Debt Swap

A DEBT SWAP IS an arrangement that involves the conversion of overly burdensome debt obligations into new obligations. Developing countries have welcomed debt swaps as a chance to renegotiate and ease their debt burden while the creditors accepted debt swaps as an increased likelihood that they would be repaid.

By using the debt swap, the creditor and its debtor agree to exchange debt for a new asset or obligation with different repayment terms. There are different types of debt swaps: the debt-equity swap, the debt-for-development swap, the debt-for-nature swap, or another arrangement that converts debt into funding for a certain project, policy change, or economic or political reform. The common feature of all types of debt swaps is the willingness of a creditor to exchange debt for assets or obligations of lower face value but with a higher likelihood of repayment than of original debt.

Debt-equity swap occurs when the creditor sells the debt at a discount in a secondary debt market to an investor who, in turn, sells the debt to the debtor government in return for equity in a company of a debtor country. It can be used as a part of privatization programs when the debtor government agrees to exchange debt for public assets. The introduction of the debt-swap mechanism coincides with the attempts to resolve the international debt crisis of the 1980s. The first debtequity [Page 238]swap program was established in Chile in 1985 to contribute to debt reduction and stimulation of investment and growth. Since 1985, about 50 countries have used different types of debt swaps in their quest for debt resolution. For example, Argentina, Mexico, and the Philippines have used debt-equity swaps as a way of attracting foreign direct investment and stimulating interest in their privatization programs. The secondary debt market, also known as the emerging markets debt market, continued to grow substantially during the 1980s and 1990s, being dominated by debt owed by middle-income Latin American countries (Brazil, Argentina, Chile, and Mexico). On the other hand, many low-income indebted countries suffered from insufficient domestic budgetary resources to fund a debt-swap program, and relied more on pure grants, some concessional loans, or debt cancellation in their efforts toward debt resolution.

Debt-for-development swap is an arrangement where a development organization (nongovernmental organization or United Nations agency) purchases debt at a discount and then exchanges the debt with the debtor government for funding in a local currency of a certain development project. Debt-for-development swaps include debt-for-child-development, debt-for-education, and debt-for-health swaps.

For example, in the early 1990s, UNICEF carried out numerous debt-swap transactions to convert a total of $199 million face-value debt into the funding of $52 million in programs in support of child and maternal development in Senegal. Also, by relying on debt-for-development swaps, the United Nations’ UNICEF helped to implement programs related to water, sanitation, and health in Sudan; education programs in the Philippines and Bolivia; and similar programs in Peru, Zambia, and Mexico.

In contrast to debt-equity swaps, debt-for-development swaps did not significantly contribute to debt reduction in developing countries. The first debt-for-nature swap was implemented by Conservation International in Bolivia in 1987, involving the cancellation of Bolivian external debt in exchange for funding for nature preservation and environmental protection. One of the largest environmental swaps to date was the cancellation of 50 percent of Poland's Paris Club debt in 1992 and its conversion to create the Polish EcoFund, an independent foundation.

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