Will Sri Lanka have gdp-linked bonds?

Negotiations to finally bring an end to Sri Lanka’s long-running $13bn debt default could result in an innovative new type of bond that would link payouts to economic growth and governance reforms, a long-held aim of emerging market bond investors.

The bankrupt south Asian nation and its creditors have agreed in principle to replace the debt, which it stopped paying in 2022 following a currency crisis, with so-called macro-linked bonds that would track the country’s recovery.

The inclusion of GDP-tied payouts into bonds that could be included in major indices is a big step forwards in trying to develop debt structures that will lure international investors back to riskier emerging market nations desperately in need of financing, say analysts…

In return for taking a roughly one-third haircut on their original debt, creditors have proposed a new $9bn bond with payments adjusted higher or lower in 2028 depending on the average US dollar GDP that Sri Lanka achieves. The country has put forward other ways of setting GDP-linked payments and is also assessing a creditor proposal for a separate governance-linked bond. This would cut coupon payments if the country raises tax revenue collection as a share of GDP and passes anti-corruption reforms.

As they emerge from defaults, countries such as Ukraine and Uruguay have handed out equity-like warrants, which promise extra money based on factors like movements in the price of commodities that the country produces or GDP, as a way of getting creditors to swallow debt losses.

Here is the full FT story by Joseph Cotterill, here is an earlier Alex post on Bob Shiller and related ideas.

Addendum: Brad Setser comments critically.