The World Bank is ignoring a key step in fighting climate change

Economists estimate that developing countries need to raise at least $1 trillion per year by 2030 in climate finance from external sources for the world to meet the Paris Agreement warming goals. Multilateral development banks are generally happy to get behind this goal and do what they can to lend more — they’re banks, after all.

But for many countries, new lending may be deeply counterproductive, as it adds to what is already a crushing debt burden. The U.N. reported last week that 3.3 billion people live in countries that spend more on interest payments than on health and education. Yet debt relief is a solution that none of the decisive players are incentivized to advocate for.

In a recent study, Gallagher and his colleagues found that the 61 countries under the greatest debt distress — mostly in Africa, South Asia, and island nations — owe about $992 billion in external debt, of which 40% is due to multilateral development banks (MDBs) and the IMF. About 80% of the overall figure needs to be restructured, Gallagher argues. The question is how.

Barbados Prime Minister Mia Mottley and other leading advocates for climate finance reform have proposed that countries’ debt repayments be postponed following natural disasters. The Seychelles and Gabon have experimented with innovative debt-for-nature swaps, in which debt is reduced in exchange for new conservation policies. Barbados is also considering such a deal, its finance minister told Reuters this week. But most of it will have to be simply written off, a “haircut” that could amount to $500 billion, according to Gallagher.

Historically, MDBs have been willing to take sizable haircuts on developing countries’ debt (especially when prodded by Bono). Helping countries out of debt distress ultimately saves MDBs money, because highly-indebted countries can more easily qualify for MDB grants (as opposed to loans). But MDBs are reluctant to support debt relief now because doing so would jeopardize their AAA credit ratings, which are essential for them to lend money more cheaply than commercial banks. At a deeper level, individual bankers within MDBs are incentivized only to get as much money out the door as possible.

Gallagher proposes a two-part solution. One, MDBs should be responsible for a smaller share of debt relief, to reflect the fact that they are already lending money at lower rates than the private sector or China, the other top lender (in Gallagher’s analysis, private lenders would need to cover some of the difference, no small obstacle). And, he suggests, the wealthiest countries should direct more of their contributions to the MDBs into debt relief trusts, which already exist to cover MDBs’ losses from haircuts but are currently close to empty. But that’s a political challenge, since wiping out a pile of old debt isn’t a sexy way to spend money in the eyes of taxpayers.

“Politicians can barely get it together to raise the balance sheet,” Gallagher said. “There’s no momentum to clean up a mess from the past.”

The key to breaking this impasse might lie with China, which has also tended to resist calls for debt relief. Under Gallagher’s approach, Beijing should also be responsible for a smaller share of the overall haircut, because it also lends at concessional rates.

“If China were more open to taking a haircut, then I think you could unblock the rest, because of the moral pressure,” said Michael Jacobs, a senior fellow at the Overseas Development Institute, a London-based think tank, and former climate adviser to U.K. Prime Minister Gordon Brown.

Debt relief negotiations are no fun, usually requiring painful and unpopular domestic measures to curb government spending and raise taxes, as Ghana and Zambia found over the last year as they went through an IMF-led default process that “is universally regarded as too slow, too cumbersome, and basically failing,” Jacobs said.

Asking too loudly for debt relief can also spook potential investors, and drain MDB resources that would otherwise go to badly-needed new projects, said Annalisa Prizzon, ODI’s principal research fellow. It comes down to a question of “lend or suspend,” she said. “The important thing is the net flow of resources: new funds should exceed debt payments.”

One other change that could help prevent future debt distress is for MDBs to make their loan books more transparent. The Global Emerging Markets Risk Database (GEMs) is a trove of nearly two decades of data on loan defaults in developing countries from all kinds of private and public lenders. The data is only available to MDBs, and not to the private sector, which a growing number of African leaders say contributes to a misconception that their countries are higher-risk than they really are, leading to poor credit ratings and higher borrowing costs.

If the data were public, it would likely drive an increase in foreign investment, said Karen Mathiasen, a researcher at the Center for Global Development and former U.S. Treasury Department official. GEMs is administered by the European Investment Bank, which is considering releasing some of it, but with a lot of crucial details stripped out, Mathiasen said.