Gdplinked bonds are particularly attractive for foreign residents, and this requires a market with several issuers. This reduces the probability of a costly default and smoothes out the debt burden for the issuing country, to the benefit of the countrys taxpayers. References intermediate islamic finance wiley online library. Making a reality of gdp linked bonds, presentation. Griffithjones and krishnan sharma for permission to reprint their paper on gdpindexed bonds in this book. Griffithjones, s and sharma, k 2009, gdpindexed bonds. Fifteen years ago, i suggested that one could level the playing field for equity and fdi by making it more difficult for developing country governments to borrow under us or british law, a device that favours debt in environments where domestic institutional capacity to enforce contracts is limited.
In early 2012, elaborating on his 1993 book, schiller published a short text. Gdp linked bonds in a precautionary way, as selfinsurance mechanism. Google scholar haldane, a 2012 tails of the unexpected, speech given at the credit crisis five years on. Inclusive economies institute of development studies. This book offers a wide range of timely lessons from history, political economy and finance to guide us in exploring new paths to a safer international financial system. Gdp linked bonds help both to reduce the incidence of sovereign default and to. Benefits of gdpindexed bonds for issuing countries, investors and international financia. Comparing gdp indexed bonds to standard government bonds lillian kamal university of hartford malek lashgari university of hartford this paper discusses the construction of a new financial instrument whose payoffs are linked to the overall performance of the u. This book brings together the vast array of new initiatives in financing mechanisms and proposals to transform the development finance architecture. Making it happen stephany griffithjones krishnan sharma 79. Can human development bonds reduce the agency costs of the. By making defaults less likely, might growth indexed bonds in fact remo ve the main.
In 1780, the state of massachusetts issued what is often considered to be the first ever inflationlinked bond, then called a depreciation note, indexing to a basket of goods. Gdp linked bonds are a form of floatingrate bond with a coupon that is associated with the growth rate of a country, just as other floatingrate bonds are linked to interest rates, such as libor or federal funds rate, or inflation rates, which is the case of inflation indexed bonds. A brief history of gdp linked bonds gdp linked bonds and other related statecontingent debt instruments have received support on and off for well over a century. Giving the people and their pension funds a stake in the wealth of the nation, cowles foundations discussion paper series, 2009. The bonds are designed to pay investors when economic growth rates exceed government projections. Gdp indexed bonds have the sensible theoretical rationale of making payments proportional to, or even contingent on, the countrys capacity to pay. A test issuance of gdpindexed bonds is needed to determine whether they would be an attractive addition to sovereign debt portfolios. Additional slides survey of investor attitudes additional slides miscellaneous interest savings over the economic cycle. As sovereign gdplinked bonds argues, the issuance of gdplinked bonds will create fiscal. Gdp linked bonds, another whole literature to synthesize into market monetarism. Innovative financing for development by suhas ketkar. Inflationindexed securities a bond or other fixedrate security with an interest rate that varies according to inflation.
The introduction of gdp indexed bonds could have a number of positive effects, for developing. The introduction of gdpindexed bonds could have a number of positive effects, for developing countries, for investors and for the international financial system. There is, in fact, plenty of evidence that the sustainability of a. Real gdp must be at a higher level than the base gdp. Making it happen in suhas ketkar and dilip ratha eds. Gdpindexed government bonds are a good instrument for advanced economies, they would be ideal for the u.
Making it happen bank of england, london, monday 30 november, 2015 overview on 30 november, 2015, the bank of england hosted a workshop on gdp linked bonds, the aim being to identify why these instruments do not exist already, to explore whether there are. The recourse to the latter class of bonds narrows the range of possible patterns of the ratio, making it less likely that negative growth shocks eventually push this ratio over the roof. Policymakers and economists have been looking for ways to make it easier to manage increasing debt burdens. Gdp indexed government bonds are a good instrument for advanced economies, they would be ideal for the u. Bondholders may be limited from calling an event of default if fixedrate bonds have not been paid by arcadia, but at the same time they will not be aggregated with the fixedrate bonds in case arcadia wants to propose a restructuring to all. Usually governments have recourse to conventional debt financing to undertake infrastructure projects. The case for gdpindexed bonds by eduardo borensztein, paolo. Making it happen, working papers 21, united nations, department of economics and social affairs. Based on four different scenarios for the next tenyear period, proposals are made for how to reach an effective. A test issuance of gdp indexed bonds is needed to determine whether they would be an attractive addition to sovereign debt portfolios.
