Vulnerable island nations turning to pricey private debt as climate disasters escalate

Government borrowing from the private sector by Small Island Developing States (SIDS) in the Caribbean, Pacific and Africa, increased in years of major disasters or shortly afterwards, as these countries turned to expensive private debt while coping with the effects of climate change, according to new analysis from IIED. 

In the early 2000s, private debt was relatively low among SIDS, averaging around 6.47% of GDP for 18 of the 39 SIDS for which IIED found data. But by the 2020s, this average rose substantially to 35.85% of GDP.

Seychelles had the highest private external debt, amassing a staggering 88.74% on average between 2020 and 2022. Around half of the debt of countries like Trinidad and Tobago, Papua New Guinea and the Solomon Islands is privately held.

SIDS often rely on external borrowing to finance development and respond to shocks but private debt, rather than debt extended by multilateral development banks or other countries, often comes at a higher interest rate. In 'Sinking islands, rising debts' researchers found that for many SIDS, including Guyana, Fiji and the Dominican Republic, private external debt increased in the years of major disaster or in the years after that. 

Ritu Bharadwaj, a principal researcher for IIED, said: “The increase in debt following climate-related disasters is alarming to see in these countries that are particularly vulnerable to rising sea levels and intensifying storms. At a time when they need to fund measures to adapt to the challenges of a heating planet to save people’s homes, livelihoods and lives, they are instead stuck paying off expensive loans to private creditors.”

Researchers also analysed the frequency and intensity of disasters in SIDS over the last three decades. Disaster intensity is measured by looking at the number of people killed or affected per head of population. They found that although the frequency of high-intensity disasters had fluctuated, there had been a general upward trend since 2010 with the number of disasters increasing from one in 2011 to eight in 2022.  

Several measures exist that allow countries to address their debt burdens including:

• Parametric insurance, which pays out when one or more of a set of pre-agreed events, like floods or droughts, takes place
• Pause clauses, where the creditor grants the debtor the option to temporarily suspend repayment for a period of six months
• Debt swaps, when the creditor country or organisation agrees to relieve a percentage of debt stocks for investment in climate, nature or resilience building measures
• Debt reprofiling, where the creditor reduces the interest rate for the loan, and
• Resilience bonds that help countries raise capital for projects that enhance resilience to climate change and disasters.

Researchers calculated the resulting reduction in the annual cost of servicing SIDS debt when each of these measures was applied. While each measure resulted in some decrease, the greatest reduction came from layering all five options at once. This reduced the annual debt servicing figure from US$12.34 billion to $9.49 billion. 

Layering debt reduction measures can also promote GDP growth. Researchers ran simulations which showed that a three percentage point increase in GDP growth rate could be achieved if debt-relief measures were applied on the debt stock of 33 SIDS ($153.75 billion).

Bharadwaj added: “The options countries have to address their spiralling debt burdens are limited and not fit for purpose. Addressing unsustainable debt needs to be tackled on a country-by-country basis, drawing simultaneously on a number of innovative solutions like pause clauses, parametric insurance, debt swaps and reprofiling.”