On the Potential of Sovereign State-Contingent Debt in Contributing to Better Public Debt Management and Enhancing Sustainability Outcomes (2024)

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Abstract

Sovereign state-contingent instruments (SCDIs) have been suggested as complements or alternatives to traditional sovereign debt instruments for a long time, but with little uptake. Markets for SCDIs have suffered from low liquidity and issues around measurement. This article argues that the escalating climate and ecological crises provide a strong rationale to reconsider the use of sovereign SCDIs as the physical and transition impacts of climate change and environmental degradation are increasingly altering the risk profile of sovereigns. The use of risk-linked sovereign instruments such as cat bonds or resilience bonds and embedding disaster risk clauses in sovereign debt contracts would be an important way for governments, especially in highly climate-vulnerable countries, to mitigate climate risks and scale up investment in resilience. Moreover, instruments such as sustainability-linked bonds that incentivise sustainability-oriented policies and investments could help to bring about better sustainability outcomes and contribute to greater debt sustainability. SCDIs can also play an important role in facilitating debt restructurings. The international community, supported by key institutions like the IMF and the major multilateral development banks, should make a concerted effort to promote the widespread adoption of sovereign SCDIs to support better public debt management, the climate-proofing of public finances, and the achievement of more ambitious sustainability outcomes.

Keywords: sovereign debt; state-contingent debt; GDP-linked bonds; sustainability-linked bonds; debt restructurings

JEL Classification: F34; H63; Q54

Corresponding author: Ulrich Volz, SOAS, University of London, London, England; London School of Economics and Political Science, London, England; and German Institute of Development and Sustainability, Bonn, Germany, E-mail: uv1@soas.ac.uk

This article was written for a special issue of the Journal of Globalization and Development on Sovereign Debt and Development. I am grateful to Ugo Panizza and Andrea Presbitero for inviting me to contribute to the special issue and for very helpful comments received from Tito Cordella, Anna Gelpern, Ugo Panizza, Andrea Presbitero and Miranda Xafa during a workshop hosted by the Graduate Institute and Johns Hopkins University in May 2021. I am also grateful for feedback received from participants at the Asian Development Bank Institute workshop on ‘Effective Public Debt Management and Fiscal Sustainability in the Post-COVID-19 Era’ in March 2022 and two anonymous referees.

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Received: 2021-10-28

Accepted: 2022-12-02

Published Online: 2022-12-16

© 2022 Walter de Gruyter GmbH, Berlin/Boston

On the Potential of Sovereign State-Contingent Debt in Contributing to Better Public Debt Management and Enhancing Sustainability Outcomes (2024)

FAQs

On the Potential of Sovereign State-Contingent Debt in Contributing to Better Public Debt Management and Enhancing Sustainability Outcomes? ›

(2021: 6): “By tying the debt service payments of restructured debt contracts to future outcomes, SCDIs may help avoid protracted disputes about current valuations and facilitate quicker agreements between creditors and debtors, thus allowing countries to restore debt sustainability and facilitating their return to ...

What is the concept of debt sustainability? ›

A country's public debt is considered sustainable if the government is able to meet all its current and future payment obligations without exceptional financial assistance or going into default.

What is a state contingent debt instrument? ›

SCDIs at a Glance

SCDIs link a sovereign's debt service payments to its capacity to pay, where the latter is linked to real world variables or events. For example, instruments can be linked to a country's GDP, to commodity prices, or to natural disasters such as hurricanes or earthquakes.

What are international debt instruments? ›

They capture debt instruments designed to be traded in financial markets, such as treasury bills, commercial paper, negotiable certificates of deposit, bonds, debentures and asset-backed securities (including issues conventionally known as eurobonds and foreign bonds but excluding negotiable loans).

What is the problem with debt sustainability? ›

To evaluate the debt sustainability, past studies followed the traditional approach and utilized the popular Domar (1944) condition, which states that “as long as the real economic growth is greater than the real interest rate, the government can have a positive primary deficit such that its debt will not rise and so ...

Why is debt sustainability important? ›

The debt sustainability model is important in allowing lenders of funds to understand the risk profiles of the countries that they are lending to. By understanding the risks of such countries, the investors can better evaluate the returns they should expect or what their potential losses could be.

What is a contingent debt? ›

Contingent debt.

These are debts that you may owe in the future, but they depend on a certain event that has not yet happened. The most common example of a contingent debt is if you cosign someone else's loan. You only owe money if the other person defaults.

What does state contingent mean? ›

A state-contingent claim, or state claim, is a contract whose future payoffs depend on future states of the world. For example, suppose you can bet on the outcome of a coin toss. If you guess the outcome correctly, you will win one dollar, and otherwise you will lose one dollar.

What are sustainable debt instruments? ›

Sustainable debt instruments are the debt market's answer to the increased focus on ESG criteria, used either to fund ESG initiatives or to align with and incentivize corporate initiatives to perform against ESG key performance indicators.

Which debt fund gives the highest return? ›

Best Performing Debt Mutual Funds
Scheme NameExpense Ratio1Y Return
Nippon India Corporate Bond Fund #1 of 15 in Corporate Bond0.34%7.22% p.a.
Nippon India Money Market Fund #1 of 15 in Money Market0.24%7.65% p.a.
Mahindra Manulife Low Duration Fund #1 of 20 in Low Duration0.3%7.57% p.a.
7 more rows

What are the advantages and disadvantages of debt instruments? ›

The advantages of debt financing include lower interest rates, tax deductibility, and flexible repayment terms. The disadvantages of debt financing include the potential for personal liability, higher interest rates, and the need to collateralize the loan.

What is the main concept of sustainability? ›

In the broadest sense, sustainability refers to the ability to maintain or support a process continuously over time. In business and policy contexts, sustainability seeks to prevent the depletion of natural or physical resources, so that they will remain available for the long term.

What is an example of a sustainable debt? ›

The debtor company applies the debt proceeds for uses such as developing its own renewable energy, energy-efficient refrigeration systems, or electric vehicles. In this case, the debtor company typically engages third-party auditors to verify that the proceeds are used for the specified sustainability purposes.

What is the basic concepts of sustainability? ›

The term sustainability is broadly used to indicate programs, initiatives and actions aimed at the preservation of a particular resource. However, it actually refers to four distinct areas: human, social, economic and environmental – known as the four pillars of sustainability.

What are the concepts of sustainability? ›

Sustainability usually has three dimensions (or pillars): environmental, economic, and social. Many definitions emphasize the environmental dimension. This can include addressing key environmental problems, including climate change and biodiversity loss.

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