The Caribbean island's new $US165 million ($NZ280 million) deal is the first debt-swap to free up money directly for climate adaptation.
About $US125 million to go towards sewage treatment plant upgrades that should boost water supplies and reduce the amount of pollution going into the Caribbean.
Debt swaps have become increasingly popular ways for countries to free up cash to invest in nature conservation projects, with the likes of Bahamas and El Salvador completing deals this year.
Those involved said the new deal sets a benchmark for financing climate adaptation that avoids increasing the burden of public debt and will help meet the $US359 billion a year the United Nations says is needed to help developing countries adapt to climate change.
Other countries have already expressed an interest in following Barbados to market, sources said.
Water scarcity in Barbados is being exacerbated by the effects of climate change, and water availability for Barbados' people and economic activity like farming is already far less than the global average.
The buy-back will finance a new facility to boost water management, food security and resilience, Barbados' Prime Minister Mia Mottley said in a news release.
"In the face of the climate crisis, this ground-breaking transaction serves as a model for vulnerable states, delivering rapid adaptation benefits for Barbados."
Mottley is a leading voice in helping to drive finance to climate-vulnerable countries. Her influential Bridgetown Initiative calls for the reform of international financial institutions like the World Bank to address the growing challenges of high debt levels, climate change and slower growth.
The cornerstone of Barbados' plan to improve water security and supply is the construction of its New South Coast Water Reclamation and Re-use Facility which aims to more than double water availability in the country by 2050. Additional funds will be invested in mangrove conservation, water restoration and agricultural resilience.
To make the debt swap work for an infrastructure project, the Inter-American Development Bank and Green Climate Fund provided upfront loans of $US70 million to kick-start development with the longer-term savings released by the swap used in part to pay back these debts.
The GCF also provided an additional $US40 million grant.
Barbados bought back $US293.3 million of its existing domestic bonds using a new 3.25% almost 600 million bajan dollar ($NZ504 million) sustainability-linked loan provided by CIBC Caribbean Bank, Scotiabank (Barbados) and RBC Royal Bank (Barbados).
The loan embeds sustainability performance targets, which, if missed, will mean the government incurs financial penalties. It is backed by guarantees from the European Investment Bank and Inter-American Development Bank which each provided $US150 million of support.
IDB President Ilan Goldfajn called the deal an "important milestone."
"It is the first debt-for-climate operation focused on climate resilience. ... This is impact at scale with innovation and partnership at work,” he said.
The country's debt management efforts come as it looks to reduce its debt-to-GDP ratio from 105% of GDP at the end of September to 60% of GDP by 2036, the IMF says.
The EIB guarantee is part of the EU's Global Gateway project, a bid to woo Global South countries that have long looked to China's Belt & Road Initiative to fund their infrastructure needs.
