The Climate-Debt Dilemma Facing the Indo-Pacific SIDS

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This article is part of the series—Jakarta Edit 2025

The Maldives seems to be inching closer to a ‘Sri Lankan fate’. With the International Monetary Fund (IMF) and World Bank deeming its debt ‘unsustainable’ in their previous debt sustainability analysis, the upcoming debt repayment deadlines in 2026 and an extremely high risk of default, the Maldives is on a similar trajectory as Sri Lanka was before its default in 2022. The causal factors of this crisis are also comparable—weak fiscal management, extensive external borrowing, drop in foreign exchange reserves, escalating debt-to-GDP ratio, inability to handle external shocks (viz. COVID-19, and oil price shocks), and inadequate policy responses to the debt crisis. The Maldives, much like Sri Lanka, has had limited access to concessional financing from multilateral agencies owing to its ‘middle income’ status, making most of its external debt commercial (higher interest rates and shorter maturities), which now exposes it to refinancing risk. Furthermore, its access to international capital markets is also constrained due to recent credit rating downgrades. The island nations have inherent structural challenges due to a lack of economic diversification, high dependency on imports, small populations, geographical limitations, vulnerability to external shocks, and other compounding factors. When such countries build a debt-fuelled economy instead of addressing core constraints and planning for contingencies, their stories tend to meet a similar fate.

The Maldives seems to be inching closer to a ‘Sri Lankan fate’. With the International Monetary Fund (IMF) and World Bank deeming its debt ‘unsustainable’ in their previous debt sustainability analysis.

The Debt and Climate Vulnerabilities

The majority of the 18 Small Island Developing States (SIDS) in the Indo-Pacific are facing some level of debt risk, and 11 out of the 18 countries are in critical risk categories, as per the latest debt sustainability analysis conducted by the IMF and the World Bank (see table below).

Public Debt Risk Assessment for Indo-Pacific SIDS

Source: World Bank Report on SIDS and IMF Country Reports

Furthermore, the debt-to-GDP ratios for many of these countries have also escalated over the past decade and more significantly since the 2020 COVID-19 pandemic. The Maldives represents a specifically stark case (see graph below).

Debt-to-GDP Ratios for Indo-Pacific SIDS

Generally, a debt-to-GDP ratio of ~60 percent is considered a prudent level for developing countries. Of course, this ratio is not the only key indicator one can rely on to assess whether a country is on a sustainable debt path, a well-known lesson from the Sri Lankan debt crisis. This is why the IMF and World Bank use specific and nuanced indicators and thresholds for a comprehensive analysis. While debt sustainability is just one aspect of the problem, SIDS are also facing an urgent need to invest in climate change adaptation. SIDS contribute less than 1 percent of the greenhouse gas (GHG) emissions but are the most affected by the climate crisis. All 18 SIDS in the Indo-Pacific region have significantly high levels of climate vulnerability, demonstrated by their high ranking in the Notre Dame Global Adaptation Initiative (ND-GAIN)  sub-index of Exposure to Climate Change (see graph below).

Note: There are a total of 192 countries ranked in this sub-index. A higher ranking denotes greater exposure to climate change.

Source: Author’s graph based on the data from the ND-GAIN Country Index

It is worth noting that in the rankings above, all the Indo-Pacific SIDS are ranked between 120 and 192 out of the 192 countries, placing them in the top ~40 percent, with the Maldives being the most vulnerable. This makes the case of climate adaptation and resilience building for the Indo-Pacific SIDS all the more pressing. Climate adaptation costs for SIDS involve both investments into resilient physical infrastructure and building fiscal buffers for recovery. One of the biggest constraints in this regard for such countries is their small population, which does not allow for economies of scale in the massive public investments needed for such adaptation. These countries are often trapped in a vicious cycle where they are forced to raise expensive external commercial debt to finance climate infrastructure and recovery efforts. However, this rising debt further exacerbates the already existing fiscal pressures from repeated climate shocks and other external shocks. A doom loop of sorts.

These countries are often trapped in a vicious cycle where they are forced to raise expensive external commercial debt to finance climate infrastructure and recovery efforts. However, this rising debt further exacerbates the already existing fiscal pressures from repeated climate shocks and other external shocks. A doom loop of sorts.

