Globally, 3.4 billion people live in countries that spend more on debt repayment than on social development. Almost half of humanity, as the United Nations (UN) Secretary-General recently warned, is plunged into a development disaster, driven by the relentless burden of the global debt crisis.
We need bold collective action, as called for at the fourth International Conference on Financing for Development (FFD4) held this year in Spain. The Sevilla Commitment offers a timely and practical roadmap to reverse the debt trap for developing countries and boost growth and prosperity.
The countries most in need of development financing are those facing rising debt distress. In developing countries, in the decade since 2010, debt has surged at twice the pace of wealthier countries. They are now caught in a vicious cycle of rising interest payments and shrinking fiscal space. While facing an annual development financing gap of $ 4 trillion, over 45 developing countries spent more public resources on interest than on education or health.
Public investment growth in developing economies dropped by half between the 2000s and 2010s, compromising quality and integrity of basic services and infrastructure, making growth gains more costly. This investment gap exacerbates inequality, fuels grievances and tensions, and slows growth and progress towards the Sustainable Development Goals (SDGs).
While they play an important role, domestic policies only partially explain the debt trap. Unprecedented global challenges such as the pandemic, accelerating costs for climate change adaptation, and rising geopolitical tensions have intensified debt distress. With already fragile fiscal foundations, many developing countries are hard-pressed to withstand these shocks on their own.
Sri Lanka has one of the highest ratios of interest payments to revenue. In 2024, the country spent 67% of its revenue on interest payments, while allocating 16% to health and education combined. The average for lower-middle-income countries is 20%. Public expenditure remains far too low, with average routine maintenance expenditure at 0.05% of Gross Domestic Product (GDP) and capital stock maintenance 13 times lower than minimum standards.
Debt payments drain vital resources that could have otherwise been invested in schools, roads, digital infrastructure, or sustainable development. This is particularly difficult in an economy where private investment remains severely constrained.
A few ways out of the debt trap
As Sri Lanka defaulted on its debt in 2022, no framework existed to ensure a coherent and fair response. Sri Lanka was excluded from the G20’s Common Framework due to its middle-income status. Meanwhile, private creditors – who held over half of its external public debt – refused to join official debt restructuring efforts.
The system proved to be unfair, unsustainable, and unaffordable, just as the UN Secretary-General has repeatedly alerted. After extensive and complex negotiations with bilateral creditors and bondholders, Sri Lanka secured a $ 3 billion bailout from the International Monetary Fund (IMF) in 2023. The country is now finalising restructuring and tackling debt towards the target of 95% of GDP by 2032.
While Sri Lanka has needed the return of macroeconomic stability, the impact of fiscal austerity on the population, especially the most vulnerable, is undeniable. The World Bank’s recent public finance review showed how the Value-Added Tax (VAT) hike contributed to rising costs for poorer households, contributing to a 2.2-percentage-point increase in poverty and a 0.2-point rise in the Gini index of inequality.
In the short to medium term, sustaining growth and reversing development losses from the crises requires a lot more domestic public and private investments, while revenue generation efforts pick up and economic reforms pave the way to foreign investment, which remains sluggish at 0.9% of GDP in 2024, including loans.
At this year’s FFD4 Conference, member states, along with multilateral development banks and international financial institutions, came together to commit to a more inclusive international financial and debt architecture, which the President of Sri Lanka also referred to in his inaugural UN General Assembly speech. For Sri Lanka, at least three options offer a balanced mix of policies that may reduce the debt stock to stimulate public investment.
A new Borrowers’ Club
First, with the launch of the Borrowers’ Club, debt-distressed countries can now coordinate actions, amplify their collective voice, and mobilise ideas and resources. For Sri Lanka, as it prepares to resume borrowing, the club offers an opportunity to revitalise its economic diplomacy and collaborate with peers to advocate for more equitable terms and inclusive debt governance.
Drawing on its experience with debt default and restructuring, Sri Lanka can leverage the club to shape future debt terms, including the adoption of state-contingent clauses. With major lenders already committing to incorporate debt pause clauses, Sri Lanka can use the network to influence these provisions.
Having restructured its debt through a fragmented process, Sri Lanka can also advocate for improvements to the G20 Common Framework, expanding its scope to middle-income countries, a multilateral framework inclusive of China for debt relief to market access countries, and ensuring comparable treatment between sovereign and private creditors.
By engaging proactively in this global network, Sri Lanka can shift from reactive crisis response to forward-looking policy leadership.
Converting debt into investments
Second, Spain and the World Bank launched the Global Hub for Debt Swaps for Development to scale up debt swaps as a tool to reduce debt stock.
Ecuador has demonstrated a promising practice with a debt-for-nature swap that enabled the country to buy back approximately $ 1.6 billion in debt for $ 644 million, saving nearly $ 1 billion in repayments over 17 years.
As Sri Lanka concludes its debt restructuring, pursuing debt swaps is an opportunity. Sri Lanka’s prior experience with a debt-for-health swap with Germany can be leveraged. Assuming a buyback of existing debt at a 40% discount, similar to Ecuador’s model, Sri Lanka could reduce its debt by approximately $ 400 million for every $ 1 billion swapped, or up to $ 4.4 billion on its bilateral debt alone. For this, without any delay, the country needs to develop a pipeline of bankable projects and proposals aligning with its sustainable development priorities.
Blended finance for scale and impact
A third option from Sevilla aligns with Sri Lanka’s efforts to leverage a much larger portion of its public investment to unlock private investment while not growing the debt.
While an amendment to the Public-Private Partnership (PPP) Act is urgently needed, experience shows PPPs prioritise capital-intensive projects – such as power and port developments – that often fail to simultaneously drive growth, equity, and sustainability. Complementing PPPs, blended finance catalyses public and private resources, equitably distributes risks and rewards, and channels investments directly into sustainable development.
Regional peers have taken steps in this direction: Mongolia, for example, has established a $ 50 million green financing facility funded by the Government, global funds, and the private sector. Similarly, Bangladesh, under its $ 1.4 billion Resilience and Sustainability Facility with the IMF, launched a Climate and Development Platform to coordinate bilateral and multilateral support for its climate agenda.
In Sri Lanka for instance, Sarvodaya and Alliance Finance have launched SDG bonds to unlock resources for underserved sectors such micro and small enterprises. But this remains far too little to have an impact at scale.
By learning from these efforts and attracting private capital for sustainable development projects, from irrigation systems to fishing fleet upgrades, Sri Lanka can boost growth without incurring more debt on its balance sheet
The operationalisation of a fully functional debt management office, as committed by early next year, could be catalytic in advancing these actions. Beyond management of debt, this public institute could facilitate collection, collation, and dissemination of information on available opportunities and resources and coordinate the concerned authorities.
By seizing these emerging tools and reforms in a streamlined approach, Sri Lanka can turn the page on the crisis – and begin building a future where investment in its people takes priority over interest payments.
(The writer is the United Nations Resident Coordinator in Sri Lanka)
(The views and opinions expressed in this article are those of the writer and do not necessarily reflect the official position of this publication)