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Sri Lanka chamber outlines alternative financing mechanisms

ECONOMYNEXT – Sri Lanka’s Ceylon Chambers of Commerce has suggested alternative finance options for the island nation that as it emerges from a currency crisis and default.

The report by the Ceylon Chamber’s Economic Intelligence Unit (EIU) is reproduced below:

Alternative Financing Options

The Government of Sri Lanka has currently embarked on capacity development programmes for the adoption of alternative financing mechanisms such as green bonds. The Securities and Exchange Commission (SEC) too has developed a policy and regulatory framework governing green bonds and in April 2023, the SEC approved rules for issuing green bonds for listed companies and statutory entities.

This was subsequent to the publication of the green finance taxonomy by the Central Bank of Sri Lanka (CBSL), which provided clarity on economic activities that are environmentally sustainable. Therefore, the landscape for adopting alternative financing mechanisms is being created, enabling a favorable environment for the use of alternative financing mechanisms in the future.

An array of solutions can be considered for Sri Lanka, some of which are more appropriate than others in the country context and government priorities. Debt-for-climate or debt-for-sustainability swaps have proven to be a successful debt alleviation tool globally while promoting investment in green and sustainable projects. Carbon credits too can be a feasible and innovative way to address debt overhang and climate change simultaneously but requires more research on the impacts and scalability.

Concessional and blended finance models too can provide favourable results while linking these to development objectives of Sri Lanka. In the long term, thematic bonds are also a tool that can be used to mobilise domestic and foreign capital. However, prior to a thematic bond issuance, access to the international finance markets should be established. This is expected to be facilitated by the completion of the IMF programme.

Debt-for-Climate or Debt-for-Sustainability Swaps

This is a financial instrument where the country would swap a promise (repayments on debt) with another promise (such as funding SDGs). Recently, in the aftermath of Sri Lanka’s default, a global financial firm too expressed interest in restructuring USD 1 billion of debt for environmental purposes.

Under a bilateral debt swap a debtor country and a creditor involve the cancellation or reduction of a portion of the debt in exchange for the debtor’s commitment to invest in sustainability projects. For example, Sri Lanka could look to negotiate with China (one of its largest bilateral creditors), to swap some of its debt for investments in protecting its forests, wetlands and coral reefs, which are rich in biodiversity and provide valuable ecosystem services. This would reduce Sri Lanka’s debt burden and free up fiscal space for other development priorities, while also enhancing its resilience. (Refer the full report for more details and tripartite agreements).

Other Country Experience
In 2021, Belize swapped USD 553 million (total external commercial debt) through a blue bond arranged by The Nature Conservancy (TNC) to the Belize government to finance a bond-for-cash exchange at 55 cents per dollar. This was in exchange for a 20-year commitment to expand and strengthen its marine protected area. The US Development Finance Corporation (DFC) provided political risk insurance for the blue bond.
In 2022, Barbados swapped USD 150 million of sovereign debt with guarantees from the Inter-American Development Bank (IDB) and TNC to protect 30 per cent of the waters surrounding the island following a similar model of Belize.
In 2023, Ecuador swapped USD 1.6 billion of the country’s debt for conservation in the Galápagos Islands. To date, this is the largest debt-for-nature swap completed in the world. It consisted of an USD 85 million IDB guarantee and an USD 656 million DFC political-risk insurance.

Carbon Credits

Carbon credits are certificates that represent a reduction or avoidance of greenhouse gas emissions. It allows countries or entities that reduce their emissions below a certain level to sell their surplus emission reductions (or carbon credits) to countries or entities that need to comply with their emission targets or voluntarily offset their emissions. This can lower the cost of compliance for buyers and generate additional income for sellers.

The Paris Agreement has introduced a new mechanism for international cooperation on climate action, known as Article 6. This mechanism allows countries to cooperate in achieving their Nationally Determined Contributions (NDCs) through various approaches, such as bilateral or multilateral agreements, or carbon pricing instruments.

Sri Lanka can also benefit from Article 6 by engaging in arrangements with other countries or entities that are interested in purchasing its emission reductions. For example, Sri Lanka can enter into bilateral agreements with countries that have higher emission targets than Sri Lanka, such as Norway, and sell its emission reductions from sectors that are not covered by NDCs, such as agriculture or tourism, or from forestry sequestration.

