A way to address country indebtedness: GDP-linked sovereign bonds could be the smart way to go

More equity-like financing could be one way out of current record high levels of country indebtedness. GDP-linked sovereign bonds, for example, would tie the interest on government debt to an economic variable such as actual GDP growth.

Swiss Re makes this recommendation in a report setting out ways to strengthen financial market resilience. A country would pay higher interest to creditors when growth is higher, and correspondingly lower interest when growth slows. This would help prevent the government resorting to “pro-cyclical” fiscal policy that can otherwise exacerbate economic downturns (by cutting expenditure) and booms (by overspending). Hence, instead of more traditional borrowing, countries could develop GDP-linked sovereign bonds to fund infrastructure investments to improve their GDP growth trajectory, whilst contributing to improved debt sustainability. Looking ahead, model transactions by higher-rated advanced economies would be extremely useful to establish the new asset class.

The benefits

Equity-like financing such as GDP-linked sovereign bonds is a necessary counter-weight to traditional debt. Using these instruments, governments would then be able to focus on the factors promoting longer-term growth such as legislation on labour, education and tax.

For Emerging Market countries in particular, the public sector would have a stronger incentive to develop a more effective and efficient capital market, as well as to strengthen their institutional setup. A debt-to-GDP ratio of more than 90% can lead to a loss of confidence in a government’s ability to repay, thereby translating into higher borrowing costs that could add to a downward debt spiral. GDP-linked sovereign bonds, on the other hand, could provide governments with much more fiscal space, and could increase the sustainable debt ratios to 150–200% of GDP from the 90% threshold as noted by the Bank of England.

Supporting financial resilience

Re/insurance supports financial resilience by acting as a shock absorber and promoting growth through its core businesses. This is particularly important in a challenging and volatile macro-economic environment.

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