Portugal has agreed to swap Cape Verde’s foreign debt for investments in a fund for climate action and energy transition that is being set up by the West African country. The agreement, known as a “debt-for-nature” swap, is fast expanding across emerging countries as a way to reduce their debt while increasing environmental action. For developed countries, which became developed by burning a lot of fossil fuel, it’s also a way to make up for past emissions.

Cape Verde owes around $150 million to Portugal and over $430 million to its banks and other entities. Initially, $12 million of debt repayments to the state will be put in the environmental fund and ultimately “the entire amount of debt repayments” will end up there, Portuguese Prime Minister Antonio Costa said in a visit to Cape Verde. Essentially, Portugal is waving the debt if Cape Verde invests in climate action.

“It is a way of converting what is a debt into what becomes Cape Verde’s capacity to invest in the energy transition and in combating climate change. We are doing this together,” Costa said, speaking in a press conference. “Climate change is surely the greatest challenge facing humanity today, but this challenge is on a global scale.”

The country is facing record levels of food insecurity, affecting 32% of the country, according to a report by the World Food Program. This is driven by a combination of factors, including years of drought, which has declined food production, and the ongoing pandemic, which has resulted in an 80% decline in tourism revenue in two years.

But it doesn’t end there. The country is also affected by sea level rise, with water levels increasing by three centimeters per decade, according to the World Bank. This not only affects its physical coastline, but also the coastal ecosystems. Saltwater can contaminate freshwater aquifers, many of which support agricultural water supplies and the natural ecosystem. All in all, climate change can be devastating for Cape Verde, as is the case with all island nations.

The role of debt-for-nature swaps

High debt payments in emerging countries like Cape Verde means they have fewer resources to act in the face of climate and biodiversity crises. Simultaneously, environmental crises can also increase countries’ vulnerability, and this can raise their sovereign risk – increasing the cost of the debt. It’s a vicious cycle that often traps small, developing nations in an endless cycle of debt.

As a solution, countries and finance and environmental organizations are talking about climate and nature debt swaps to address all these problems at the same time. In a nutshell, these are voluntary deals in which a creditor cancels or reduces a government’s debt in exchange for the government to make ambitious environmental commitments.

The first debt-for-nature swap took place in 1987 between Bolivia and foreign creditors, who forgave $650,000 of their debt in exchange for protecting Amazonian lands. Other countries in the region, such as Costa Rica, followed suit in the years that followed. While successful, the extent of the debt relief achieved has been limited.

The scheme has since lost some popularity since then, but emerging countries, especially in Africa and Latin America, have brought it back to the table. Barbados, Belize, and Seychelles have recently carried out their own swaps. Belize, for example, reduced its debt in exchange for designating 30% of its marine areas as protected areas.

Still, there are challenges ahead to expanding its implementation. The International Monetary Fund (IMF) and the World Bank haven’t said yes to the schemes yet, and neither has China – the usual big creditors in emerging countries. Swaps can also take years to be negotiated, and they don’t usually cover the entire debt of the countries.

“Cabo Verde [Cape Verde] – alongside other vulnerable middle-income countries – needs urgent access to concessional financing, as well as effective debt relief and restructuring,” UN Secretary General Antonio Guterres said in a recent visit to the country. “Sea level rise and biodiversity and ecosystem loss pose existential threats to this archipelago.”

For developed nations, this is also a way to make a more efficient climate investment abroad. The same money used in Portugal for climate investments wouldn’t have had as big an impact as in Cape Verde, and this is a way to maximize the benefits of climate funds.

Whether or not the approach will become more common remains to be seen.