Dollar-denominated debt: the hidden threat to global climate ambitions

As G20 leaders prepare to convene in Rio later this month, the global south’s crushing dollar-denominated debt is emerging as a critical threat to multilateral climate finance efforts. Experts warn that this looming crisis creates often-overlooked systemic challenges which undermine the Brazilian presidency’s mission statement of “building a just world and sustainable planet”.

In their recent communiqué, G20 central bankers and ministers acknowledged that currency risks and debt vulnerabilities hinder sustainable infrastructure investments in the global south.

Federico Sibaja of advocacy group Recourse explained to Green Central Banking that this places climate-vulnerable countries without access to reserve currencies in a precarious position. “There’s huge pressure on what global south countries can do to lead just energy transitions, while at the same time ensuring that they have balance of payments ability,” he said.

According to data from research group Development Finance International, the global south is facing its worst debt crisis since records began, with debt service absorbing an average of 38% of budget revenue, rising to 54% in Africa. Presently, foreign currency lending constitutes about 70-85% of low-income countries’ debt.

This lack of fiscal flexibility not only hinders climate initiatives but also limits countries’ ability to absorb external economic and climate shocks. The G20 communiqué stressed the urgent need for increased domestic fiscal capacity to address these challenges; however at present servicing dollarised debt means countries are often compelled to prioritise “short- term profits” over long-term economic resilience and clean energy transitions, said Sibaja.

The vicious cycle of dollar-denominated debt

Fadhel Kaboub, senior advisor with clean energy thinktank Power Shift Africa, said dollarised debt “rewires” non-industrialised economies towards unsustainable exports like cash crops and fossil fuels. “With massive external debt, every time you’re budgeting for your economic priorities, you focus on incentivising economic activity that generates dollars the quickest. That’s going to be extractivism.”

Recent research from Recourse revealed that, in its advice to 11 countries receiving its loans, the International Monetary Fund (IMF) endorsed fossil fuel extraction “to bolster fiscal and debt positions as well as foreign reserves through exports”.

Consequently, sustainability- and productivity-enhancing projects in critical industries, such as local food systems, high-value added manufacturing and domestic energy production, are structurally neglected, Kaboub explained. This creates a self-reinforcing cycle that relegates economies to the “bottom of the global value chain”, towards low-value-added manufacturing and exports of cheap raw materials.

It also forces nations to rely on imports of essentials like food and fuel even when sustainable local production is possible. In Nigeria, the ninth largest crude petroleum exporter with vast renewable potential, 75% of electricity comes from generators that relied, until late last year, exclusively on imported gasoline.

“When you have these three structural deficits – food, energy and manufacturing – you have a structural trade deficit year after year, decade after decade, meaning your currency is constantly weakened relative to the dollar,” said Kaboub.

During currency devaluations, import-dependent economies with low foreign reserves deplete remaining reserves and “literally import inflation in the most sensitive areas for society”, he said. When central banks subsequently borrow dollars to defend exchange rates this deepens this vicious cycle, further eroding their monetary sovereignty..

Even well-intentioned climate finance in hard currencies can exacerbate the problem. “The only way in which countries will be able to repay climate-finance-related loans is by accelerating extractivism,” said Sibaja, noting that this contradicts their climate commitments.

Impact of currency risk on clean infrastructure investments

According to the Organisation for Economic Co-operation and Development, currency risk poses a persistent barrier to externally financed clean energy projects in the global south. These projects, with long lifespans and high upfront costs, tend to produce revenues in domestic currencies and face viability challenges when local currencies depreciate against hard currency debt, even in cases with substantial de-risking components.

Argentina’s Plan RenovAr is a cautionary tale. Launched in 2016 to boost renewable energy production, the programme initially attracted foreign investment through dollar-denominated power purchase agreements (PPAs) and World Bank guarantees. However, the 2018 economic crisis – sparked by a devastating drought – caused the peso to plummet. This rendered dollar-denominated PPAs untenable, leading to the collapse of all projects in the plan’s final bidding round.

This case underscores the danger global south nations face in implementing energy transitions when investors demand hard currency contracts. This is especially problematic as the global financial safety net, led by the IMF, often responds to associated downturns with austerity measures that further “derail development and energy transition programmes”, said Sibaja.

A holistic approach to harnessing the global south’s sustainable potential

A holistic approach is crucial to address currency risk and harness the global south’s sustainable potential, according to Sibaja. He explained that enhancing monetary sovereignty, which includes the ability to issue debt in national currencies, will reduce financial instability linked to dollar-denominated debt and create more fiscal space for green infrastructure development.

Both Sibaja and Kaboub cautioned against over-reliance on private finance and de-risking strategies, advocating for whole-system solutions that address the root causes of external debt.

“I’m sceptical of initiatives aimed at hedging currency risk as you’re not properly addressing the systemic issues,” said Sibaja, adding that “the real problem lies in the lack of monetary sovereignty” and the “extreme macroeconomic volatility” this exposes global south economies to.

Kaboub emphasises the need for strategic local currency investments in food sovereignty, agroecology and domestic renewable energy systems. Together, these measures can reduce import reliance, shifting economies away from dollar dependency and the associated extraction of natural resources.

Many global south countries have resources for ambitious green industrial policies, but lack the technology needed to harness them. “They have all the critical minerals and the labour force. They just need the manufacturing technology, which is usually where you borrow dollars,” said Kaboub, who outlines a “zero-dollar green industrialisation policy” based on regional cooperation and technology transfers.

Kaboub explains that with technological partners willing to transfer knowledge, industrial blocs can collaborate to replicate renewable energy value chains, achieving economies of scale without dollar borrowing. Labour and resources for clean energy industries can be paid for using local currencies, with regional currency swaps providing insulation against currency risks within the bloc.

Reshaping multilateral finance for structural transformation

In the near term, G20 nations can facilitate this holistic transition through expanded issuance of SDRs, according to Sibaja, as well as reforms to the multilateral financial architecture.

Kaboub said that “every single project and dollar that comes from MDBs needs to be assessed and filtered based on whether it is contributing to continuing entrapment or to structural transformation”. He also stressed that currency swap lines from reserve-issuing central banks can provide a “lifeline for real development and industrialisation” in the global south.

He suggests the G20 reviews country risk models and debt burdens for African nations, arguing they have been overcharged based on a presumed “risk of default that never materialised”, what has been described as the “Africa premium”.

Kaboub also wants to see debt cancellation from nations that have overspent their carbon budget. This would enable global south nations with a carbon surplus to save foreign reserves for  climate shock buffers and green technology imports.

“Every green kilowatt hour produced within the bloc saves you the equivalent of dollars you have to borrow to import fossil fuels, and interest you have to pay for the next decade or more. That’s how to structurally address the root causes of debt,” he said.

Cover photo: Repaying loans in dollars means global south countries are exposed to currency fluctuations. © Land Rover Our Planet