection and over-optimism.
Some key differences between bilateral and trilateral debt swaps:
This paper argues that the debate is now over, and given the tool’s track record to date, it is clear that debt swaps are an additional financial tool to help achieve the SDGs and enhance debt sustainability. In a particularly challenging funding environment for Low- and Middle-Income countries (LMICs), debt swaps have unlocked additional resources on a scale rarely seen. To date, nine debt swaps have been implemented in seven countries, mainly in the Americas, releasing nearly $1.7Bn in nominal financing over time and reducing debt stocks and debt service by billions of US dollars. When used in the right circumstances and well-structured around specific objectives, debt swaps can make a significant additional impact.
Marine and nature conservation have dominated debt swap transactions, accounting for $1.5Bn of the $1.7Bn in resources released. However, in the last quarter of 2024, two transactions supported education and climate objectives.
This paper argues that, as they extend to a broader diversity of sectors and stakeholders, debt swap arrangements should also be apprehended as a tool for public finance. Specifically, debt swap flows stand out in the world of development finance for their long-term, regular, and predictable nature due to:
- The length of the financial commitment, which goes well beyond the usual economic and political cycles;
- An institutional and legal framework capable of withstanding shocks and system changes; and
- A context involving an alliance of multiple stakeholders.
The distinctive structure of these flows and the legal obligations behind them warrant careful consideration to harness their unique potential for advancing development outcomes. The author proposes a set of three guiding principles to ensure that the potential of swap resources is optimized:
- Define a long-term vision of what can be achieved through swap resources through consultations, both at the design and operational stages.
- Target expenditures that particularly benefit from long-term financing, such as maintenance, vaccine campaigns or climate-resilient infrastructure.
- Establish mechanisms to ensure additionality with government spending as the swap is operationalized.