By Pablo Saavedra, Ousmane Diagana, Jorge Familiar and Junaid Kamal Ahmad
The idea behind debt-for-development swaps is straightforward: A country exchanges its expensive debt for cheaper debt, often supported by a credit enhancement like a guarantee, and then redirects the savings into development spending.
Until recently, there were a limited number of these transactions, partly due to the costs required and partly due to skepticism around their effectiveness. But as liquidity pressures mount for some countries, there is renewed interest in debt swaps as a liability management tool. And the recent success of a new approach to this old idea is attracting attention from both debtors and creditors.
Historically, critics have argued that debt swaps deliver neither meaningful improvements in debt sustainability nor significant development outcomes. Often, governments complain about hefty financial, administrative, and transaction costs and that national sovereignty is undermined by prioritizing external agendas over local development needs. The same authorities protest the use of overseas financial mechanisms to manage debt savings, like special purpose vehicles and ringfenced trust funds, which some officials claim undermine their own domestic systems.
A new debt-for-development swap operation in Côte d’Ivoire, enabled by the World Bank Group, has found a way to avoid these pitfalls while achieving the goals of a good debt-for-development swap: a reduced debt service burden, improved debt sustainability, and more investment in development—in this case in the education sector. It’s the first application of a concept developed jointly by the World Bank Group and the International Monetary Fund.
The swap operation targeted close to €370 million of Côte d’Ivoire’s most expensive commercial debt that matures in the next five years. Thanks to a partial credit enhancement from the World Bank Group Guarantee Platform, Côte d’Ivoire executed a buyback of high-interest debt using a commercial loan with a lower interest rate, a longer maturity, and a grace period. There is no additional net debt due to the swap. The transaction freed up around €330 million in liquidity over the next five years, improving debt sustainability and allowing for critical investments in education.
The pressures on Côte d’Ivoire’s education system are immense, driven by a population that’s growing at 2.6 percent annually and the largest inflows of migrants in West and Central Africa. The government’s 2015 policy mandating compulsory education for children aged 6 to 16 has further amplified the demand for schools, classrooms, teachers, and basic facilities.
Our model also differs in several other important ways. A major challenge of many debt swaps is the cost and complexity. Separate financial mechanisms to manage the transaction add costs and may offer the debtor government limited or no control over expenditure programs delivered. Other mechanisms to monitor the investments may also need to be built out, which could mean more costs.
In the new model, the savings remain in government coffers. And to ensure the savings are redirected as intended, the investments are channeled through an ongoing education project supported by the World Bank, which already provides a built-in spending and results monitoring mechanism. Meeting the revised, more ambitious targets for the program is necessary to receive World Bank support for this structure.
The new approach can be replicated and scaled up. For example, the same mechanism can be used in cases of bilateral debt. In some large federal countries, it could also address liquidity challenges for sub-national governments.
Advanced economies may be facing domestic fiscal and political pressures that do not allow them to extend new loans. Outstanding loans, meanwhile, often represent a tiny part of an advanced economy’s balance sheet but a significant pain point for the debtor. Under the new swap model, these debts could be exchanged for highly impactful development projects, including those vetted by the World Bank and other multilateral institutions.
Debt-for-development swaps are not a panacea for the debt challenges facing many developing economies. They should not be used in countries that have solvency problems and need debt restructuring. However, they can be helpful in countries with sustainable debt and adequate macroeconomic policy frameworks, but which may be facing temporary liquidity pressures.
The new swap model used in Côte d’Ivoire shows that when well-designed and effectively implemented, debt-for-development swaps can alleviate debt pressures and create fiscal space to advance development goals, all while reducing transaction costs. In a time of tightening fiscal space across the world, this approach can offer some breathing room when developing countries need it most.
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