In current carbon markets, the price of one carbon credit can vary from USD 15 to 20 per metric ton of CO2 emissions (mtCO2e) for afforestation or reforestation projects (Refer the full report for more details).

However, there is a need for further analysis on the feasibility, viability and sustainability of carbon credits, as well as for more stakeholder engagement and participation in the design and implementation of carbon credit projects. If done properly, using carbon credits could be a game-changer for climate finance and a catalyst for a green recovery from the crisis.

Blended Financing

This is a financing mode that combines concessional public finance with non-concessional private finance and, expertise from both the public and private sectors is gathered for this process. For example, Sri Lanka could partner with multilateral development banks, or bilateral donors to co-finance projects that have high development impact but low commercial viability or high risks. The concessional funds could be used to provide guarantees, subsidies, grants or technical assistance to reduce the risks or costs for private investors. This would mobilise more resources for Sri Lanka’s development and catalyse private sector participation.

The Renewable Energy (RE) resource potential in Sri Lanka is substantial and estimated at 133 GW. This potential can be supported by blended financing mechanisms, which can help diversify the electricity generation mix in Sri Lanka by adding more RE such as solar and wind to the national grid. Thereby, minimising the vulnerability to vagaries in rainfall in electricity generation, the continuous strain on the import bill and global fossil fuel prices. The government is working on addressing the debt overhang in the RE sector. Fast tracking this, can allow more financing tools to be leveraged by the sector.

Thematic Bonds

Thematic bonds are debt instruments that are issued by a borrower (usually a government or a corporation) to raise funds for specific projects or activities that have a positive environmental or social impact. For example, Sri Lanka could issue green bonds to finance projects that support renewable energy, green transport, waste management, etc. Alternatively, it could issue social bonds to finance projects that support health care, education, social housing or gender equality. These bonds could attract investors who are looking for both financial returns and social or environmental benefits, such as impact investors, ethical funds or socially responsible individuals. This would diversify Sri Lanka’s investor base and lower its borrowing costs.

Other Country Experience
In 2017, Seychelles issued the world’s first sovereign blue bond, which raised USD 15 million to support marine sustainability. This was partially guaranteed by the World Bank and the Global Environment Facility, and offered a lower interest rate than conventional bonds. The proceeds of the bond were used to repay part of Seychelles’ debt to its Paris Club creditors, who agreed to cancel 20 per cent of the debt in exchange for the country’s commitment to protect 30 per cent of its marine areas.
Another example is Nigeria, which issued Africa’s first sovereign green bond in 2017, raising USD 26 million to fund renewable energy and afforestation projects. The green bond was certified by Climate Bonds Initiative, an international organisation that sets standards for green bonds, and was oversubscribed by local investors.

These examples show how thematic bonds can be a useful tool for countries to address their debt overhang while also pursuing their environmental or social goals. However, issuing thematic bonds also requires a high level of transparency and accountability from the issuers, as they need to demonstrate that the funds are used for the intended purposes and that they generate measurable impacts. To ensure this, issuers can follow internationally recognised frameworks and principles for thematic bonds.
Thematic bonds are not a panacea for solving the debt overhang problem, but they can be a valuable complement to other debt relief measures, such as debt restructuring, debt swaps, or debt cancellation.

By issuing thematic bonds, countries can not only reduce their debt burden, but also mobilise additional resources for sustainable development and signal their commitment to addressing global challenges.

Conclusion

By adopting these alternative financing mechanisms, Sri Lanka can not only address the debt overhang but also achieve its economic development goals while also building resilience to avert any future crises.

However, while adopting alternative financing mechanisms have risen in popularity, they lead to some limitations and challenges that need to be carefully considered and managed. The implementation of these mechanisms requires strong institutional and legal frameworks, governance systems, monitoring and evaluation mechanisms, and technical expertise to ensure transparency, accountability, effectiveness and efficiency. In Sri Lanka, some of these have already begun and are ongoing. It should also not create new forms of debt dependency or conditionality that could undermine its fiscal sustainability or development autonomy.

In conclusion, alternative financing mechanisms can offer tremendous opportunities for Sri Lanka to overcome its economic and debt crisis while also pursuing its environmental and social objectives. However, these mechanisms are not silver bullets that can solve all of Sri Lanka’s problems. They need to be carefully designed, implemented and monitored to ensure that they deliver the intended benefits.

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