In a recent post I described the concept of the Debt-for-nature swaps, which is, if well done, a win-win situation for a benevolent investor and a highly indebted government, as well as the future generations. But what happens if a highly indebted government, in urgent need of finances to sustain its sovereign debt, stumbles upon that one selfish investor that decides to use the indebted country’s resources for himself?

Or worse, what happens if an indebted government tries to sell its natural resources to whomever simply to keep itself from defaulting? For example, Zimbabwe’s Prime Minister Mutambara tries to leverage its diamonds to reduce its sovereign debt by entering into deals with foreign firms. McDonalds is known to have converted large rainforest area to pastures or soya bean production, and it is unlikely that they received these rainforest areas for free. Selling resources per se is not the problem – most countries do this all the time – but it certainly becomes a problem if the money for the resources does not provide a service for the future generation. A sell-off of the natural resources reduces genuine savings, which is likely to leave the future worse off.

Even worse, Manzano and Rigobon (2001) suggest that some countries may have achieved a large sovereign debt only because they were implicitly using their natural resources as collateral. This has two dire implications:

1. If these natural resources are overused, then the collateral value reduces and the sovereign debt is not anymore backed up by sufficient collateral. As a consequence, environmental degradation in one country can also lead to sovereign debt risk. (An additional channel arises via taxes from natural resources or rents from natural resources which may diminish, thus making government debt unsustainable, see HERE.)

2. If a country really does default, then the investor in that country will receive the natural resources since it was the country’s collateral. Most investors are not the benevolent kind like Mr Bill Gates (Hello Mr Bill Gates, wink wink) and may thus simply sell off those natural resources to the highest bidders. These highest bidders are unlikely to be non-profit oriented organizations.

An interesting research question in that regards would be whether there is a positive correlation between government debt and natural resources. This may suggest that a country with more resources may use these as collateral or may know that it always has a fallback option to sell that resources in order to pay off its debt.

Summing up, using natural resources as collateral for government debt, or being pressed to sell nature to prevent sovereign default, may lead to a transfer of resources from a more benevolent owner to a profit-oriented firm that simply does not care about the future value of the resource.

I do not see a useful (economic) solution in this case. One has to carefully weigh-off the current and future value of the environment with the cost of a government default or the higher, risk-adjusted interest payments on the sovereign debt. And one has to do this on a case-by-case basis. Our could do this based on the genuine savings indicator. HOWEVER, the problem is that if a country undertakes a debt-to-nature swap even with a benevolent investor, then the genuine savings indicator will count this as a reduction in that country’s natural resources. And it is also not entirely clear even how the genuine savings indicator should treat these resources then.

Clearly, countries want to keep their sovereignity, and therefore international regulations that define rules for a potentially large-scale sell-off of natural resources in case a government uses these to reduce its risk of default are not the right approach. This is especially true since then no country should have sovereignity over its natural resources – I do not see an important difference between continuously selling off resources as every country does and a large-scale sell-off due to a sovereign crisis.