Table 1 Opportunities and challenges of debt swaps for the involved parties [43]

- Through debt relief and conversion, the overall debt burden on the debtor country is lowered and the strain on the national budget is reduced

- Since counterpart payments into environmental projects are generally made in local currency, debtor governments save scarce hard currency which they can then use to establish foreign exchange reserves

- Debt relief can strengthen economic stability, improve the credit rating of a debtor, and attract new investments

- Environmental projects benefit from freed finance that would have otherwise gone towards the creditor’s budget, often bringing economic and social benefits at a local level

- Grants to environmental projects or local NGOs are typically distributed via a trust fund which is set up according to original repayment schedules. This long-term regular funding facilitates fund and, therefore, debtor’s absorption of climate finance

- From a financial perspective, creditor countries’ remaining debt claims increase in value through such swaps, and creditors can recover either full or at least part of their debt and thereby avoid the accumulation of arrears. Debt swaps are particularly beneficial if parts of the debt are already written off and full repayment is unlikely

- Creditors have to mobilize less additional finance to meet their international climate commitments and, at the same time, can register the instrument as the provision of ODA. Since the nominal value of non-concessional debt can be registered as ODA, many creditor countries have used this instrument to boost their ODA numbers

- Furthermore, creditor countries can raise their environmental credentials by mobilizing co-financing through international funding institutions. A debt swap that is carefully designed can guarantee an adequate use of funds and carries a greater responsibility than a single donation

- If the discount rate is low or even zero, no extra budgetary room is provided, which leaves the overall macroeconomic situation unaffected

- If the debt swap volume is small, the positive impact on the debtor’s economic situation is negligible or might even be outweighed by the costs incurred when negotiating a swap and setting up a trust fund

- Debtor countries must have sufficient funds to put into trust funds, and there exists a risk of inflation if debtor governments print money to pay the agreed amount in local currency

- Debt swaps carry the threat of crowding out other forms of finance that are potentially more effective. Debt swaps should be additional to the already delivered ODA and not substitute other channels of new aid

- Climate-relevant debt swaps have to compete with other sectors (health, education, infrastructure) for a limited amount of eligible debt