Abstract
As one of Kyoto’s three flexibility mechanisms, the Clean Development Mechanism (CDM) allows the issuance of Certified Emission Reduction credits from offset projects in non-Annex I countries. As little attention has been paid to how CDM projects are financed, this article assesses whether offset schemes with public bodies should utilise debt swaps as a form of funding. Specifically, we examine whether a debt-for-efficiency swap between Uruguay and Spain within a wind power project increased project finance and generated greater development co-benefits. We assess the transaction using a simple evaluative framework: whether it delivered additional resources to the debtor country and/or government budget; whether it delivered more resources for climate change mitigation; whether it had a sizeable effect on overall debt burdens (creating ‘indirect’ benefits); and whether it aligned with government policy and systems (elements of the new aid approach). We find evidence that cautions against using the Spanish–Uruguayan case as a model for future debt-for-efficiency swaps.
Abstract
Parmi les trois mécanismes de flexibilité du Protocole de Kyoto, le Mécanisme de Développement Propre (MDP) permet la diffusion des crédits de carbone provenant des projets compensatoires dans des pays non-Annexe I. Manque de réflexion sur les modes de financement des projets MDP, cet article vise à évaluer l’utilisation, par des bailleurs de fonds officiels comme intervention d’aide publique au développement, des opérations de conversion de la dette officielle comme mode de financement utile. Plus particulièrement, nous examinons dans quel mesure une opération de conversion de dette au bénéfice des économies d’énergie entre l’Uruguay et l’Espagne dans le secteur d’énergie éolienne, inclue dans un projet MDP, a bénéficié au financement du projet et à la disponibilité des ressources additionnelles pour le pays débiteur et pour la mitigation climatique, a créé des avantages complémentaires sur le plan du développement, et s’inscrit dans la nouvelle approche « d’alignement » de l’aide au développement aux politiques et systèmes du pays récepteur. Nos résultats mettent en garde contre l’adoption du cas espagnol-uruguayen comme modèle exemplaire pour des opérations futures de conversion de dette au bénéfice des énergies propres dans le cadre MDP.
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Notes
An indirect channel through which governments can judge projects to be developmental is through increasing revenues.
A number of initiatives have been put in place to help overcome this financing gap, for example a programmatic approach to CDM; moreover, from 2013 the EU will only purchase CERs from projects in LDCs.
We restrict ourselves to a discussion of debt-for-development swaps, that is, the practice of exchanging debt claims with the debtor country for development-related domestic spending (including on environmental goals). Many other forms of debt swaps exist, some of which are touched upon in the text.
The Brady Plan, launched in 1989, offered commercial banks with claims on (mostly Latin American) developing countries a menu of options to swap these debt titles for new bonds with lower nominal value and/or reduced interest rates or, alternatively, to retain their exposure but provide additional credit to compensate for any capital gains due to the reduced indebtedness of debtor countries. The Brady Plan resulted in deals typically involving several hundreds of millions of dollars per country (see, for example, Claessens and Diwan, 1994).
The idea of transplanting the debt-for-equity philosophy to environmental protection is generally ascribed to Lovejoy (1984), a former vice president of the World Wildlife Fund.
In 1996, the IMF and the World Bank jointly initiated the HIPC Initiative to bring debt burdens of severely indebted developing countries back to sustainable levels. Bilateral, multilateral and commercial creditors were requested to contribute in proportion to their exposure. The Enhanced HIPC Initiative in 1999 deepened relief and made debtor country participation conditional upon the preparation and implementation of a PRSP, a country-owned document describing the debtor’s medium-term structural and social policy for poverty reduction. Finally, in 2005, the IMF, World Bank’s International Development Association (IDA) and African Development Fund committed themselves to forgive the remaining debt owed to them by post-completion point HIPCs through the MDRI. As of end-July 2011, HIPC/MDRI debt cancellation packages have been approved for 36 countries (another 4 countries are on the waiting list), corresponding to approximately $128 billion of relief in nominal terms (IDA and IMF, 2011).
For example cases and a detailed critique of such debt-for-health and debt-for-education swaps, see Cassimon et al (2008, 2011b).
These figures were calculated from data obtained through the Spanish Ministry of Economy and Finance. The reported €923 million excludes a number of debt-for-equity swaps (with Jordan, Morocco, Algeria and Equatorial Guinea) between 2000 and 2006, but includes swaps with Honduras and Nicaragua in 1999 and 2000, respectively, whereby debts were directly cancelled in full (without counterpart commitments) in the wake of Hurricane Mitch.
Law No. 38/2006 of 7 December; see www.boe.es/boe/dias/2006/12/08/pdfs/A43049-43053.pdf. Article 5 (on debt conversion) refers to the need to ensure debt swap practice is consistent with agreements at the international creditor community level and to target those developing countries with the highest levels of external debt, preferably partner countries of Spain’s development policy.