Gdpindexed bonds from a macroeconomic perspective, the idea of using gdpindexed bonds in sovereign debt portfolios is quite easy to understand. Gdplinked bonds and sovereign default springerlink. We simulate the effects of gdpindexed bonds under different assumptions about fiscal policy reaction functions and their output effects and find that they could substantially reduce the likelihood that debtgdp paths become explosive. Indexed bond bond whose payments are linked to an index, e. By indexing interest payments to growth, they limit the increase in the debt ratio in bad times, thus decreasing the probability that the debt becomes unsustainable. Gdp indexed bonds could be structured so that if gdp falls by 25 percent, their nominal amount falls by 25 percent and, conversely, if gdp rises by 25 percent, so does the debt. The debtto gdp ratio would decline by 15% on average with the issuance of gdp indexed bonds over a 25year horizon for the 5% least favourable debt paths. We show that gdpindexed bonds could provide substantial benefits in reducing the likelihood of default crises and allowing countries to avoid procyclical fiscal policies. There has been increasing interest in exploring financial instruments that could limit the cyclical vulnerabilities of developing countries and.
This is an instrument that improves risk management, and it gives investors an option on top of the traditional government bonds. Advantages of gdp indexed bonds, and how they would work gdp indexed bonds tend to keep debt gdp ratios within a narrower range than do plain vanilla bonds, thereby providing two key advantages. Making it happen 11 different potential investors an important issue to consider is the type of investors that are or could be interested in gdplinked. Advantages of gdpindexed bonds, and how they would work gdpindexed bonds tend to keep debtgdp ratios within a narrower range than do plain vanilla bonds, thereby providing two key advantages. An inflationindexed bond, for example, may pay a fixed coupon plus an additional coupon with the amount adjusted every so often according to. Gdp indexed bond would pay out a fraction of the earnings of the issuing countryits gdp. As dale domian and i have been frustrated at our continuous attempts to publish our quasireal indexing research, i have kept reminding myself of one thing and that is that we were the first to design quasireal indexing eagle and domian, 1995. Are statecontingent sovereign bonds the solution to avoid. This column argues that against this background, growthindexed bonds can help.
Palgrave studies in islamic banking, finance, and economics. What will happen if the government somehow fails to produce a gdp. This book argues that poor countries need additional, crossborder capital channeled to the private sector for employment generation, growth, and poverty reduction. The case for growthindexed bonds vox, cepr policy portal. Gdpis and to what extent these bonds could reduce the risk borne by the treasury that shocks would inflate the debttogdp ratio to the point of triggering a crisis of confidence in the sustainability of public finances. Our work explores what characterises inclusive economies and how these can be achieved, particularly in a world where new technologies, rural to urban migration, and growing youth populations are disrupting and putting new pressures on peoples lives and livelihoods. Global financial integration thirty years on edited by. Gdplinked bonds, another whole literature to synthesize into market monetarism. Global financial integration thirty years on from reform to crisis. Gdpindexed bonds could be structured so that if gdp falls by 25 percent, their nominal amount falls by 25 percent and, conversely, if gdp rises by 25 percent, so does the debt. Pricing and hedging gdplinked bonds in incomplete markets. This paper seeks to revive the case for countries to selfinsure against economic growth slowdowns by issuing gdpindexed bonds. In my 1993 book macro markets, i described the worlds gdps as the. New sources and innovative mechanisms for financing development in subsaharan africa dilip ratha sanket mohapatra sonia plaza 143 index 185.
While current levels may be sustainable, another series of bad shocks could easily tip the balance and lead to unsustainable debt ratios. We simulate the effects of gdp indexed bonds under different assumptions about fiscal policy reaction functions and their output effects and find that they could substantially reduce the likelihood that debt gdp paths become explosive. An inflation indexed bond, for example, may pay a fixed coupon plus an additional coupon with the amount adjusted every so often according to some inflation indicator, such as the consumer price index. The introduction of gdpindexed bonds could have a number of positive effects, for developing. It compiles pioneering methods of raising development finance including securitization of future flow receivables, diaspora bonds, and gdpindexed bonds.