The Antigua and Barbuda Accord

To address this loop, the Antigua and Barbuda Accord, a transformative 10-year plan (2024–2034), was adopted at the 4th United Nations (UN) International Conference on SIDS in 2024, for coordinated efforts to build resilience and support sustainable development in these countries. A central component of the accord is the establishment of the Global Small Island Developing States (SIDS) Debt Sustainability Support Service (DSSS) to help the SIDS break the vicious cycle of debt distress through multilayered support services and create a fiscal space for building climate resilience. The support includes — assessment of debt sustainability and financial implications, layering of multiple relief measures in the sovereign debt agreements including contingent debt/pause clauses (debt suspension during shocks), parametric insurance (for specific climate events to cover immediate recovery costs), and debt swaps (debt-for-nature or debt-for-climate) as part of the debt restructuring strategy. Through these innovative financing mechanisms, the SIDS can access new forms of concessional financing. This is intended to provide both short-term relief and long-term fiscal sustainability. The Seychelles’ success with debt-for-nature swaps and blue bonds is a well-documented example of how innovative financing can simultaneously reduce debt burden and support climate resilience in an Indo-Pacific island state.

Another critical aspect of the DSSS is creditor coordination, an issue that often arises in the author’s discussions with stakeholders who have been part of sovereign debt restructurings. Lack of coordination, diverse incentives, and information asymmetries between different creditor classes can be a major roadblock to efficient, timely, and fair debt restructuring processes, which is especially crucial for vulnerable island nations. For instance, in the Sri Lankan debt restructuring, China negotiated separate terms and refused to accept the restructuring framework agreed upon by most official creditors. Adding to this complexity are disagreements or delays by private creditors, considering they operate with entirely different incentives compared to official creditors, especially hedge funds, which are sometimes known to favour defaults over restructurings when they hold credit default swaps — as seen in the Argentine and Greek debt crises.

The Seychelles’ success with debt-for-nature swaps and blue bonds is a well-documented example of how innovative financing can simultaneously reduce debt burden and support climate resilience in an Indo-Pacific island state.

Lastly, the DSSS is expected to strive for the use of the Multidimensional Vulnerability Index, a composite and nuanced indicator of structural vulnerabilities in the SIDS, touted as a better metric than the usual income-based ones. This is to aid the creditors and donors in debt restructuring and providing concessional finance, as well as to urge the creditor rating agencies to account for these vulnerabilities in their rating methodologies.

While these efforts are certainly in the right direction, this is not the first time such an international framework has been adopted. However, COVID-19 was an inflexion point that highlighted the urgency of these challenges facing SIDS. Lessons learned from the recent debt restructurings, along with the emergence and success of new innovative financing mechanisms, appear to have helped enhance the approach this time around.

Key Takeaways

• In the aftermath of COVID-19, the vulnerabilities and risks for SIDS in the Indo-Pacific are not only amplified, but the countries are at a critical juncture, such that any further missteps will set them on a difficult recovery path.
• Island nations with their small economies and disproportionate climate exposure lack the fiscal flexibilities that large economies enjoy. Their policies tend to be shaped more by structural constraints and mismanagement than policy ambitions.
• SIDS tend to fall into a financial grey zone, as most qualify as middle-income, which makes them too ‘wealthy’ to qualify for traditional concessional financing from multilateral agencies and too ‘risky’ for affordable financing from international capital markets. This is why new forms of concessional financing are critical for them. To address this mismatch, consistent support and intervention are required, especially through the Antigua and Barbuda Accord, which one can only hope does not die a conceptual death.
• Addressing this crisis requires a multi-layered and coordinated approach from all stakeholders to implement effective solutions that are both economically viable and mutually beneficial. It is in their own interest to do so.

Why this Matters

~94 percent of the Indo-Pacific SIDS have some form of sovereign debt concerns, and ~60 percent are already in critical risk categories. Failing to address these issues as a priority could lead to more cases such as the ongoing Maldives debt crisis, with potential ripple effects regionally and globally.

Lavanya Mani is a Fellow at the Observer Research Foundation.

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