1. Growth-indexed Bonds Advantages Avoid defaults and collateral damage Avoid defaults and collateral damage Avoid pro-cyclical fiscal policy Avoid pro-cyclical fiscal policy Promote international risk sharing Promote international risk sharing Eduardo Borensztein IMF, April 2003

2. Growth-indexed Bond—An Example Consider a floating-rate bond with a coupon rate equal to: Consider a floating-rate bond with a coupon rate equal to: with a minimum of zero. Suppose that in 1990: r* = 7 percent r* = 7 percent g* = average growth rate of previous 20 years g* = average growth rate of previous 20 years 50 percent of government debt is growth-indexed 50 percent of government debt is growth-indexed Define Fiscal saving = reduction in annual interest payments thanks to the growth-indexed bonds

3. Mexico

4. Argentina

5. Issues/Nonissues Too risky? Too risky? Already exposed to GDP. Less default risk Already exposed to GDP. Less default risk Too complicated? Too complicated? Growth is well-understood and followed Growth is well-understood and followed Misreporting of GDP data Misreporting of GDP data Incentives not strong. Could be audited Incentives not strong. Could be audited Moral Hazard Moral Hazard Political resistance to “pay insurance” Political resistance to “pay insurance”

6. Precedents Brady Value Recovery Rights (VRRs) Brady Value Recovery Rights (VRRs) GDP VRRs (Costa Rica, Bulgaria, Bosnia) GDP VRRs (Costa Rica, Bulgaria, Bosnia) Ciudad de Buenos Aires Ciudad de Buenos Aires Options on US economic statistics (Longitude-DB-GS) Options on US economic statistics (Longitude-DB-GS) Inflation-indexed bonds Inflation-indexed bonds

7. Which Contingent Bond? Room for various liquid contingent bonds? Room for various liquid contingent bonds? Commodity-linked Commodity-linked Good proxy? Good proxy? Not under control of the sovereign Not under control of the sovereign More market base, except for long maturities More market base, except for long maturities Domestic Currency Domestic Currency Different but correlated—could provide similar degree of insurance Different but correlated—could provide similar degree of insurance Growth-indexed domestic-currency debt Growth-indexed domestic-currency debt Risks of capital controls, manipulation Risks of capital controls, manipulation

8. How Will It Happen? History evolves randomly, eg, Banks vs Bonds in sovereign finance, inflation- indexed bonds History evolves randomly, eg, Banks vs Bonds in sovereign finance, inflation- indexed bonds Externalities and coordination problems, official intervention Externalities and coordination problems, official intervention Debt Restructuring: time for innovation? Debt Restructuring: time for innovation? Role for IFIs? Role for IFIs?