GDP-indexed bond

GDP-linked bond

In finance, a GDP-linked bond is a debt security in which the authorized issuer (a country) promises to pay a return, in addition to amortization, that varies with the behavior of Gross Domestic Product (GDP). In some sense, this type of security can be thought as a “stock on a country” in the sense that is has “equity-like” features. It pays more/less when the performance of the country is better/worse than expected. Nevertheless, it is substantially different to a stock because it there are no ownership-rights over the country.

GDP-linked bonds are a form of floating-rate bond with a coupon that is associated with the growth rate of a country, just as other floating-rate bonds are linked to interest rates, such as LIBOR or federal funds rate, or inflation rates, which is the case of inflation-indexed bonds.

Advantages for the issuer

Debt service varies with ability to pay, when a country has poor economic performance it has to pay less debt obligations to the bond holders. This means that this type of security has countercyclical features. The existence of this type of debt can reduce the probability of default because they tend to keep the debt/GDP ratios within a narrower range than fixed income bonds.

GDP-linked bonds also act as automatic stabilizers and reduce the temptation for policymakers to spend too much in periods of high growth. In this sense this type of bonds may be especially useful for developing countries where the presence of weaker institutions makes it easier for governants to implement more volatile of policies. Moreover, this type of bonds allow governments to implement less volatile tax policies, since there is no need to increase taxes during times of poor economic performance because it is precisely during these times when debt repayments are lower. If we believe that agents prefer to smooth consumption across time and across states of nature then it is worth it to do so. Hence using GDP-linked bonds may be welfare improving.

Furthermore, emerging markets are usually forced to actually undertake more austere measures in times of crises than their developed counterparts, and it is common to see that emerging markets reduce public expenditures in times of crises with the purpose of reassuring international investors. This means that countries cut their expenditures when they need it the most.

In terms of social policy it has been mentioned that GDP-linked bonds disproportionately benefit the poor because using them reduces the need to cut social benefits when economic performance is low, given that the debt repayments are lower.

Finally, even if this type of bonds were initially thought in the context of emerging markets, they also constitute an interesting idea for developed countries.


GDP-linked bonds may cause political economy problems, in good times countries have to pay more to their debt holders, so citizens can potentially complain arguing that the governors contracted debt to favor the lenders. Another reason to worry about the charasteristics of these bonds is that they may create perverse incentives (moral hazard) to misreport growth, not revise GDP figures or even worse to repress growth.

Another problem that this type of bond is facing with their implementation is that there is not a sufficient amount of first movers that are ready to issue and invest in this type of security. The market has not developed in part because there are few incentives to be the first to move. Being one of the initiators in this type of markets implies taking some risk and most of the agents are not willing to do it. A critical mass is required to reduce the risk to the issuer. Also, a greater amount of countries issuing these types of securities is required so that investors are able to diversify. Given this facts there is scope for public intervention, for example, an initiative from multilateral institutions could play the role of the first mover and coordinate issuances of GDP-linked bonds from different countries.

An additional critique that has been exposed is that there are other debt instruments that could be superior in the task of insuring risk for consumers. That is, for example, the case of CPI-indexed local currency bonds. Crises are generally accompanied by large exchange rate depreciations that are driven by the fall in domestic consumption. This fall in consumption decelerates the CPI growth and in turn bonds linked to it pay less during crisis. Given that economic agents are more interested in consumption smoothing than in the stabilization of output, CPI-indexed local currency bonds can provide a better insurance against shocks than GDP-linked bonds.

Historical background

Previous to the actual issuance of GDP -linked bonds, there were some financial innovations that lead to the appearance of bonds that had features related to the economic performance of the issuing country. Mexico issued several bonds indexed to oil prices during the 1970s and later on, in the early 1990s, Mexico, Nigeria, Uruguay and Venezuela issued some Brady bonds with Value Recovery Rights (VRR), that were structured to pay higher returns when the price of certain commodities was sufficiently high.

The first pure GDP-linked bonds were issued by Costa Rica, Bulgaria and Bosnia Herzegovina, also in the context of the Brady restructuring agreements, in the 1990s.

Finally, Argentina issued a GDP-linked bond in 2002, as part of a debt-restructuring of its 2001 default.

A simple example

Suppose a country has been growing in the last few years at an average rate of 3% and is expected to do so in the coming years. Suppose also that this country can issue debt using a fixed-income bond with a coupon of 7%. This country can issue a GDP-linked bond that pays 7% when output growth at the end of the year is exactly 3% and will pay more or less accordingly to its economic performance. That is, for example, if the country grows 1% instead of 3%, then the GDP-linked bond will pay a coupon of 1% instead of 3%. Conversely, if there is an unusually better economic performance and the country grows 5% instead of 3%, then the GDP-linked bond will pay a coupon of 9%.


Shiller method: The value of the instrument depends on the value of GDP

Borensztein and Mauro: The return varies with the growth rate of real GDP

See also


  1. Williamson, John. (2006). “Borrowing Strategy: The Role of GDP-Linked Bonds”. Peterson Institute for International Economics.
  2. Borensztein, Eduardo, and Paolo Mauro (2004). "The Case for GDP-indexed Bonds." Economic Policy 19 (38): 166-216.
  3. Acemoglu, Daron et al.(2003). "Institutional Causes, Macroeconomic Symptoms: Volatility, Crisis and Growth." Journal of Monetary Economics 50, p.49-123.
  4. Gavin Michael and Roberto Perotti. (1997). “Fiscal Policy in Latin America.” NBER Macroeconomics Annual, MIT Press, Cambridge, MA, 11-61.
  5. Griffith-Jones, Stephanie and Krishnan Sharma. (2006). “GDP-Indexed Bonds: Making It Happen”. United Nations Department of Economic and Social Affairs Working Paper No.21.
  6. David, Javier. (2011). “Worried About U.S. Debt? Shiller Pushes GDP-Linked Bonds.” The Wall Street Journal, February 17, 2011. http://blogs.wsj.com/economics/2011/02/17/worried-about-us-debt-shiller-pushes-gdp-linked-bonds
  7. Korinek, Anton. (2007). “Excessive Dollar Borrowing in Emerging Markets: Balance Sheet Effects and Macroeconomic Externalities”. University of Maryland, April.
  8. Caballero, Ricardo. (2002). “Coping with Chile’s external vulnerability: a financial problem”. Central Bank of Chile Working Papers No 154, May.
  9. Kopcke, Richard and Ralph Kimball. (1999). “Inflation-Indexed Bonds: The Dog That Didn’t Bark.” New England Economic Review, January, 3-24.
  10. Durdu, Ceyhun. (2009). “Quantitative Implications of Index Bonds in Small Open Economies”. Journal of Economic Dynamics and Control. Vol.33.
  11. Shiller, Robert (2005a). "In Favour of Growth-Linked Bonds." The Indian Express. March 10. Shiller, Robert (2005b). In Inge Kaul and Pedro Conceicao [eds]. The New Public Finance, Responding to Global Challenges. New York: Oxford University Press.
  12. Borensztein, Eduardo, and Paolo Mauro (2004). "The Case for GDP-indexed Bonds." Economic Policy 19 (38): 166-216.

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