Sovereign Debt Management with Environmental Conditionality and Macroeconomic Stability - Evidence from Colombia

Low and middle income countries (LMICs) face several macroeconomic and financial constraints in accessing global capital markets, which hinder their capacity to pursue long-term sustainable development and adaptation strategies. Comprehensive solutions for debt management are increasingly recognised as essential to enable developing countries to free fiscal space for environmental investments. Despite this recognition, a gap remains in the literature regarding the design and implementation of various debt relief mechanisms, as well as their ecological and macroeconomic implications. 
To fill this gap, this paper explores the fiscal and macrofinancial impacts of combinations of four debt relief levers in Colombia: (1) greenium (concessional borrowing), (2) foreign investment in local currency-denominated bonds, (3) interest renegotiation, and (4) principal adjustment. We adapt the GEMMES macroeconomic framework—a dynamic Stock-Flow Consistent model—to simulate these levers and their combinations within comprehensive debt management strategies under a multi-objective robust decision-making approach.

We find marked heterogeneity across mechanisms. Concessional (1,2) and reprofiling (3,4) levers vary in their potential for financing environmental protection and mitigating macro-financial vulnerabilities associated with a climate and nature transition. Principal adjustment is a consistent feature of best-performing debt strategies, while a high share of local currency bonds increases the robustness of green debt strategies under deep uncertainty. Interest-rate-based instruments need to be aligned with the timing of investment. The levers’ effects are importantly driven by their influence on foreign reserves and currency outflows, highlighting the need to consider exchange rate variation when designing debt management strategies. 
From the 632 robust Pareto-optimal green debt strategies that were identified, two distinct clusters emerged, reflecting contrasted uses of external financing for future borrowing. No single mechanism is sufficient to close the green investment gap in Colombia. Ultimately, while debt relief can offer temporary relief for trade imbalances, achieving lasting macroeconomic stability will necessitate structural changes in production and exports. Linking future solvability and green investment raises questions about the conditionality of these mechanisms and the type of investment they should support.