Developing countries face two simultaneous challenges: elevated and rising public debt levels, and the growing impact of climate change and natural disasters. Traditional borrowing has become increasingly expensive and, in many cases, unsustainable. Grants remain limited. In this context, debt-for-climate swaps are emerging as an innovative tool that promises both debt relief and investment in climate resilience.
But can they truly serve as a sustainable source of development financing, or do they simply shift fiscal risks into new forms?
What Are Debt Swaps?
Debt swaps are agreements between a government and one or two of its creditors to replace sovereign debt with a spending commitment over time towards a development goal, such as climate action, nature conservation, social stability, education, support to vulnerable groups, among others.
Debt swaps are most commonly used in developing countries facing high debt burdens and constrained fiscal space. With the support of donors and development partners, these arrangements aim to strengthen development cooperation by linking debt relief to progress on priority areas, including the Sustainable Development Goals (SDGs).
Debt-for-Climate Swaps
A specific type of debt swaps are debt-for-climate swaps, which link debt relief to climate-related investments. They support activities such as climate adaptation, including water management, resilience, and disaster risk reduction; and climate mitigation such as renewable energy and emissions reduction. They are often used to address climate vulnerability and meet climate commitments without further increasing debt levels, particularly in contexts marked by climate financing gaps.
Source: Climate Policy Initiative
When Can They Be Development Tools?
Debt swaps are most often used for bilateral or multilateral debt, meaning money a country owes to another government or an international institution. These deals are easier to negotiate directly between governments. In contrast, commercial or bonded debt involves private investors and is usually more complicated to restructure.
According to a joint World Bank and IMF report titled Debt for Development Swaps: An Approach Framework, countries that may benefit from debt swaps are those with “moderate” or “high” debt levels. However, they must still have debt that is considered manageable and must have strong systems in place to oversee and manage public debt.
The report also notes that debt swaps are complex. They require high levels of transparency, strong institutional capacity, sound governance, careful planning and integration into national strategies and budgets. Effective monitoring is also essential to ensure that the benefits outweigh the risks.
If designed and implemented properly, debt swaps can improve sustainable development outcomes. Using data from 127 developing countries between 1990 and 2020, Coulibaly (2025) finds that countries that implemented debt-for-nature swaps recorded significantly better sustainable development results. According to the study, the Sustainable Development Index was about 11 percent lower in countries that did not use swaps. In contrast, countries without swaps could have seen an improvement of around 2 percent if they had adopted such mechanisms.
When Do They Become Risky?
While presented as innovative solutions for managing high public debt levels, they also carry risks that should not be overlooked.
Scale risk: In many cases, the size of a debt swap is small compared to a country’s total public debt. If a country has $100 billion in public debt and a swap covers $200 million, the overall impact on debt sustainability is limited. The macroeconomic effect may therefore be modest, especially in highly indebted economies.
Reallocation risk: There is also the risk that swaps simply re-label spending that was already planned. If climate or environmental projects were already part of the national budget, a swap may not create new fiscal space, but instead repackage existing commitments.
Governance risk: Debt swaps require strong monitoring systems, institutional capacity, and transparent reporting. Funds are usually earmarked for specific projects, which means governments must be able to track and evaluate how the money is used. Weak governance can turn swaps into symbolic tools rather than effective fiscal instruments. The World Bank and IMF, in their report Debt for Development Swaps: An Approach Framework, stress that strong debt management and transparency are essential for these instruments to work properly.
Moral hazard risk: If swaps provide temporary relief, governments may delay broader fiscal reforms. Instead of structural reforms to address ineffective government spending, swaps may be relied on as a short-term solution.
Conditionality risk: Some swaps may limit fiscal flexibility. They can tie funds to sectors preferred by creditors or donors, reducing a government’s ability to allocate resources based on its own development priorities. This can create tensions between national strategies and externally driven agendas.
Effective Localization for Sustainable Economic Development
Beyond fiscal design, debt-for-climate swaps raise questions about national ownership. If swap funds are tightly directed by external creditors, they may limit policy flexibility and weaken the localization agenda, which emphasizes country-led development and domestic institutional control. For swaps to support long-term development, they must align with national strategies and strengthen, rather than bypass, local institutions.
