The Finance Dilemma in Developing Countries: Balancing Debt Servicing and Climate Stabilization

Abstract This paper examines the dilemma faced by low- and lower-middle-income countries in balancing debt servicing with climate stabilization investments. The need to service external debt compels governments in developing countries to engage in extractive practices to generate foreign-exchange revenue to service their high external debt, creating a trade-off with climate-stabilization investments. Utilizing a panel dataset from 47 low – and lower-middle-income countries, excluding India, that produce at least one of the three fossil fuels- oil, natural gas, or coal- from 2010 to 2021, along with three case studies from the Democratic Republic of the Congo, Cameroon, and Bangladesh, this paper found that fossil fuel-producing low- and lower-middle-income countries increase fossil fuel production to manage external debt and consequently forgo investment in climate stabilization. Additionally, increasing debt forgiveness or providing debt reduction can reduce fossil fuel production and promote renewable energy production. Therefore, to enhance investment in climate stabilization in these countries, debt forgiveness programs could serve as practical tools to increase climate stabilization efforts, address the high demand for climate investment, and decouple external debt from fossil fuel production.