Debt relief is needed for circular economy initiatives in the Global South to flourish

By Megan Murdie , Ana Birliga Sutherland and Marvin Nusseck

This article was originally published by World Commerce Review.?

What if, instead of being burdened by the debt of the past, Global South countries could redirect those funds to prevent environmental collapse and transform waste into wealth? This is the powerful promise of the circular economy. The worldwide push towards sustainable development has put the circular economy centre-stage—and for countries in the Global South that are striving for economic and social development without exceeding our planetary boundaries, the integration of circular economy principles can be transformative. However, many circular projects require high upfront investments, making them less accessible to countries with significant debt burdens. With this in mind, debt relief and restructuring measures can be strategically designed to support the implementation of circular economy strategies, offering a pathway to sustainable development and economic resilience.

The debt burden

Global South countries are largely not responsible for the climate crisis, nor overconsumption—yet bear the brunt of the impacts, often pushed further into debt due to factors beyond their control. Dependence on resource extraction—a result of colonialism—is deeply entrenched, yet the capital to reverse this trend is sorely lacking. Now shouldering the burden of wealthier countries’ offshored production centres and bearing the weight—figuratively and literally—of millions of tonnes of waste shipped from the Global North, as well as racing to mitigate the damage done by storms, floods and droughts, Global South countries are at the crux of the crisis of our time. In many cases, debt levels are not accrued because of macroeconomic mismanagement, but rather as a result of low- and middle-income countries bearing the brunt of climate impacts, as well as their heightened exposure to volatile international markets for finance and trade. The structure of international lending, in many cases, means that rising interest rates globally increase the cost of borrowing. For the Global South, where credit ratings are typically lower, these are amplified further still. It’s no wonder that governments—which are required to operate within tight budgets after debt repayments are made—feel bound by the choice of addressing immediate welfare concerns or future environmental ones. And even the former isn’t so simple: over 40% of the world’s population lives in countries that spend more on debt interest payments than on health and education.

The countries most impacted by the climate crisis are often those least capable of investing in a more resilient future, largely due to their extreme debt burdens. A staggering 93% of the 63 countries deemed most vulnerable to climate breakdown are in—or are at risk of—debt distress, where countries are no longer able to fulfil their financial obligations. According to figures from Debt Justice, 34 of the world’s poorest nations spend five-times more—a substantial $29.4 billion annually—on debt repayments than on measures to combat climate breakdown, which are allocated just $5.4 billion. What’s more, the majority of the climate funding allocated to these countries is provided as loans, exacerbating their already significant debts. These figures contrast starkly with the estimated $3 trillion needed for lower- and middle-income economies—China excluded—to achieve international climate and development goals. If current patterns continue, Global South countries will remain hamstrung, faced with the impossible trade-off between servicing debt and making crucial investments in climate mitigation.

Understanding the circular economy

So where does the circular economy come into play? Unlike the linear ‘take-make-waste’ economic model, the circular economy is an economic system where waste is designed out, everything is used at its highest value for as long as possible, and natural systems are regenerated. The concept of circularity closely mimics nature, where there is no waste and all materials are continuously cycled. This makes it possible to live within the means of the planet—using fewer materials and generating less waste—while still providing for the global population.?

If managed well, the circular economy offers solutions to drastically reduce material-related emissions, and address other systemic issues such as biodiversity loss, pollution, and social inequality. As noted, governments in resource-dependent low- and middle-income countries are often faced with the impossible choice of funding essential services for development or addressing the climate crisis—but the circular economy offers an opportunity to address both issues at once, mitigating the perceived trade-off between supporting development and tackling environmental breakdown.

Linking debt relief with circular economy initiatives

It’s becoming increasingly clear that without debt relief measures, governments in the Global South cannot be expected to achieve crucial sustainable development goals. Substantial debt relief or scaling up debt-for-climate swaps, where a portion of a country’s debt is forgiven in exchange for commitments to invest in climate projects, is essential. Debt relief can be a powerful tool to enable low- and middle-income countries to adopt circular economy principles: by easing the financial burden, these countries are free to invest in building a more resilient future. Multilateral Development Banks (MDBs) have an important role to play in engaging with client countries to collectively support specific outcomes in service of the circular economy.

This shift requires a comprehensive approach, encompassing strategies to boost alternatives to borrowing, improve borrowing, enhance accountability mechanisms and lending practices, for example by increasing concessional lending—loans offered at lower interest rates and with more favourable terms than standard market loans. The International Monetary Fund notes that it’s often more effective to address debt and climate separately, claiming that a simple climate-conditional grant tends to be effective in supporting sustainable development without the added complexity of other measures, such as a debt swap. Unfortunately, at present, grants and concessional loans from bilateral donors and MDBs aren’t making much of a dent in the enormous amount of sustainability financing needed, and other options—like debt restructuring—often aren’t available until a country defaults on its loans and loses market access. In other words, countries have to be in serious financial trouble to get access to solutions.?

