Debt and financing the energy transition: The climate–debt trap

Many low- and middle-income countries face a dual crisis: escalating climate impacts while suffering the burden of unsustainable external debt. Much of the current debt in low- and middle-income countries stems from decades of “structural adjustment” policies, volatile commodity dependence, repeated global shocks (financial crises, pandemics, wars), and a global financial architecture that forces countries to borrow in foreign currencies under unequal terms.

Debt service payments have often exceeded spending on health, education or climate action. This severely limits fiscal space to invest in renewable energy and adaptation. 

External debt of low and middle income countries (excluding China) reached nearly $6.5 trillion in 2023. Over half of low-income countries are in or at high risk of debt distress.

Therefore climate ambition is impossible without addressing debt.

Why structural debt cancellation is necessary for phase-out

Countries trapped in debt are often:

  • Encouraged to expand fossil fuel extraction to generate revenue.

  • Locked into mega fossil fuel projects that risk becoming stranded assets.

  • Unable to invest in diversification and renewable energy.

This creates a vicious cycle: Debt → fossil expansion → climate risk → more instability → more debt.

What solutions are on the table?

Proposals cluster around three areas:

  • Debt management and relief

    • Debt cancellation

    • Debt suspension

    • Debt-for-climate ‘swaps’ (agreements in which a portion of a country’s external debt is reduced or cancelled in exchange for the government committing to invest the equivalent funds in climate or environmental projects, instead of repaying creditors

    • Sovereign debt resolution mechanisms (formal international processes designed to help countries restructure or reduce unsustainable public debt in an orderly and fair way, through payment rescheduling, term extensions as well as partial or full cancellation)

  • New forms of finance

    • A global “Just Transition Fund”

    • Concessional and grant-based finance from donors

    • Public development banking reform, including new guidelines such as end of fossil fuel financing and aligning portfolios with the 1.5°C goal, expansion of concessional lending and grants, especially for low-income countries, or lower interest rates and extended repayment periods.

  • Replacing fossil revenues by :

    • Green industrial strategies

    • a fair taxation of fossil fuels

    • International levies, such as shipping emissions

Our principles for financing a just transition

  • Grants, not loans.

  • No increase in debt burdens.

  • Predictable and long-term support.

  • Transparent and accountable mechanisms.

  • Alignment with 1.5°C and equity.

Climate justice requires financial justice. There is no just transition without debt reform.