Traditional sovereign debt has been used for a long time. The benefit of accessing to these international markets is that the country can smooth national consumption over time. The main disadvantage is that repayment is a rigid commitment; hence countries face difficulties to honor the debt service when an adverse event occurs. That is, countries, especially developing ones, can hardly avoid the pain of pro-cyclical adjustment.
Since the external debt crisis of the 1980s and more recently, the great financial crisis of 2008-09, there has been some attempts to link the obligation to pay to an indicator of the ability to pay. The handful of cases that exist are mostly part of restructuring packages negotiated in the aftermath of defaults, such as the prominent GDP-indexed bonds of Argentina and Greece. It is argued that these instruments substantially reduce the risk of defaults.
This paper describes these instruments to understand how they work, what is needed for their success and what are their advantages and disadvantages.