Beyond Conventional Sovereign Debt Instruments: Issuance of GDP-linked Bonds in OECD Countries?

Abstract

Debt-to-GDP measures in major OECD countries are at historical highs and a considerable part of sovereign debt needs to be refinanced soon, while projections of real GDP growth are fairly weak and uncertain and assessed sovereign credit quality has declined. Against this, the OECD Committee on Financial Markets discussed proposals for sovereign debt managers to consider issuing GDP-linked sovereign bonds. The Committee considered proposals timely and the idea conceptually attractive, as additional insurance against economic downturns over the medium term would be available. It identified however also a number of issues that would complicate issuance in practise. Questions arise in particular as regards investor demand for such instruments and how an additional novelty, liquidity and indexation premium would compare to a potentially reduced default premium on more traditional debt. Debt management offices confirm and stress such practical difficulties and remain sceptical, quoting a lack of sustainable demand for such bonds. As a result, issuance of such bonds would be too costly. It is not clear however whether debt management offices take into account the full macroeconomic and financial stability risk-return trade-off that a broader perspective would take into account. Proposals for issuance of sovereign GDP-linked bonds among advanced economies, which had received increased attention after the German G20-presidency included the topic in the G20 finance track, may have lost some momentum, but there continues to be considerable support from both academics and practitioners.