Winds of up to 240 kilometres per hour flattened entire neighbourhoods and toppled power and communication lines, causing damage equivalent to a third of the country’s annual economic output, according to early government estimates.

Many Grenadians cast their minds back 20 years when a similarly powerful storm – Hurricane Ivan – brought the island state to its knees, triggering a vicious circle of financial distress that eventually led to a debt default.

But, unlike in 2004, officials this time could deploy a tool that has been widely discussed in climate circles to provide financial help in the wake of fierce storms: hurricane clauses built into its agreements with international creditors.

Grenada last week became the first country in the world to use such a provision in a government bond which will allow it to postpone debt repayments to private investors, including US investment firms Franklin Templeton and T. Rowe Price.

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The move will save the Caribbean island nation a total of around $30 million in payments due this November and in May next year. While the money owed will be added to future bills, in the meantime the cash injection will help fund immediate recovery efforts and keep essential services like healthcare and education running, a senior official in Grenada’s Ministry of Finance told Climate Home.

The government is now “in talks” about triggering similar clauses with other creditors.

Fighting the debt trap

Grenada’s use of debt suspension clauses will be seen as a litmus test for their effectiveness in shoring up disaster-hit economies, as major international financial institutions like the World Bank promise to offer them more widely to climate-vulnerable countries.

Mike Sylvester, permanent secretary at Grenada’s Ministry of Finance, told Climate Home the debt repayment pause can have a “significant” impact in the short term, giving “some breathing space to the government to be able to properly and adequately respond to the crisis”.

Without this option and other relief measures, the government may have struggled to meet basic needs without making painful cuts to services, he added.

Simon Stiell, the head of the UN Climate Change body (UNFCCC), told Climate Home that “mechanisms such as this will be increasingly important as the scale, frequency and impacts of climate disasters continue to worsen”. Last month Stiell saw first hand the scale the devastation Hurricane Beryl inflicted on his home island of Carriacou – part of Grenada – where 98% of homes and buildings had been destroyed or severely damaged.

Like Grenada, many developing nations are finding it hard to deal with the combined effect of rising debt and worsening climate impacts.

Nearly half of low-income countries currently experiencing or at high risk of debt distress are also highly vulnerable to the effects of climate change, according to a March 2023 report by the UN Trade and Development agency (UNCTAD).

A separate analysis by charity Debt Justice found that debt payments for the most climate-vulnerable countries have reached their highest level in at least 30 years.

Emily Wilkinson, a senior research fellow at think-tank ODI, said that when a natural disaster hits a highly debt-distressed country, the impact on the economy is likely to prompt a default unless there are safeguards in place or the debt can be renegotiated quickly.

Disaster clauses in spotlight

Debt suspension clauses have risen to the top of the agenda since they were featured among the key recommendations put forward by Barbados Prime Minister Mia Mottley in her Bridgetown Agenda, a vision for reforming the global financial architecture and making it fit for a world grappling with rising climate pressures.

The World Bank expanded the scope of its climate-resilient debt clauses last year. Pauses on repayments of all new and existing loans, and related interest payments, are now being offered to 45 states it classes as “small” including island nations.

Other international development lenders, like the African Development Bank, the Inter American Development Bank and the UK Export Finance, have introduced similar options.

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For Marina Zucker-Marques, an economist and senior researcher with the Boston University Global Development Policy Center, temporary debt suspensions are an important tool that gives disaster-hit countries “some breathing space, allowing them to prioritise social spending, which is critical in the immediate aftermath of a natural disaster”.

But while these clauses have become more popular, they are still “a tiny fraction of debt contracts,” she added.

The lesson of 2004

Grenada is among a handful of countries that have pioneered the inclusion of hurricane clauses in their loan agreements dating back nearly a decade.

After the devastating experience of Hurricane Ivan in 2004 and a subsequent default, the island nation insisted on including such provisions in 2015 when it restructured debt with its main creditors, international private bondholders and the Exim Bank of the Republic of China (Taiwan).

One of the main challenges during the extended negotiations was to settle on specific parameters that would allow Grenada to trigger the clause in the event of a severe storm. These could be the wind-speed or the size of the economic losses caused by the disaster.

In the end, Grenada and its creditors agreed that a payout from the Caribbean Catastrophe Risk Insurance Facility (CCRIF), a regional disaster insurance fund Grenada is part of, for losses over $15 million would be the trigger.

After the passage of Hurricane Beryl, CCRIF has made a record $44 million insurance payout to Grenada as a result of the extensive damages to the islands. This enabled the government to activate its debt suspension clauses.

The aftermath of the devastating passage of Hurricane Beryl on the island of Petite Martinique, Grenada in July 2024. REUTERS/Arthur Daniel

Sylvester from Grenada’s Ministry of Finance said the country is now much better prepared to deal with the financial aftershocks of a hurricane, having learned the lesson of the events in 2004 – but more needs to be done.

“The money that we’ve received so far is still a drop in the bucket, given our significant needs,” he added. “We need to continue to build our resilience with the right financial tools, because we don’t want to pile up our debt just to reconstruct damaged infrastructure.”

Grants and debt relief

To that end, the government has set up a disaster relief fund, while looking to repurpose some of its loans and obtain new financial help from multilateral banks.

Boston University’s Zucker-Marques said support from rich countries, which are major contributors to climate change through their historically high greenhouse gas emissions, is fundamental to prevent financial crisis in developing countries on the frontline of extreme weather.

“Climate vulnerable countries need access to more grants and affordable long-term finance to invest in resilient infrastructure and economies,” she said. “Otherwise, the vicious cycle of natural disasters and financial instability will only worsen in the years to come.”

ODI’s Wilkinson said pausing countries’ debt is helpful, but she called for further action from creditors. “In the case of a qualifying disaster, they should offer some form of debt relief on repayments rather than just delaying them – which only kicks the can down the road,” she added.

The article was updated on 23/8 to add a comment from UNFCCC chief Simon Stiell received after publication.

(Reporting by Matteo Civillini; editing by Megan Rowling)

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