Debt for Nature Swap

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Debt for nature swap

Debt for nature swaps are designed to relieve developing countries of two devastating problems: spiraling debt burdens and environmental degradation .Ina debt for nature swap, developing country debt held by a private bank is sold at a substantial discount on the secondary debt market to an environmental nongovernmental organization (NGO). The NGO cancels the debt if the debtor country agrees to implement a particular environmental protection or conservation project. The arrangement benefits all parties involved in the transaction. The debtor country decreases a debt burden that may cripple its ability to make internal investments and generate economic growth. Debt for nature swaps may also be seen as a good alternative to defaulting on loans, which hurts the country's chances of receiving necessary loans in the future. In addition, the country enjoys the benefits of curbing environmental degradation. The creditor (bank) decreases its holdings of potentially bad debt, which may have to be written off at a loss. The NGO experiences global environmental improvement.

Debt for nature swaps were first suggested by Thomas Lovejoy in 1984. Swaps have taken place between Bolivia, Costa Rica, and Ecuador and NGOs in the United States. The first debt for nature swap was implemented in Bolivia in 1987. Conservation International , an American NGO, purchased $650,000 of Bolivia's foreign debt from a private bank in the United States at a discounted price of $100,000. The NGO then swapped the face value of the debt with the Bolivian government for "conservation payments-in-kind," which involved a conservation program in a 3.7 million acre (1.5 million ha) tropical forest region implemented by the government and a local NGO.

Despite the benefits associated with debt for nature swaps, implementation has been minimal so far. Less than two percent of the $38 billion in debt for equity swaps have been debt for nature swaps. A lack of incentives on the part of the debtor or the creditor and the lack of well-developed supporting institutional infrastructure can hinder progress in arranging debt for nature swaps.

If a debtor country is unable to repay foreign debt, it has the option of defaulting on the loans or agreeing to a debt for nature swap. The country has an incentive to agree to a debt for nature swap if defaulting is not a viable option and if the benefits of decreasing debt through a swap out-weigh the costs of implementing a particular environmental protection project. The cost of the environmental protection programs can be substantial if the developing country does not have the appropriate institutional infrastructure in place. The program will require the input of professional public administrators and environmental experts. Without institutions to support these individuals, the developing countries may find it impossible to carry out the programs they promise to undertake in exchange for cancellation of the debt. If, in addition, the debtor country is highly capital-constrained, then it might not give high priority to the benefits of an environmental investment.

Whether the creditor has an incentive to sell a debt on the secondary debt market to an NGO depends on the creditor's estimate of the likelihood of receiving payment from the developing country; on the proportion of potentially bad credit the creditor is holding; and on its own financial situation. If the NGOs are willing to pay the price demanded by private banks for developing country debt and swap it for environmental protection projects in the debtor countries, they will have the incentive to pursue debt for nature swaps.

Benefits that may be taken into account by the NGOs are those commonly associated with environmental protection. Many developing countries hold the world's richest tropical rain forests, and the global community will benefit greatly from the preservation of these forests. Tropical forests hold a great deal of carbon dioxide , which is released into the atmosphere and contributes to the greenhouse effect when the forests are destroyed. Another benefit is known as "option value," the value of retaining the option of future use of plant or animal resources that might otherwise become extinct. Although we may not know at present of what use, if any, these species might be, there is a value associated with preserving them for unknown future use. Examples of future uses might be pharmaceutical remedies, scientific understanding or ecotourism . In addition, NGOs may attach "existence value" to environmental amenities. Existence value refers to the value placed on just knowing that natural environments exist and are being preserved. Many NGOs believe preservation is important so that future generations can enjoy the environment . This value is known as "bequest value." Finally, the NGO may be interested in decreasing hunger and poverty in developing countries, and both the reduction of external debt and the slowing of the depletion of natural resources in developing countries is perceived as a benefit for this purpose.

To make a swap attractive, however, the NGO must be assured that the environmental project will be carried out after the debt has been canceled. Without adequate enforcement and assistance, a country might promise to implement an environmental project without being able or willing to follow through. Again, the solution to this problem lies in the development of institutions that are committed to monitoring and giving assistance in the implementation of the programs. Such institutions might encourage longterm relationships between the debtor and NGO to facilitate a structure by which debt is canceled piecemeal on the condition that the debtor continues to comply with the agreement.

A complicating factor that may affect an NGO's cost-benefit analysis of debt for nature swaps in the future is that, as the number of swaps and environmental protection projects increases, the value to be derived from any additional projects will decrease, due to diminishing marginal returns.

As described above, the benefits associated with debt for nature swaps both for the debtor countries and NGOs hinge on the presence of supporting institutions in the developing countries. It is particularly important to promote the establishment of appropriate, professionally managed public agencies with adequate resources to hire and maintain environmental experts and managers. These institutions should be responsible for planning and implementing the programs.

It should be noted that, although large debt burdens and environmental degradation are both serious problems faced by many developing countries, there is no direct linkage between them. Nevertheless, debt for nature swaps are an intriguing remedy that seems to address both problems simultaneously. As the quantity and magnitude of swaps so far have been relatively small, it is impossible to say how successful a remedy it may be on a larger scale. It is clear, though, that the future of debt for nature swaps depends on the development of appropriate incentives to all parties in the swap and on the development of institutions to support the fulfillment of the agreements.

[Barbara J. Kanninen ]