Unravelling the Impact of the Global Debt Crisis on the Green Transition

The world is facing an unprecedented global debt crisis. What used to be a minority problem amongst the world’s poorest developing nations is now an issue covered in the mainstream media of economic powerhouses such as the United States. Yet, few outside of the expert realm of global finance understand how sovereign debt has a trickle-down impact on their own lives. A global debt crisis could trigger a global economic downturn, setting back government’s development agendas, especially in relation to climate change. This would ultimately hurt the poorest and most vulnerable in society who depend on the government to shelter economic shocks.

According to the International Monetary Fund, sovereign debt is money that governments borrow that couldn’t otherwise be raised from taxation. There are two major reasons why governments borrow money. One is to avoid cutting social programs during times of economic downturn when tax revenue falls short of sustaining the national budget. The more common reason why governments borrow however is to invest in the future wellbeing of their citizens through infrastructure projects. Most of a country’s tax revenue is committed to the ordinary operations of the government such as paying the civil service and maintaining social services such as public schools, hospitals, clinics, etc. Therefore, to embark on long-term investment projects such as building roads, power plants, and other public projects, a government may decide to take out loans to cover costly upfront capital costs.

These capital investments are often financed by a combination of loans from local banks and larger multinational lending agencies such as the International Monetary Fund and the World Bank. Caribbean governments also borrow from regional banks such as the Caribbean Development Bank and the Inter-American Development Bank. Governments can also secure financing by accessing a traditional capital market which includes seeking private investment from other governments, investment firms, or selling bonds to the public. (IMF)

The Caribbean region is one of the most highly leveraged regions in the world, carrying some of the highest debt burdens. The term leverage refers to the ratio of assets to debt. This is not inherently bad, since borrowing is necessary to access capital to generate returns, however having a high GDP-to-debt ratio increases the risk of these loans since the likelihood of making on time payments is compromised. (Business Development Bank of Canada)

Caribbean countries are being crushed by debt service.

While an unprecedented number of countries, both developed and developing, are experiencing high levels of debt, countries in the Global South including the Caribbean are at the greatest risk of facing a debt crisis. Using, Barbados as an example, researchers at the University of Albany identified how colonialism directly influenced the Caribbean and Latin American region’s propensity to experience cycles of debt crises.

Emerging from colonialism, floundering new republics depended on taking out debt to develop industries, economies and infrastructure. (Chase, 2019) These loans had high interest rates and were prone to default which would cause economic hardship and incur scrutiny from global bodies like the IMF.

When a country is at risk of not paying its debt, its lenders can demand debt service be made first, causing the government to cut spending on other sectors of the government such as halting new projects and initiatives, reducing the number of government employees, cutting social welfare policies such as unemployment benefits etc.

Many financial experts hypothesize that COVID-19 is to blame largely for the growing debt crisis, especially in the Caribbean. Countries borrowed money for infrastructure projects that were halted during the pandemic. At the same time expenditure in the form of stimulus and health care increased while income fell. Despite this, many governments were still required to make payments on outstanding debt, further pushing them to the brink.

Global capital markets are a complex interconnected web. It is like a line of dominoes set so that the toppling of one may set off a chain reaction in other places. A default in the region may cause other investors across the region to become spooked, causing them to pull their investments or demand debt service, causing additional stress on a government’s ability to repay. As many things are, a global debt crisis is only compounded by the impacts of climate change. Since countries must grow their economies to make debt service, then natural disasters such as hurricanes, wildfires and floods which impact economic activity like agriculture and tourism, creates risk of default. Infrastructure projects can become destroyed or delayed, decreasing the taxable income of citizens, further exacerbating the need for social assistance.

Source: Center for Economic and Policy Research.

A government finds themselves deciding between debt service and running the country. If a country chooses debt service, their economies may further contract, causing discontent locally and threatening political stability. However, if a country chooses not to make debt service, they may default on debts, inviting in predatory measures from the IMF or international bodies to ensure that the debt is paid. It creates a cycle of catch-22’s.

In the Caribbean, even before the stress of the COVID-19 pandemic, natural disasters were a major factor leading to defaults. To embark on green energy transitions that makes economies less vulnerable to global shocks, one would thus have to invest in green energy – requiring capital investment. To rebuild after a disaster, one might also require taking out loans.

It seems that whichever direction a Caribbean leader turns they are faced with the need to sacrifice some element of the country’s autonomy and sovereignty for survival – in the form of loans or the economic collapse that would occur without it. This is the rationale between the advocacy of many governments in the global south to receive debt-free financing from the largest industrialized countries in the world who are undoubtedly more responsible for the climate crisis.

Barbados Prime Minister the Hon. Mia Mottley has made waves globally for proposing the Bridgetown Initiative, a restructuring of the global finance ecosystem to recognize the inequitable nature of the current global debt market. According to the proposal, global multilateral lending agencies such as the IMF and World Bank must reform their current policies towards adjudicating risk and interest with climate financing to realize the disproportional risk that Caribbean Islands and other countries in the global south face with regards to the climate crisis. Additionally, lenders must adopt a climate vulnerability framework to recognize that a country’s ability to pay can be greatly diminished by climate change and natural disasters.

Such a proposal is necessary to creating more equity and justice in global capital markets and will also slow the descent into high risk of default that many countries are experiencing. However, on its own it is unlikely to reverse course of the spiraling debt crisis that currently engulfs even the richest countries in the world such as the United States.

If you're interested in further reading here is a link to my sources!