Why Does Debt Matter for Sustainable Development and Climate Action?

At the 29th UN Climate Change Conference (COP 29), developed nations agreed to increase financial support for developing countries by committing to mobilize USD 300 billion annually by 2035 to support climate action in the Global South. The total financing needs of emerging markets and developing economies (EMDE) go beyond this goal: USD 700 billion per year until 2030 to preserve global biodiversity, and an extra USD 3.9 to 4.3 trillion per year needed to meet the Sustainable Development Goals (SDGs).

The sums needed are even bigger for these countries to fund a green, inclusive economic transformation and move up the value chain.

These estimates highlight the urgent need for sustainable financing to address the pressing challenges of climate change and development. Given the scale of these investment needs, access to credit is vital. Without debt, governments’ ability to invest would be limited by their current fiscal space–the revenue generated through taxes, among other sources.

Debt can initiate a virtuous cycle when managed effectively, increasing a country’s investment capacity and fostering growth. The flip side is that debt carries risks.

A country’s ability to service its debts depends on future conditions, which are often difficult to predict. Its success lies in its capacity to raise taxes and respond to factors beyond its control, such as external shocks.

Why Debt Is Relevant Today

While debt is a necessary tool for development, too much of the wrong sort of debt, can result in debt sustainability problems and undermine economic growth.

We saw an acceleration of debt accumulation in EMDEs during the fourth wave of debt, a sustained surge in global sovereign debt levels that started after the 2008 financial crisis. The COVID-19 pandemic's economic impact, coupled with ongoing geoeconomic instability, has left EMDEs increasingly vulnerable. In the past, many EMDEs relied on concessional loans from bilateral lenders or multilateral development banks. Today, they face high debt servicing costs and higher interest rates, due to borrowing from international financial markets and interest hikes from major central banks. Capital outflows are often higher than inflows, creating balance-of-payments problems, fiscal squeeze and scarce resources for crucial investments.

According to the United Nations Conference on Trade and Development, developing countries spend more on debt servicing than on essential public spending in areas like health and education. For instance, in the early years of the COVID-19 pandemic, regions such as Africa and Asia and Oceania (excluding China) allocated more funds to interest payments than to healthcare. Altogether, approximately 3.3 billion people reside in countries where spending on interest payments surpasses that on either education or health. In 2023, net interest payments on public debt for developing countries reached $847 billion, and 54 developing countries allocated 10% or more of their government revenues to interest payments.

In addition, climate hazards place a heavy burden on poorer countries, where the large sums required for climate adaptation are often either costly or inaccessible. Climate risks are driving up premiums on non-concessional debt as investors demand higher compensation for rising environmental risks. Tax revenues alone are insufficient to cover these costs, and allocating a large portion of government revenues to debt servicing can have detrimental effects.

How Can Sustainable Debt Contribute to a Green and Inclusive Economic Transformation?

Developing economies must strengthen institutional capacities to manage debt effectively, ensuring that it becomes a tool for development rather than a source of vulnerability. Despite decades of establishment, DMOs often face capacity gaps, such as inadequate organizational structures and limited integration with other financial governance bodies. Debt management should be approached as a holistic process involving not only Debt Management Offices (DMOs) but also broader institutional and regulatory frameworks. Many countries also lack the capacity to conduct their own DSAs or interpret those of the International Monetary Fund.

State capacity to effectively utilize financing opportunities and various debt instruments is also impacted by existing power imbalance between debtor countries and their creditors throughout the debt cycle. Many countries aim to enhance their understanding of the complex risks, costs, and political-economic factors involved in choosing debt instruments to support their green and inclusive economic transitions. This requires a comprehensive approach that accounts for factors impacting debt, such as investment needs, tax collection potential, spending needs, interest rates on debt, and debt maturity profiles.

Linking these strategies to climate-focused initiatives like Just Transition Energy Plans is crucial, as they provide key insights into the investment requirements for sustainable energy transitions.

How Can We Tackle These Gaps 

For developing countries, the challenges of meeting the SDGs, addressing climate change and investing in a green and inclusive transformation are compounded by the difficulties of managing sovereign debt. Strengthening state capacity is essential for aligning debt management with development and climate goals while avoiding overexposure to financial risks. Equally important is the need to reform the international financial architecture, which often creates an uneven playing field. The international community must support both national efforts and changes to the financial system, ensuring that global financial structures are conducive to the long-term success of these countries.

IISD’s debt program works alongside developing countries to strengthen debt management and enhance debt sustainability. The program strengthens DMOs and the broader fiscal policy regime in selected countries by optimizing their structures and processes and offering targeted trainings different actors with debt management functions. It also promotes coordination among ministries, central banks, and parliaments while building oversight capacity. Through foundational courses and multistakeholder platforms, we help debt managers improve their use of debt sustainability analysis and foster trust in revenue and investment estimates.

Together with capacity building, research is key to support developing countries in using debt sustainably and enabling a green and inclusive economic transformation. IISD’s debt program conducts innovative and impactful research, that sheds light on necessary domestic and international reforms that contribute to long-term, sustainable economic transformations. Finally, greater coordination among debtors is crucial to reduce the power imbalances characterizing the International Financial Architecture.

Strengthening existing networks, fostering knowledge exchange, and amplifying the voices of developing countries in international policy-setting processes can drive the shift toward a more equitable and effective global financial system. Such efforts are crucial in reducing power imbalances and ensuring that financial structures better support developing countries in achieving their climate, biodiversity, and development goals.