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Normandin Beaudry

Bonds linked to the revenues of the Canadian economy


There, in black and white

Bulletin NB Vol. 11 N. 10, September 2008

In connection with its Pension Papers Program, the C.D. Howe Institute recently published a document proposing the introduction of a bond that would allow investors to participate in Canada's economic growth. These securities could be a viable alternative to real return bonds and an attractive long-term source of return for pension funds.

The C.D. Howe Institute, backed by an advisory panel made up of important players from the Canadian pension industry, is proposing the introduction of a new debt security, the "Trill." Similar to an equity stake in a corporation, this security would offer investors an equity stake in the Canadian economy. The Trill would pay a fraction of the revenues generated by Canada, i.e. the gross domestic product (GDP). The Trill is so named because the GDP's value stands at around $1 trillion.

A GDP-linked bond is not an entirely new concept; however, this simple and direct structure has yet to be adopted. Argentina, Bulgaria, Bosnia, Costa Rica and Singapore all borrowed on terms indirectly tied to their GDP growth. For example, the clauses specifying a bond's coupon payment rate were based on predetermined levels of the borrowing country's GDP. No developed country in a strong financial position has ever issued bonds of this type


The Trill would be issued by the Government of Canada and its maturity date would be long-term or perhaps perpetual. It would pay an annual coupon on a fixed date and would be traded on financial markets. The coupon paid would vary with GDP growth. Because the GDP is expressed in current dollars, income would be protected from inflation. In addition, this security would offer income growth opportunities tied to the creation of the nation's wealth, in comparison with real return bonds that simply offer inflation protection.

Benefits for pension funds

Through their long-term cash flows and inflation protection, Trills would meet the needs of many pension funds seeking to better match their revenues with their obligations to pensioners.

Trills would also provide an additional source of diversification. There is currently no financial instrument on the market that allows investors to participate in the growth of Canada's standard of living, for which wages, salaries and other compensation earned by Canadians account for two thirds of revenues. Trills would thus bring additional diversification to investors' portfolios. Pension funds could certainly benefit from having a portion of their investment income tied to labour cost growth.

Based on modelling of historic GDP data, the authors of this study, Mr. Kamstra and Mr. Shiller, estimate the historic return for these securities to be 2% higher annually than that of long-term bonds for the last 50 years.

Benefits for the Canadian government

The government would find great benefits from issuing GDP-linked bonds. This form of debt would provide a less expensive source of funds during economic slowdowns, when tax revenues tend to decline. However, during periods of strong economic growth, higher payments would be met by rising tax revenues. Greater budgetary stability would ensue. In addition, according to the authors of the study, the cost of this type of debt is low, and presents certain savings with respect to funding from existing bond programs.

From the Canadian government's standpoint, some issues may still be raised for consideration. The government has enjoyed a budgetary surplus for the last few years, is in debt buyback mode and does not have a great need for long-term bonds. In regards to managing its financing needs, the government's primary goal is to fund itself at the lowest possible cost. In contrast, a secondary goal is to maintain capital market liquidity and foster its smooth operation by allowing access to sizable issues. Because its funding requirements are declining, it would be surprising to see Ottawa decrease its nominal bond borrowings at once, thereby lowering the market's liquidity level, to create a new bond category. The real return bond program experience provides a good case in point.

In spite of these issues, the Canadian government should give careful consideration to and respond to the C.D. Howe Institute's very attractive proposal on the basis of the benefits that these securities would offer investors, particularly pension funds, and the government itself.

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