Over the past 15 years, the International Monetary Fund (IMF) has investigated many ways to tackle government debt crises. First it proposed a global bankruptcy court called the ‘sovereign debt restructuring mechanism’, which failed to get off the ground. Then it helped strengthen collective action clauses (CACs) to give governments more power when negotiating with holdout creditors.
Its latest line of investigation is a suite of bonds designed to stop sovereigns needing CACs or a bankruptcy court in the first place. State-contingent debt, as it has become known, promotes greater risk sharing between the issuer and investors. A good example is growth-linked bonds, which see the coupon and principal repayment grow and shrink in line with the issuing country’s gross domestic product (GDP).
Studies by central banks and think tanks show that GDP-linked bonds could substantially improve sovereign debt sustainability. They moderate government spending by reducing payments in tough times and curbing excess in good times. This makes them particularly well suited to emerging markets with volatile GDPs and those without strong budgeting experience. But they could also help reduce some European governments’ worryingly high debt-to-GDP levels; according to Statista, last year Italy’s stood at 133%, Portugal’s at 128% and Belgium’s at 107%. The oft-cited recommended limit for developed countries is 60%.
As a way to stop governments falling into debt crises, GDP-linked bonds are perfect – in theory. Unfortunately, there are many issues that make them equally impossible in practice, most of which relate to getting investors on board.
But for the IMF and central banks looking into GDP-linked bonds, it is worth persevering. Making changes to sovereign debt on an international scale is never easy, but as the revamped CACs show, it can be done. GDP-linked bonds are a bold proposition, but also a vital one in the IMF’s pursuit of global financial stability.
