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Are State-Contingent Sovereign Bonds the Solution to Avoid Government Debt Crisis?

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  • Christophe Destais

Abstract

The idea that sovereign borrowers may issue new debt, the service of which is contingent or GDP growth (GDP linked bonds) has been increasingly discussed in recent years. Some central banks (England, Canada and, recently, Germany and France) have taken steps to raise the awareness of stakeholders and launch a global conversation on GDP-linked bonds. The IMF participated in this debate though with extreme caution. The G20 mentioned the issue in its last Hamburg communiqué but refrained from taking side. GDP-linked bonds offer many advantages. They would limit the issuers’ debt-service obligations in time of slow or negative growth, reduce the likelihood of debt crises and defaults, avoid sharp spending cuts in order to maintain access to capital markets, and even provide some latitude for additional spending at a time when it is most needed. GDP-linked bonds would also render investors more responsible when it comes to lending money to a sovereign. In addition, investors would know in advance the terms of their bond restructuring and gain an equity-like exposure to a country. The counter-cyclical feature of GDP-linked bonds and the fact that they would alleviate the economic cost of a debt restructuring would also make them beneficial for financial stability and the broader economy. These benefits would justify a global policy initiative to promote the idea and kickstart the market. However, many issues remain unresolved (pricing, design, institutional framework…). The learning curve for such a new financial product might, therefore, justify a cautious and experimental approach even though the quick development of a large GDP-linked bond market would have many advantages, including liquidity and arbitrage.

Suggested Citation

  • Christophe Destais, 2017. "Are State-Contingent Sovereign Bonds the Solution to Avoid Government Debt Crisis?," CEPII Policy Brief 2017-19, CEPII research center.
  • Handle: RePEc:cii:cepipb:2017-19
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    References listed on IDEAS

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    1. Patrick Bolton & Olivier Jeanne, 2011. "Sovereign Default Risk and Bank Fragility in Financially Integrated Economies," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 59(2), pages 162-194, June.
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    4. Ricardo Caballero, 2002. "Coping with Chile´s External Vulnerability: a Financial Problem," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Raimundo Soto & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.),Economic Growth: Sources, Trends, and Cycles, edition 1, volume 6, chapter 12, pages 377-416, Central Bank of Chile.
    5. Barr, David & Bush, Oliver & Pienkowski, Alex, 2014. "GDP-linked bonds and sovereign default," Bank of England working papers 484, Bank of England.
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    Cited by:

    1. Harris Ntantanis & Lawrence Pohlman, 2020. "Market implied GDP," Journal of Asset Management, Palgrave Macmillan, vol. 21(7), pages 636-646, December.

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    More about this item

    Keywords

    Sovereign Debt; State Contingent Bonds; GDP-linked Bonds;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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