The case for GDP growth bonds
For the past year official and private sector representatives, acting under the G20’s original direction, have organised informal working groups and events to discuss the possible introduction of GDP growth-linked bonds. The idea first gained notice in the aftermath of the 1990s Asian financial crisis, and more recently for Greece, as an automatic stabiliser with countercyclical risk-sharing when recession or natural disaster hit that can also provide upside in boom times.
Argentina and Ukraine followed early post-Brady plan restructurings in offering warrants that pay a premium when annual economic growth is more than 3 per cent, but fully-fledged instruments have yet to be adopted in standard issuance and workouts, despite concerted pushes from the International Monetary Fund, the Institute of International Finance and other bodies.
Since the middle of 2016, the IMF has published papers on “state-contingent” debt, while the Bank of England and the International Capital Markets Association in London have taken the lead on global emerging market investor outreach, which resulted in a model term sheet. It indexes coupons and amortisation to nominal GDP, has both foreign and local currency options, and would be governed under international law with creditors ranking equally.
The framework also contains complex provisions on collective action clauses and statistical calculations, which muddy its legal and practical understanding.
An easier approach would be to incorporate the concept into smaller deals, such as the recent frontier sovereign wave in Africa and elsewhere, to build a credible record where any dispute from the limited buyer base and transaction size could be handled by independent experts.
The IMF’s May review examined a range of bond alternatives adjusted for economic indicators or weather events and found that other tools can “preserve space” in difficult periods, such as international reserve accumulation, fiscal rules, commercial insurance, and central bank swap lines. However, well-designed GDP-formula bonds are more accessible and promote concrete securities diversification and the more abstract “global safety net”, in the fund’s view. Its simulations showed that having one-fifth of the debt stock in this form would increase emerging economy limits on average 10 per cent before they reached dangerous levels.
Real money long-term managers at big institutions are the logical buyers, as they have wider fiduciary scope to balance country welfare with asset returns, the paper argued.
However, pilot efforts will still demand a novelty premium because of doubts over liquidity and performance, which could be magnified by data frequency and reporting gaps as in Argentina’s past and in Venezuela’s present case, where related bad governance and economic policies would probably make upfront costs prohibitive.
Professional debt agencies and not politicians should be in charge of these operations to plan beyond the next election cycle, and rating agencies should participate at an early stage, the primer recommended.
Inflation-adjusted instruments offer a foundation and remain popular in Latin America among local and foreign investors, and commodity-tied value recovery rights featured in a dozen decades-old sovereign debt exchanges, but verification lags behind and other intricacies have impeded mainstream embrace.
GDP-linkers will take time to develop benchmarks, and pricing is assumed to be at least 50 basis points more than conventional offerings at the outset, according to the literature. Global pension funds controlling $40tn may be confined to hard-currency investment-grade exposure to further narrow the structure, while Islamic finance vehicles committed to risk-sharing could be a smooth fit.
In discussions on the London term sheet, lawyers have criticised voting and cross-default clauses that seem to prevent aggregation and subordinate “plain vanilla” bonds to GDP-related ones.
Analysts in turn are deeply suspicious of government data manipulation in the absence of an established separate mechanism for calculation and publication, and insist in the proposal on possible immediate redemption through a put option for protection.
Instead of mainly relying on these elaborate consultations, often with acrimonious debate over motives and principles, GDP-linked bond advocates including the IMF, which has indicated possible balance sheet and technical support, should instead be open to ad hoc insertion in ongoing minor emerging market placements.
Leading candidates were the past year’s restructurings in Belize, Mongolia and Mozambique amid their other outstanding economic policy and statistical disclosure concerns. The three are serial defaulters with fates connected to natural resources, and creditors have been frustrated by continued negotiation and workout impasses that may be more readily overcome with specific data or event-triggered instruments.
A standing group of mutually-agreed professional monitors could oversee adapted versions of the template, as innovation champions bypass lengthy deliberations to forge missing links.