‘Debt-for-climate’ and ‘debt-for-nature’ swaps have emerged as tools attempting to address financial and planetary health: here, a portion of a lower-income nation’s foreign debt is forgiven in exchange for local investments in sustainability initiatives. These arrangements can protect nature and spur climate action—especially in cases where action wouldn’t have been possible without the swap—and can even create revenue for countries with invaluable ecosystem services: those with significant carbon sinks, for example, or flourishing biodiversity, both of which provide benefits to the global public. Given the circular economy’s crucial role in both mitigating climate breakdown and regenerating nature, the surprisingly not-yet-coined ‘debt-for-circular-economy’ swap may even better describe such tools’ intended outcomes. While swaps certainly aren’t a fix-all for countries with unsustainable levels of debt, they’re among the few tools available to tackle debt and environmental challenges in tandem.

Swaps typically fall under three main categories: commercial swaps, which involve a third party acquiring debt titles and replacing them with more affordable debt by issuing ‘SDG’ or ‘blue’ bonds in capital markets, bilateral swaps, which occur between two governments and in which the creditor country forgives a portion of the debtor nation’s debt in exchange for environmental commitments, and multilateral swaps, which are similar to bilateral debt-for-nature swaps but involve international transactions between three or more national governments. While bilateral debt swaps are the most common and straightforward, commercial debt swaps can achieve greater scale as there’s often more money at stake. Herein lies the challenge: pushing swaps into the mainstream as a means to effectively tackle the challenges faced by Global South countries.?

Recent trends show debt swaps are on the rise

Although not yet de rigeur, debt-for-nature swaps have been around for decades—but their typically small size has meant that impact is limited. This may be finally changing, however, with Ecuador announcing the largest debt-for-nature swap to date in 2023. Credit Suisse helped the Ecuadorian government buy back around $1.6 billion of debt for $644 million, with an $85 million guarantee from the Inter-American Development Bank that could, if needed, cover the first six interest payments—highlighting the important role of MDBs in de-risking such activities for commercial banks. The swap will free up conservation funds for the Galapagos Islands—one of the planet’s most precious and diverse ecosystems—and will save the country roughly $1 billion in repayments over 17 years. Nature conservation supports a circular economy by preserving and restoring natural resources and ecosystems, enabling more sustainable resource use, cutting waste, bolstering essential ecosystem services and enhancing overall resilience. The debt swap will allow Ecuador, which has defaulted multiple times in recent years, to not only repair its finances but to protect many animal species that are found nowhere else in the world.

Although Ecuador’s 2023 swap broke records, other relatively large commercial swaps—each around $500 million—have been announced for Belize and Gabon, and Sri Lanka may be considering a deal that shaves $1 billion off its debt. The current global market potential for debt for climate swaps is estimated at a whopping $800 billion—despite only a fraction of this being used today—sparking stiff competition between banks amid growing demand for green investments.?

Debt swaps can’t exist in a vacuum—so what’s next?

Ultimately, debt-for-nature swaps aren’t a silver bullet—and enacted in a vacuum, they’ll do little to support lower- and middle-income countries in transitioning to a circular economy. Although the circular economy offers a means to address development goals in tandem with environmental ones, significant financing will be needed to get circular initiatives off the ground and ensure they’re rolled out at scale. In the 2024 edition of its Circularity Gap Report—an annual check-up on the circular state of the world—Circle Economy calls for a number of actions to mobilise finance towards circularity. It highlights that the circular transition doesn’t fall within the remit of environmental ministries alone—and governments shouldn’t shy away from outreach beyond their own offices.

MDBs are especially well-poised to facilitate collaboration with and among multilateral organisations, industries, academia and even other national governments—but being explicitly demand-driven organisations, can only do so at a country’s request. Governments of lower- and middle-income countries should signal where help is required and ask for support to reach specific targets, while governments in higher-income countries can directly support debt relief efforts by ensuring multilateral financial institutions provide direct funding and prioritise access to affordable capital.?

Ensuring sufficient financial capital flows to just, circular solutions is a critical challenge—especially in our current linear world, where virgin materials are cheaper due to the externalisation of social and environmental costs, financiers are largely wary of shifting paradigms and businesses are hesitant to change their tried-and-true approaches. The solutions are there, but need knitting together—and finance will be a key linking pin in this process. Circle Economy’s upcoming Circularity Gap Report Finance, the first of its kind, aims to map investments made into the circular economy, at the global scale, and with this explore how we can direct capital towards high impact circular economy solutions, motivate financiers to understand and track risks of the linear economy, and overall change business as usual in the financial sector and beyond, to shape an enabling environment at scale. In doing so, it will help forge the path towards equitable and sustainable development for all.?

Learn more about Circle Economy's Finance programme here.