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Rich countries may take lead in recession-proof debt project
[LONDON] Some of the world's most advanced economies may club together to sell growth-linked bonds, creating a market that could help avert future debt crises, sources familiar with discussions among Group of 20 policymakers told Reuters.
Countries like Britain and Germany could breathe life into an academic theory intended to offer poorer, emerging economies some respite if they fall on hard times.
Growth-linked bonds allow a government's debt repayments to fluctuate during economic cycles - meaning it pays less if its revenues are hit by recession.
The only existing such bonds - sold by Argentina, Greece and most recently Ukraine - emerged from debt restructurings, as a way of coaxing creditors to accept writedowns. That has created a stigma which has put off other investors and borrowers alike.
But one source familiar with discussions between Group of 20 finance ministers and central bankers said developed countries are being urged to take the lead in creating a market for growth-linked bonds that will help improve their image.
A second source said, "It is clear that emerging markets, at least absent leadership from elsewhere, are not going to be first movers here ... there could be a case for collective action."
The G20 discussions were at "early stages", he said.
The Bank of England has been pushing the idea in recent years. It has published numerous papers, organised workshops and steered a market group to develop a legal framework or "term sheet", which is being tested with investors by the capital markets association ICMA.
Term sheets create a market standard, contributing to the widespread use of new instruments.
Sources said the Bank of England has also helped get growth-linked debt on the G20's agenda. At a meeting of finance chiefs in July, the G20 called for further analysis of "state contingent debts, including GDP-linked bonds" and asked the International Monetary Fund to report on the subject in 2017.
For countries vulnerable to macroeconomic shock, the appeal of growth-linked debt is obvious. Most recently in early 2015, Greece proposed swapping debt held by its euro zone creditors for growth-linked bonds to help it break a vicious debt spiral.
But they can be a hard sell. Fund managers say they might struggle to match the returns on growth-linked bonds to the demands of their clients, who are used to the fixed-rate interest offered on most bonds.
The bonds also depend on economic data, which investors may or may not trust. Argentina, for example, spent years dodging payouts on its inflation-linked debt after reporting consumer prices that differed wildly from private estimates.
But Ali Abbas, who works in the debt policy division at the IMF, said the initial investor feedback on its review of growth-linked bonds had been promising.
"While noting the complexity of state-contingent instruments, some investors do appear to have interest in the idea of GDP-linked bonds and similar instruments, particularly because investors are looking for higher returns in an environment of record-low bond yields," he said.
The IMF aims to complete the review early next year, in time for the G20's spring meeting, Abbas said.
Starla Griffin, a lawyer who worked with the Bank of England on the term sheet, said the issue of data integrity meant the first country to sell a GDP-linked bond must have a strong credit rating and be respected by investors. "What this initiative is trying to do is to really try to get away from the stigma and show that in fact it is only the most credible issuers that can issue one of these," Mr Griffin said. "The ideal situation would be to have the US, Britain and Germany issue and then a couple of emerging markets like Turkey and Mexico to create a basket." Those that are best-placed to issue, though, may have little incentive to do so.
Germany, the eurozone's strongest economy, which takes over the presidency of the G20 next year, can raise long-term debt at negative yields, meaning investors effectively pay to lend to the government.
With its ageing population and commitment to balancing its budget, Berlin has in recent years taken a frugal attitude towards borrowing.
But in a sign even the most cautious of borrowers might be open to growth-linked debt, Germany's central bank governor, Jens Weidmann, said in June that while many questions still need answering, growth-linked bonds are "an avenue worth exploring".
And advanced economies may have some incentives. In Britain, for instance, monetary policy appears to be reaching its limits and the government is weighing fiscal stimulus to counter the effects of its vote to leave the European Union. But its high level of debt give it little room to act.
"The extra fiscal space that such GDP-linked bonds offer in the event of a downturn could be especially useful today, given the constraints of operating near the effective lower bound to policy interest rates," the Bank of England said in a paper last month.