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Should Bangladesh become the world's first issuer of GDP-linked bonds?
Bangladesh has an opportunity to set a new world record by becoming the first country in the world to issue a GDP growth-linked bond.
In a New York Times article on May 11, Nobel Prize winning economist Robert Shiller reiterated the case for bonds linked directly to the economy as “the next new thing in finance'.
As one of the early proponents of inflation-linked bonds (which in the US now attracts more than $ 1 trillion in investments), Shiller is no novice to innovation. His idea of governments issuing bonds with coupons linked directly to GDP performance is outlined in a joint paper with economists from the Bank of England and the International Monetary Fund. It has also received support from experts at the G20 and the European Commission.
Bangladesh - already home to world-leading innovations in inclusive credit and payments - is well-suited to be a pioneer in this instrument of macroeconomic management.
The fundamental economic story of Bangladesh is now well-accepted. Its demographic profile and trajectory of social progress (often through home-grown solutions) and an emphasis on digital infrastructure gives it the potential for sustaining one of the highest growth rates in the world for some years to come.
However, potential is not destiny.
One important factor is the management of monetary and financial policy. Finance is an octane that can turbo-charge a solid fundamental story. Conversely, like all forms of fuel, it has the power to devastate with the effect of a wildfire.
Credit and import growth can be positive if they are used to finance genuine investments and purchase of capital equipment which, in turn, enhances the potential for future growth. Credit and import growth can be negative if they are used to reschedule nonperforming loans, drive up asset bubbles or to pay for expenses that do not contribute to the productive capacity of the economy.
It is not sufficient to have a target for economic growth at, say, 8 percent without a parallel dashboard for growth in credit, nonperforming loans or drawdowns from foreign currency reserves. How high is too high?
As Bangladesh develops a diverse financial ecosystem, it will have to balance short-term and long-term considerations. Especially when it comes to market-based finance, several factors need to move in tandem: governance and accountability processes, transparent reporting, fair access and financial literacy -including the basic realisation that markets can go down as well as up.
Bangladesh does not need to repeat the mistakes of other countries. Two factors can enable finance to sabotage a positive economic story. First, finance is not the same as economics. Yet, finance ministries the world over are populated with macroeconomists who do not understand the subtleties of expectations management, liquidity linkages, timely communication or credibility spiralling. Famously, prior to the global financial crisis of2008, economists were forecasting the 'impending collapse of the dollar' (based on the size of US deficits) yet what materialised was dollar appreciation based on banking flows.
The second factor is politicisation of financial policy. Money is more valuable than random pieces of paper because of the promise of stability and fair play that underpins it. The right to print money is also the easiest to abuse because it is hard to detect in real-time, it generates feel-good emotions in the near-term and adverse consequences can be postponed to another day. Invariably, this ends with runaway inflation and/or a collapse in the foreign exchange value of the domestic currency. Even from the perspective of political expediency, there are less harmful ways of handling interest groups without destabilising the financial system.
So, why is Bangladesh well-suited to become the world's first issuer of GDP-linked bonds?
Firstly - and I cannot reiterate enough - the fundamental economic story is strong. I am sufficiently sold on the story to invest in an instrument that gives me a higher coupon based on higher growth, accepting the risk of a lower coupon in the event of lower growth.Secondly, widespread investment in this bond at a retail level -including members of the civil service and others currently invested in Sanchayapatra - would align incentives. More people will effectively share in a “bonus" if they contribute towards the growth rate sustaining at a high level.
Thirdly, by linking coupons to GDP performance (hence indirectly to tax revenue), the government will create fiscal space during cyclical downturns. Finally, if these are offered internationally in foreign currency denominations (perhaps starting with nonresident Bangladeshis), I'd expect significant demand for exposure to the Bangladesh growth story at a reasonable cost to the issuer.
Of course, implementing this is non-trivial and some issues need to be thought through. Should the government be the sole calculator of growth rate? Are there social and environmental side-effects from pursuing a GDP-based strategy? Should the coupons be linked to both GDP and inflation? Should these be listed on the stock market with the facility for secondary trading? What are the unintended consequences?
Even as we navigate these considerations, the idea is worth pursuing. If executed successfully, the celebratory and signalling effect of Bangladesh launching the world's first GDP-linked bond will be felt far and wide - certainly beyond just the world of finance
The author is a visiting professor-in-practice at the London School of Economics and a member of the World Economic Forum council on long-term investing.