While financial institutions promote debt swaps as ‘win-win’ solutions that address both debt distress and development financing, borrowing countries report a systematic failure in achieving both objectives, revealing an inversion of development finance principles.

Experiences across various developing countries highlight this critical contradiction. While Belize’s Prime Minister hailed their swap as providing vital ‘breathing space’, Ecuador faced intense pushback, with over 260 activists and academics cautioning against ‘green vulture funds’ exploiting vulnerable economies. This divergence exposes how debt swaps attempt to solve two fundamentally different problems – debt sustainability and development financing – through a single mechanism that systematically underperforms in addressing either objective effectively.

Figure 1. Systematic dual-objective failure across developing countries

Debt swaps in Belize, Ecuador, Gabon, Côte d’Ivoire, 2021-24

Sources: World Bank/TNC; LSE analysis; Ecuador Ministry of Finance; Bond prospectus analysis; Bank of America/DFC; Fee structure confidential; World Bank press release; Industry analysis

Across documented swaps totalling $3.5bn, the average debt relief measures 0.8% of gross domestic product. No swap has achieved a meaningful improvement in debt sustainability, while development resources remain systematically inadequate to meet sectoral needs.

Scale constraints

The 2024 IMF-World Bank framework explicitly recognises debt swaps as optimal primarily for countries facing moderate distress and temporary liquidity pressures rather than comprehensive restructuring needs. Côte d’Ivoire’s successful education swap hinged on demonstrating sound debt management practices, reducing its deficit to 4% of GDP from 6.8%. Countries lacking similar institutional strength systematically face exclusion.

Even successful cases illustrate constrained outcomes on both objectives. Côte d’Ivoire’s swap targeted €400m of expensive debt, freeing €330m over five years – merely 0.8% of GDP. This modest debt relief offers minimal structural improvement to debt sustainability, while the €60m net present value savings barely address substantial education infrastructure needs. Gabon’s $500m blue bond yields only $60m in net savings over 15 years – insufficient for either meaningful debt relief or conservation impact.

Transaction costs and sovereignty constraints undermine objectives

Ecuador’s swap illustrates hidden cost structures, with the government paying 11.04% interest compared to bond issuance at 5.4%, creating a 5.6 percentage point spread benefitting intermediaries rather than conservation.

Gabon’s experience confirms this pattern. Industry analysis suggests costs approached 15-20% of nominal debt relief. These transaction costs absorbed nearly 25% of Belize’s debt relief while diverting resources from conservation spending to financial intermediaries.

Borrowing countries report systematic sovereignty constraints through offshore control mechanisms. Ecuador’s former Environment Minister Daniel Ortega characterises swaps as replacing debt cancellation with ‘new loans with severe conditions’, involving external oversight, rigid performance targets and decades-long commitments constraining future policy choices.

Current swap structures systematically impede parliamentary oversight. Research reveals it remains ‘impossible for the public, or parliament, to scrutinise these deals before they are finalised’. Ecuador’s Galápagos Life Fund operates from Delaware, while Gabon’s conservation fund utilises similar offshore structures managed by private entities rather than government systems. The World Bank acknowledges that such structures can ‘prioritise external agendas over local development needs’.

The African Development Bank’s response reflects growing institutional scepticism, emphasising ‘African-led solutions’ while criticising ‘opaque natural resource-backed loans’, signalling regional resistance to externally designed swap structures.

Institutional capacity requirements create systematic bias

Small island developing states face institutional barriers that expose systematic prerequisites for swap participation. Seychelles officials acknowledge that administering swap proceeds ‘requires dedication and enthusiasm of a full-time team, with appropriate experience and training’.

Belize’s success depended on The Nature Conservancy’s 30-year presence in the country. Côte d’Ivoire succeeded through existing World Bank frameworks. Such prerequisites ensure that swap mechanisms serve middle-income countries with temporary gaps rather than addressing acute development finance needs.

Creditor coordination failures limit effectiveness

Private creditors hold 43% of debt in distressed countries but rarely participate in debt swaps, despite their substantial exposure. Successful swaps require voluntary participation from diverse creditor types. However, coordination failures systematically undermine the effectiveness of swaps. The Debt Service Suspension Initiative demonstrated these constraints indicating that simple, coordinated mechanisms deliver faster results than complex swap negotiations. Despite G20 encouragement, only one private creditor participated in a $12.9bn debt service suspension.

Creditor composition has shifted dramatically, with Paris Club debt falling to 11% from 28% for DSSI-eligible countries, while non-Paris Club lenders increased to 18% from 18%. For debt swaps, this fragmentation means negotiating with creditors operating under distinct legal frameworks with conflicting incentives, making comprehensive participation increasingly difficult.

Historical precedents expose systematic constraints

Contemporary swaps fail compared to historical single-purpose mechanisms. The Brady Plan achieved a 35% debt reduction through focused restructuring without conditionalities on development. The DSSI suspended $12.9bn across 48 countries within months through straightforward coordination.

Contemporary swaps achieve 2-3% debt reduction while generating inadequate development resources – inferior performance on both objectives compared to specialised instruments. The European Network on Debt and Development analysis suggests comprehensive debt moratoriums could free $50.4bn over two years, substantially exceeding realistic swap scenarios.

The 2024 framework inadvertently exposes twin-objective limitations. For debt sustainability, swaps are most suitable for countries with moderate distress and strong institutions, precisely those that require minimal debt relief. For development financing, swaps generate resources too constrained to address acute development needs.

Policy implications

Countries facing genuine debt distress require comprehensive restructuring focused on restoring solvency rather than managing marginal liabilities with conditional development.

G20 Common Framework implementation offers appropriate mechanisms for structural insolvency, providing the scale of principal reduction that swap mechanisms cannot deliver. Special Drawing Rights allocations address immediate fiscal pressures without transaction costs and sovereignty constraints.

Development financing requirements demand direct, unconditional mechanisms. Regional development banks possess the sectoral expertise and country relationships necessary for effective delivery of development finance.

Where swap deployment remains appropriate, strict criteria must govern implementation. Middle-income countries with moderate distress, strong institutions and existing sectoral capacity represent circumstances where swaps might complement debt management strategies. Transparent cost-benefit analysis requiring public disclosure addresses sovereignty erosion.

Debt swaps represent expensive financial engineering that systematically fails both debt sustainability and development finance objectives. Policy frameworks should abandon hybrid mechanisms in favour of specialised instruments designed for single purposes – comprehensive restructuring for debt problems, direct financing for development needs. Only through acknowledging these distinct requirements and deploying appropriately specialised instruments can policy effectively serve either debt relief or development finance objectives rather than pursuing financial complexity that achieves neither.

Udaibir Das is a Visiting Professor at the National Council of Applied Economic Research, Senior Non-Resident Adviser at the Bank of England, Senior Adviser of the International Forum for Sovereign Wealth Funds, and Distinguished Fellow at the Observer Research Foundation America.

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