This section draws on the information we have been able to extract from project documents, including the debt swap agreement and the CDM project design document and formal letters, as well as from correspondence with some of the officials involved. All documents (mostly in Spanish) are available from the authors.
These FAD credits were concessional loans granted to Uruguay during 1990–1994.
The Spanish Carbon Fund is a public–private partnership managed by the World Bank for the Spanish government. Since 2005, the Fund has been active in purchasing emission reductions to assist Spain in fulfilling its Kyoto Protocol obligations (see wbcarbonfinance.org/Router.cfm?Page=SCF&ItemID=9714&FID=9714).
Crediting can be renewed for two further 7-year terms subject to Designated Operational Entity and Executive Board approval (UNFCCC, 2002, p. 37).
These two first qualifications give rise to the concept of the ‘economic value’ of debt (relief), that is, the PV of the debt that would have been effectively serviced in the absence of the debt relief (swap) intervention, as the most appropriate indicator to measure the value of debt relief to the recipient country (see Cassimon and Vaessen, 2007).
The DAC of the OECD, the most important body for measuring and publishing donor aid efforts, allows the full nominal value of debt relief to be counted for as ODA. Of course, to avoid double counting, for loans that already previously qualified as ODA and are later subject to debt swaps only the redirection of the interest component (and not the principal) is recorded as new ODA.
On the other hand, from the perspective of the counterpart fund management, which typically wants to make a noticeable impact by spending sizeable amounts at once, the issue becomes to bring forward as much of the available resources as possible. One way of resolving this inherent tension is for the government to issue bonds whose repayment is backed by the stream of future counterpart payments.
In normal times, this may not be an important issue for Uruguay relative to other countries, due to the country’s status as an offshore financial centre for the region and the resulting level of dollarisation.
No less than $5 billion of foreign currency bonded debt was exchanged for new bonds, largely at par, but with extended maturities and capitalised interest payments during the first years. As such, even though the face value reduction of debt was negligible, debt service was reduced considerably, especially in the immediate aftermath of the exchange: debt service went down from $3.5 billion to $1.8 billion over the 2003–2007 period, closing the estimated residual external financing gap of the country (IMF, 2003, pp. 48–49). Overall, external private creditors on average took a ‘haircut’ of about 13 per cent to 26 per cent of their exposure, according to standard definitions (see Sturzenegger and Zettelmeyer, 2005).
As witnessed by the increase in the excess return (the so-called yield ‘spread’) of Uruguayan bonds over US government bonds on the secondary market, from about 5 per cent (500 basis points) to more than 20 per cent in the 2002–2003 period, and the downgrading of these bonds to below-investment grade. After the bond exchange, spreads and credit ratings returned to pre-crisis levels by end-2006 (see Adler and Eble, 2008 for details).
For more on this mitigation marker, including eligibility criteria, see www.oecd.org/dac/stats/rioconventions.htm.
To the extent that debt swaps are framed in terms of providing additional resources rather than improving the overall debt situation of a country (as they typically are today), this argument is of less importance.
More information on the Paris Declaration and Accra Agenda for Action can be found at www.oecd.org/dac/effectiveness/parisdeclarationandaccraagendaforactionfullrelateddocumentation.htm.
When looking at other swaps, this seems less self-evident than one would expect. In a recent US–Indonesian case, Indonesian government officials were under-represented in the swap’s dominant oversight committee, because they had to make way for (international) NGOs (see Cassimon et al, 2011a).
A PIU is defined by the OECD as a ‘dedicated management unit designed to support the implementation and administration of projects or programmes’. It is now widely accepted that too many parallel PIUs lead to a fragmentation of aid.
Such tying was less obvious in more recent Spanish debt swaps.
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Acknowledgements
An earlier draft version of this article was presented at the 2011 EADI/DSA joint Conference on Rethinking Development in an Age of Scarcity and Uncertainty at the University of York. The authors wish to thank Ana de Vicente Lancho of the Spanish Ministry of Economy and Finance and Roberto Aiello of the World Bank Carbon Finance Unit for providing useful documentation on the debt swap agreement under consideration here. Helpful comments and suggestions of two anonymous referees are also gratefully acknowledged. The opinions expressed in this article, as well as any remaining errors, are those of the authors only.
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Cassimon, D., Prowse, M. & Essers, D. Financing the Clean Development Mechanism through Debt-for-Efficiency Swaps? Case Study Evidence from a Uruguayan Wind Farm Project. Eur J Dev Res 26, 142–159 (2014). https://doi.org/10.1057/ejdr.2013.34
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DOI: https://doi.org/10.1057/ejdr.2013.34