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Growth-indexed Bonds Advantages • Help avoid defaults and collateral damage • Avoid pro-cyclical fiscal policy • Promote international risk sharing Eduardo Borensztein IMF, January 2004 Precedents (Ideas) • Debt crisis of 1980s: Krugman (1988), Froot, Scharfstein and Stein (1989). Index to exogenous indicator (export prices) to maximize investment • Shiller (1992) securities. Perpetual GDP-indexed claims for international risk diversification • More recently: Caballero (2001,2003): debt indexed to indicators correlated to business cycle (“copper bonds” for Chilean public and private debt). Hausmann’s original sin. Growth-indexed Bond—An Example Consider a floating-rate bond with a coupon rate equal to: Coupont r * gt g * with a minimum of zero. Suppose that in 1990, for Mexico and Argentina: • r* = 7 percent • g* = average growth rate of previous 20 years • 50 percent of government debt is growth-indexed Mexico Coupon Rates Ave rage : 5.9% 10 8 6 4 2 0 1991 1993 1995 1997 1999 2001 FIscal Savings as % of GDP Average: 0.2 2 1.5 1 0.5 0 -0.5 -1 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Argentina Coupon Rates Ave rage : 8.8% 20 15 10 5 0 1991 1993 1995 1997 1999 2001 Fiscal Savings as % of GDP Average: 0.4 4 3 2 1 0 -1 -2 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Issues/Nonissues • Too risky? • • Too complicated? • • Already exposed to GDP. Less default risk Growth is well-understood and followed Misreporting of GDP data • Incentives not strong. Could be audited and penalties set for delays or revisions Argentina. Growth and EMBI Spread, 1993-2002 1993 Inverse of Spread 1997 2000 1998 1994 1999 1996 1995 2001 2002 -15.0 -10.0 -5.0 0.0 GDP Growth 5.0 10.0 Issues/Nonissues (cont.) • Fixed income investors do not want an equity-like instrument • Specification could include a minimum assured coupon • Moral hazard • Political resistance to pay insurance in good times Two Specifications of GrowthIndexed Bonds 14.0 12.0 "Symmetric" bond (c*=7%, g*=3%) Coupon 10.0 8.0 "Growth upside" bond (c*=5%, g*=2%) 6.0 4.0 2.0 0.0 -7.0 -6.0 -5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 Growth Rate 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 Precedents • • • • • Brady Bonds Value Recovery Rights (VRRs) GDP VRRs (Costa Rica, Bulgaria, Bosnia) Ciudad de Buenos Aires Options on US economic statistics (Longitude-DB-GS) Inflation-indexed bonds Which Instrument? • • Different risks, different contingencies. Is there room for several different liquid markets for the same country? Commodity-linked • • • • Good proxy for growth and tax revenues? Not under control of the sovereign Already some market base exists, but only at short maturities Domestic Currency Debt • • • Correlated with growth—also provides same type of insurance. Could correlation change if debt is denominated in domestic currency? Growth-indexed domestic-currency debt Risks of capital controls, exchange rate manipulation How Will It Happen? • • • • Financial innovation is somewhat random, eg, Banks vs Bonds in sovereign finance, inflation-indexed bonds Externalities and coordination problems. Official intervention Debt Restructuring: time for innovation? First mover problem? Groucho Marx problem? Introduction of Inflation Indexed Securities by Sovereigns Australia Canada Finland France Greece Iceland Ireland Italy New Zealand Norway UK USA Period of Issue 1985-1988 19931991194519981997- Average CPI Inflation Rate in Three Years Prior to Introduction (in percent) 8.4 3.8 4.6 n.a. 1.7 7.6 195519831983 3/ 1977-1984 199419821975- 5/ 19811997- 4.3 18.6 18.5 14.2 1.4 9.8 10.7 13.2 2.8 Indexed Public Debt Outstanding in 1999 in Percent of Total Govt in million US$ Debt ----27,860 29.5 6,636 1.5 0.7 0.0 3,994 0.6 197 0.2 494 2/ 260 0 n.a. 361 30 --55,288 57,014 11.5 2/ 1.1 0.0 n.a. 2.3 0.1 --12.0 0.8 Sources: Campbell and Shiller (1996), Kopcke and Kimball (1999), Price (1997); Deacon, M. and A. Derry (1998), official web sites of country authorities, and IMF desks. 1/ January 2003. 2/ February 2003. 3/ Only one issue of inflation-indexed bonds. 4/ From April 2000 5/ Index-linked national savings certificates. Introduction of Inflation Indexed Securities by Sovereigns Argentina Brazil Chile Colombia Czech Republic Hungary India Israel Mexico Poland Turkey Period of Issue 1972-1989 19641956196719971995n.a. 195519891992-2000 1994- Average CPI Inflation Rate in Three Years Prior to Introduction (in percent) 18.6 n.a. 39.6 13.7 9.3 23.2 n.a. 32.7 110.7 292.2 80.8 Indexed Public Debt Outstanding in 1999 in Percent of Total Govt in million US$ Debt 0 0.0 45,291 19.6 14,960 62.0 4,949 1/ 150 394 166 79,037 2,528 13.2 1/ 1.7 3.0 0.2 80.2 8.4 0 4/ 8,561 0.0 4/ 24.3 Sources: Campbell and Shiller (1996), Kopcke and Kimball (1999), Price (1997); Deacon, M. and A. Derry (1998), official web sites of country authorities, and IMF desks. 1/ January 2003. 2/ February 2003. 3/ Only one issue of inflation-indexed bonds. 4/ From April 2000 5/ Index-linked national savings certificates.