The ‘Hidden Cost’ of Sustainable Debt Financing in Emerging Markets

Abstract International sustainable debt markets are a critical source of capital for EMDEs progressing sustainable development and climate goals. However, finance provided in ‘hard’ currencies preferred by international investors, rather than local currencies in which borrowers earn revenue, transfers currency risk from developed country lenders to EMDE borrowers. This shift amplifies financial vulnerabilities at both the micro and macroeconomic level. Here we investigate the risk factors influencing the currency composition of EMDE sustainable corporate debt over the past two decades. We show that EMDE borrowers choose hard currency financing as the price for market access during volatile periods, creating a ‘hidden cost’ of sustainable debt. In addition to currency risk, global uncertainty depresses access to local currency financing in a ‘flight-to-safety’ phenomenon. A ‘ratings trap’ further develops whereby improved sovereign credit ratings increase foreign currency borrowing with potentially negative feedback effects on sovereign credit stability and ongoing access to debt markets.