As sovereign gdp linked bonds argues, the issuance of gdplinked bonds will create fiscal. This paper seeks to revive the case for countries to selfinsure against economic growth slowdowns by issuing gdp indexed bonds. Gdplinked bonds and sovereign default bank of england. In doing so, the paper introduces two elements of novelty compared to the extant related literature. This type of security can be thought as a stock on a country in the sense that it has equitylike features. The idea of bonds indexed to national income is not novel and a first sure reference goes back to. In finance, a gdplinked bond is a debt security or derivative security in which the authorized issuer a country promises to pay a return, in addition to amortization, that varies with the behavior of gross domestic product gdp. The economic case for growthindexed bonds is clear. Comparing gdp indexed bonds to standard government bonds. Gdplinked bonds make debt payments contingent on a countrys gdp, thereby ensuring that debt can. First holder of the chair of islamic finance at the international center for education in islamic finance inceif, malaysia. The development of infrastructure has been proven to be an effective means for economic growth and poverty reduction.
As a result, they reduce the default risk premium, further improving the distribution of the debt ratio. By making defaults less likely, might growthindexed bonds in fact remo ve the main. Gdpindexed bonds have the sensible theoretical rationale of making payments proportional to, or even contingent on, the countrys capacity to pay. Report on the brainstorming meeting on gdpindexed bonds. Aggregation is to happen only with other gdplinked bonds, not with all other bonds issued by arcadia. Innovative financing for development by world bank group. What will happen if the government somehow fails to produce a gdp number on time. Part of the international economic association series book series iea.
And, once gdplinked bonds are issued by a variety of countries. However, as interest payments become more volatile, growthindexed bonds. The case for gdpindexed bonds by eduardo borensztein. It is a fine example of how research can inform policy. Further technical work is required to support a test issuance of the bonds.
This paper seeks to revive the case for countries to insure against economic growth slowdowns by issuing bonds indexed to the rate of growth of gdp. The case for growth indexed bonds in advanced economies today olivier blanchard, paolo mauro, julien acalin 16 february 2016 while current levels may be sustainable, another series of bad shocks could easily tip the balance and lead to unsustainable debt ratios. Argentina has achieved great success with its gdp indexed bond, which works by way of gdp warrants. Externality from growthindexed bonds to standard bonds. The benefits of gdpindexed bonds vox, cepr policy portal. The idea behind this financial instrument, known as a gdp. Despite the huge amount of wealth in the hand of muslims, most countries with muslim majority population fall in the category of developing nations. Making it happen 5 real gdp must be at a higher level than the base gdp. In this paper we explore the ways in which gdplinked bonds can stabilize sovereign. Since there is no historical data for gdp bonds in the u. Gdplinked bonds bulletin september quarter 2016 rba. Oct 18, 2016 part of the palgrave studies in islamic banking, finance, and economics book series ibfe abstract with capital markets providing in their true nature a risk sharing mode, the role of islamic finance comes into play, and the proposed macromarket and micromarket instruments can be very beneficial. It is observed that the gdp bond has a superior performance to other high quality bonds in a risk return framework. Giving the people and their pension funds a stake in the wealth of the nation, cowles foundation discussion paper no 1717.
These securities can be issued to reference real gdp, nominal. Gdplinked bonds, with coupons and principal that rise and fall in proportion to. The gdp bonds, as formulated in this paper, possess the aforementioned properties. Innovative financing mechanisms are necessary to make this happen. If these securities are held to maturity, then the investor guarantees that the return will exceed the rate of inflation. By decreasing payments when growth is low, they can substantially reduce the. Policymakers and economists have been looking for ways to make it easier. Benefits of gdp indexed bonds for issuing countries, investors and international financia.
Griffithjones s and k sharma 2006, gdpindexed bonds. One of the legacies of the global crisis is a high ratio of public debt to gdp. Unpacking the crisis conference held at the university of edinburgh business school, june 89. We show that gdpindexed bonds could provide substantial benefits in reducing the. Gdplinked bonds could be an insurance policy against depression. Part of the palgrave studies in islamic banking, finance, and economics book series ibfe this chapter aims to compress our thoughts and discussion in the matter of how public policy managers tend to utilize capital markets through intervention to fulfill economic goals. The volatility of the reference portfolio potentially would decrease by 12% on average for a diversification through investment in gdp indexed bonds rather than in equities for a given country. Real growth of gdp versus the previous year must be greater than the growth implied by base gdp from 2015 the base growth rate is. References intermediate islamic finance wiley online. A handful of emerging market economies have already issued a few bonds with elements of indexation. Making it happen, innovative financing for development, 79. The book draws on work commissioned by the recent chinese and.
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