How lending-based climate finance is pushing poor countries deeper into debt

When the world’s wealthiest economies pledged in 2009 to mobilise $100 billion a year towards climate action for developing countries by 2020, few present at the COP15 questioned the urgency of the task before them. Certainly not then-UK prime minister Gordon Brown, the first person to propose the figure in a speech delivered in the months leading up to that year’s climate summit in Copenhagen.

In his “manifesto”, the sombre Scot listed an almost Biblical litany of disaster sweeping across the developing world: 325 million people “seriously affected” by drought, dearth, deluge or disease; a further half a billion souls at extreme risk; and 300,000 lives lost, every year, to the effects of climate change.

“In the developing world, climate change is already devastating lives,” he said.

According to the best estimates of the OECD, 2022 may have finally marked the first year the wealthiest economies finally kept their promise in delivering the funds desperately needed by developing nations to adapt to a warming world and to mitigate the impacts on populations most vulnerable to the climate crisis. But behind the rhetoric of first-world reparations for the global harm caused by a century and a half of fossil-fuel-led industrial development squats an uglier reality: most of the money that makes its way to developing nations in public climate finance is going to have to be paid back – with interest.

Market-level interest rates

OECD data from 2016-2020, the most recent we have, shows that loans made up 72 percent of international climate finance. Of that number, three-quarters of the loans from multilateral development banks (MDBs) such as the World Bank were non-concessional, or loans issued with interest rates set at market levels. Just one quarter of international climate finance over the same period took the form of grants.

More worryingly, Oxfam estimates that the proportion of non-concessional finance is growing. In their Climate Finance Shadow Report released in June 2023, the organisation estimated that the annual average of non-concessional instruments in climate finance had reached $28 billion – 42 percent – in 2019-20, while concessional lending remained largely on the same level as the previous two years.

Although MDBs accounted for much of this market-rate lending, a small number of wealthy countries continue to use loans as their main form of climate finance. Of all the bilateral providers, France leads the pack in lending, with a massive 92 percent of its bilateral public climate finance taking the form of loans.

And while a large share of that lending is made up of concessional or “soft” loans, which are offered at more favourable interest rates or longer repayment schedules, an alarming 17 percent of its bilateral climate finance is non-concessional. For Spain, that number is a staggering 85 percent. More than half of Austria’s climate financing is non-concessional, according to Oxfam’s analysis, as is almost a third of the United States’ climate financing.

Paying back billions – with interest

Put together, this adds up to tens of billions of dollars every year that countries of the Global South will one day be forced to pay back to the world’s wealthiest nations and development banks – with interest. And with global interest rates rising steeply, the cost of servicing those debts year after year will eat into the already-stretched budgets of countries buckling under the weight of debts that are getting harder to pay back.

Danielle Koh, policy analyst at the NGO Reclaim Finance, said that the problem partly arises from the sheer magnitude of the challenge of raising funds to tackle the climate crisis.

“The scale of climate funding required is enormous,” she said. “To rely only on public financing would not be sufficient to meet 1.5°C pathway-aligned targets, and loans at market rates could attract and mobilise private capital.”

By including loans at their full face value, Koh said, wealthy countries are also able to claim credit for meeting their climate pledges far beyond what they are actually giving away. Of the more than $83 billion that was claimed to have been raised in 2020, Oxfam estimates the actual value for developing countries to be between just $21 and $24 billion. And while non-concessional finance is not counted towards countries’ official development assistance spending more broadly, this distinction has yet to be made when it comes to funding climate action.

“In providing financing to developing countries, loans at market rates could be favoured because developed countries can count such loans towards being able to fulfil climate financing commitments while at the same time avoiding giving direct grants or other concessional types of financing, which would be more costly,” said Koh.

Counting non-concessional loans as climate finance may not just be disingenuous, but dangerous. Sixty percent of low-income countries are already either in or on the verge of debt distress, forced to spend five times more every year on servicing their debts than they do on climate adaptation.

Counterproductive debt burden

Safa’ Al Jayoussi, climate justice adviser at Oxfam Middle East and North Africa, said that adding to low-income countries’ debt burden would make them more vulnerable, rather than more resilient, to the ravages of the climate crisis. 

“It’s a big risk, because countries are already distressed,” she said. “Developing countries are dealing with a lot of loans from the World Bank and other institutions that are causing more austerity. Adding more pressure to the countries … will impact those most vulnerable to climate change. This kind of funding is making adaptation and mitigation to climate change more difficult.”

According to the United Nations Conference on Trade and Development (UNCTAD), public debt has been growing faster in developing nations than in their developed counterparts over the past decade. Faced with compounding crises of Covid-19, climate change and the cost-of-living crisis, the number of countries facing high levels of debt has increased dramatically, from just 22 countries in 2011 to 59 countries in 2022.

And debt is costing developing nations dearly. On average, African countries pay interest rates four times higher than those of the US, and eight times higher than Germany. To service those debts year after year, countries have little choice other than to redirect funds that may otherwise have gone to badly underfunded sectors such as health or education. In the ten years between 2010 and 2020, the number of countries where interest spending accounted for 10 percent or more of their public revenues rose from 29 to 55.

More debt, then, seems to be the last thing the developing world needs.

“There is a real danger that this could lead to high debt burdens in developing countries,” Koh said. “With global rising interest rates, the cost of servicing debt for developing nations will rise substantially. Loans in foreign currencies could expose developing countries to soaring costs over servicing their debt in the case of exchange rate fluctuations or depreciations over time. In the long term, repaying climate debt not only diverts financial resources away from developing other sectors, but could lead to economic and fiscal instability.”

Hans Peter Dejgaard, senior consultant at INKA Consult and a specialist in climate finance, said that while it made sense to finance some renewable energy infrastructure in middle-income developing countries through loans as commercially viable projects, too much reliance on loan-based financing would put poor countries in an impossible position if interest rates continued to rise.

He cited a World Bank loan of $400 million to the Philippines in early 2022 aimed at accelerating climate-related objectives. After the US Federal Reserve raised interest rates to just under 6 percent in April 2023 to fight rising inflation, he said, the total repayments that the Philippine government would have to make over a period of 20 years had potentially risen from $482 million to $686 million – a 42 percent increase.

“This will affect their social and education budget,” he said.

Reclaim Finance’s Koh said that the cost for financing climate action should not be borne by the countries least able to afford it.

“There is no ‘one model fits all’ when it comes to funding climate finance, but there are certain principles that we can rely on to guide our approach,” she said. “For example, that concessional financing and grants should be favoured over market-rate loans, whether through initiatives like the Loss and Damage Fund or others, to help developing countries build resources for climate adaptation and mitigation while avoiding increasing their debt burden.”

For Al Jayoussi, that very burden should instead be borne by the countries most responsible for fuelling the worsening climate crisis. 

“Developing countries didn’t even cause climate change,” she said. “We need to revamp and change the finance structure that caused climate change in the first place. We need grants and grant mechanisms for the most vulnerable countries, developing countries, to overcome climate change.”