State-Contingent Debt Instruments for Sovereigns

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The case for sovereign state-contingent debt instruments (SCDIs) as a countercyclical and risk-sharing tool has been around for some time and remains appealing; but take-up has been limited.
Earlier staff work had advocated the use of growth-indexed bonds in emerging markets and contingent financial instruments in low-income countries.
Staff analyzed the conceptual and practical issues SCDIs raise with a view to accelerate the development of self-sustaining markets in these instruments.
The analysis has benefited from broad consultations with both private market participants and policymakers.

By linking debt service to a measure of the sovereign’s capacity to pay, SCDIs can increase fiscal space, and thus allow greater policy flexibility in bad times.
SCDIs can broaden the sovereign’s investor base.
SCDIs can open opportunities for risk diversification for investors.
SCDIs can enhance the resilience of the international financial system.
Should SCDI issuance rise to account for a large share of public debt, it could also significantly reduce the incidence and cost of sovereign debt crises.

A high novelty and liquidity premium demanded by investors in the early stage of market development.
Adverse selection and moral hazard risks.
Undesirable pricing effects on conventional debt.
Pro-cyclical investor demand.
Migration of excessive risk to the private sector.
Adverse political economy incentives.

Title: State-Contingent Debt Instruments for Sovereigns
Date: May 22, 2017
Subjects: Bonds, Financial instruments, Fiscal policy, Fiscal risk, Investment, Risk management, Sovereign debt

State-Contingent Debt Instruments for Sovereigns (May 22, 2017)