An assessment of bilateral debt swap financing indispensable for economic growth and environment sustainability: a policy implication for heavily indebted countries.

Abstract

Bilateral debt swap is an innovative global financing mechanism designed to support heavily indebted countries (HICs). It is a debt-restructuring process involving donor countries forgiving debt owed by HICs in exchange for commitments to undertake projects on environment and socio-economic development. It is a unique approach designed to help heavily indebted countries get back on their feet. Effective debt swap financing can lead to both economic growth and environment sustainability, but they are challenging to implement. This study examines the impact of bilateral debt swap financing on economic growth and environment sustainability. For the purpose, we have used debt swap index developed with Kaiser-Meyer-Olkin (KMO) methodology. KMO widely used approach of Principle Component Analysis (PCA) to solve the problem of "over-identification" and make strong correlation among endogenous variables of interest. In order to validate the nexus empirically between bilateral debt swap financing with economic growth and environment sustainability, we have employed the Two-Step System Generalized Method of Moments (SYS-GMM) approach in 25 countries for the period of 2002 to 2021. This modern econometric method addresses endogeneity issues and controls for unobserved heterogeneity in panel data. At the same time, the technique addresses the simultaneity problem, reverse causality, and remove selection bias. Findings of the study shows that effective bilateral debt swap financing can boost economic growth and environment sustainability by investing domestic resources for targeted activities along with reduced debt burden. Empirical results reveal that 1% change in debt swap financing can lead to a maximum of 0.23% growth in the economy and 0.28% improvement in environment sustainability. However, it is important to note that in most empirical specifications, results are inconclusive. One possible reason for this is often ineffective debt swap practices coupled with inadequate monitoring and evaluation in HICs. Policymakers should focus on enhancing debt swap policies to promote economic growth and environment sustainability.