Why Debt Matters for Sustainable Development and Climate Action

By Anahí Wiedenbrüg

As the world races to address the mounting challenges of climate change and sustainable development, the staggering financial requirements to meet these goals have come sharply into focus.

For emerging markets and developing economies (EMDEs), effective debt management is not just a financial necessity—it is a lifeline. With trillions of dollars needed annually, leveraging debt sustainably has the potential to enable green, inclusive growth and bridge the gap between ambition and reality. However, this potential remains underutilized and fraught with risks, calling for comprehensive reforms and international collaboration.

The Magnitude of the Challenge

At the 29th UN Climate Change Conference (COP 29), developed nations committed to mobilizing USD 300 billion annually by 2035 to support climate action in the Global South. While significant, this pledge barely scratches the surface of what is needed.

            •           Climate Finance Needs: To preserve global biodiversity, EMDEs require an additional USD 700 billion annually by 2030. Achieving the Sustainable Development Goals (SDGs) necessitates an eye-watering USD 3.9 to 4.3 trillion every year.

            •           Inclusive Economic Transformation: Beyond climate and development targets, EMDEs need further investments to foster inclusive economic growth and move up the global value chain.

These numbers underscore the sheer scale of financing required and the critical role debt plays in unlocking these investments. Governments in the developing world face fiscal constraints, making debt a necessary tool for bridging investment gaps.

The Double-Edged Sword of Debt

Debt, when managed strategically, can spur economic growth, improve public infrastructure, and enhance resilience to external shocks. However, it is a double-edged sword. For many EMDEs, the risk of debt distress remains high, particularly in the face of unpredictable global economic conditions.

The Rising Debt Burden

Debt accumulation among developing countries has surged since the 2008 financial crisis, with the COVID-19 pandemic acting as an accelerant. Current trends highlight troubling vulnerabilities:

            •           Higher Borrowing Costs: Many developing nations increasingly depend on international financial markets, leading to high interest rates and costly debt-servicing obligations.

            •           Shifting Priorities: According to the United Nations Conference on Trade and Development (UNCTAD), more is now spent on debt servicing than on essential public services like health and education. Alarmingly, in regions such as Africa and Asia (excluding China), interest payments outstrip healthcare spending.

In 2023, net interest payments for developing countries soared to USD 847 billion, with over 54 nations allocating more than 10% of their revenues to interest costs. This fiscal squeeze hinders governments’ ability to fund critical social and climate-related programs.

Climate Risks and the Cost of Inaction

Climate change compounds the debt challenge for poorer nations. Natural disasters, rising sea levels, and extreme weather events have catastrophic economic consequences, disproportionately affecting vulnerable countries.

            •           Premiums on Climate Risks: Investors are now demanding higher returns to offset perceived environmental risks, making non-concessional debt more expensive.

            •           Resource Diversion: Governments are forced to channel significant revenues into debt repayment, leaving little for climate adaptation or disaster recovery.

Debt as a Tool for Sustainable Development

To ensure debt becomes a force for good, it must be managed with a clear focus on long-term development and climate goals. This requires stronger institutional frameworks, innovative financing instruments, and better alignment with global sustainability agendas.

Strengthening Debt Management Capacities

Debt Management Offices (DMOs) play a pivotal role in ensuring fiscal sustainability, yet many face persistent capacity gaps. Common challenges include:

            •           Lack of Expertise: Many DMOs struggle to conduct comprehensive Debt Sustainability Analyses (DSAs) or interpret those conducted by external organizations like the International Monetary Fund (IMF).

            •           Weak Integration: Effective debt management requires collaboration across ministries, central banks, and parliaments. However, coordination mechanisms are often underdeveloped.

Strengthening these capacities is vital to mitigate risks and optimize the use of borrowed funds.

Innovative Financing for Green Transitions

Developing countries must also explore innovative financing mechanisms to support their green and inclusive transitions. Examples include:

            •           Green Bonds: Issuing bonds tied to climate or biodiversity projects can attract environmentally conscious investors.

            •           Debt-for-Nature Swaps: These agreements allow countries to reduce their debt in exchange for commitments to environmental conservation.

            •           Blended Finance: Combining concessional and private-sector funding can lower risks and unlock larger investments for sustainable projects.

Linking Debt Strategies to Climate Initiatives

National debt strategies should be aligned with frameworks like Just Transition Energy Plans, which outline pathways for sustainable energy transitions. This integration ensures that borrowing directly supports climate resilience and low-carbon growth.

The Case for Global Financial Reform

For developing nations to harness debt effectively, the international financial system must evolve to address systemic inequities. Current structures often favor creditor nations, leaving debtor countries at a disadvantage.

Power Imbalances in the Debt Cycle

Developing countries frequently face unfavourable terms in negotiations with creditors, leading to a vicious cycle of dependency. To break this cycle:

            •           Debtor Coordination: Stronger alliances among debtor nations can improve their bargaining power.

            •           Fairer Terms: The international community should advocate for transparent, equitable lending practices.

Reforming Financial Architecture

Reforming the global financial architecture is essential to level the playing field. Key priorities include:

            •           Expanding Access to Concessional Loans: Multilateral development banks should scale up affordable financing for climate and development projects.

            •           Innovative Debt Restructuring: Mechanisms like the Common Framework for Debt Treatments could be expanded to include climate considerations.

Capacity Building and Research: A Twin Strategy

The International Institute for Sustainable Development (IISD) highlights the importance of capacity building and research in achieving debt sustainability. Its initiatives focus on:

            •           Strengthening DMOs: Offering training to optimize organizational structures and processes.

            •           Promoting Multistakeholder Platforms: Enhancing coordination across government institutions.

            •           Conducting Impactful Research: Providing evidence-based insights to guide reforms at both domestic and international levels.

A Call to Action

Debt is not inherently detrimental; it can be a powerful enabler of progress. However, for EMDEs to unlock its full potential, they need support from the global community. Strengthened institutions, innovative financing solutions, and systemic reforms can ensure debt becomes a tool for resilience, sustainability, and equity. As the clock ticks on climate action and development goals, the world must act collectively to address the systemic barriers that hinder progress. Only by doing so can we create a future where debt fuels growth, protects the planet, and uplifts the most vulnerable.