Brady Bonds for the 21st Century

By Ying Qian

Many developing countries continue to suffer from the impacts of debt distress that were exacerbated during the COVID-19 pandemic years. It is estimated that 61 emerging markets and developing economies (EMDEs) are in or at high risk of debt distress, and that more than $812 billion in debt needs to be restructured across all creditor classes in order to achieve debt sustainability.

Despite efforts by creditors and the international community, significant challenges remain for systematic and efficient resolution of distressed sovereign debt. Zambia’s recent announcement that its debt restructuring with Eurobond creditors cannot be implemented at this time signifies such challenges. High interest rates and growing investor risk aversion at present make the resolution of distressed debt and increased financing for sustainable development more challenging.

The conventional approaches of borrowing from the International Monetary Fund (IMF) or from private markets are now viewed as ad hoc initiatives that are too slow and that can be easily stalled due to various policy concerns or civil dissent.

As a result, more and more policymakers are looking to innovative financial arrangements and instruments to help break the trajectory of the debt crisis. This includes a renewed interest in the use of Brady bond transactions, first initiated during the Latin American debt crisis of the 1990s.

The basic principles of Brady bond transactions involve bank creditors granting debt relief in exchange for greater assurance of collectability in the form of principal and interest collaterals. The debt relief is then linked to some assurance of economic policy reforms, while the resulting debt from the new bonds is highly tradable, allowing creditors to diversify risk more widely throughout the financial and investment community.

Mexico was the first country to restructure its debt under the Brady Plan during the 1990s. Other countries soon followed, including Argentina, Brazil, Bulgaria, Costa Rica, Cote d’Ivoire, Dominican Republic, Ecuador, Jordan, Nigeria, Panama, Peru, the Philippines, Poland, Russia, Uruguay, Venezuela and Vietnam.

The Brady Plan facilitated a return from the rescheduling phase during the 1990s debt crisis to a more normalized phase with market-oriented relationships between developing countries and their creditors. In 2003, Mexico retired its Brady debt. The Philippines bought its Brady bonds back in 2007, joining Colombia, Brazil, Venezuela and Mexico in retiring their bonds.

Brady bonds fundamentally changed the landscape of sovereign finance in developing countries. Sovereign bonds, held by a diverse set of thousands of creditors, became the preferred financing instrument for countries after introduction of Brady bonds, replacing sovereign bank loans. Following the first Brady bond transactions in 1989, the issuing volume of sovereign bonds by developing countries increased from $1.5 billion in 1985 to more than $200 billion in 1992. The efficiency of the market, as measured by bid/ask spreads, fell by more than one-half in a few years.

Indeed, as I wrote in a September 2021 working paper published by the Boston University Global Development Policy Center, the principles and merits of the Brady-type restructurings are still valid for today’s market – and are gaining traction.

A December 2023 IMF working paper found that the Brady-like restructurings resulted in a sharp uptick in economic output and productivity growth after a substantial reduction in public and external debt burdens, propelled by a comparatively strong structural reform effort. Thus, the impact of the Brady Plan on overall debt burdens would be many times greater than the initial face value of the debt reduction, indicating the existence of a “Brady multiplier.”

The Brady-type restructurings can offer tailored solutions to meet domestic challenges. The main type of Brady bond is the collateralized fixed-rate par bond. This can be used by creditors who prefer not to take haircuts, as par bonds allow for the exchange of loans for bonds of equal face amount, with a fixed, below-market rate of interest, creating long-term debt service reduction and protection from fluctuations in interest rates. There were also collateralized floating-rate discount bonds to exchange for loans with a lesser face value in bonds (generally a 30 percent to 50 percent discount), allowing for immediate debt reduction, with a market-based floating rate of interest.

Furthermore, collateralization and guarantees were provided to both par and discount bonds, mainly by the IMF and other multilateral development banks (MDBs), with an extended 25- or 30-year maturity.

Many additional features can be included in Brady bonds, such as embedded call options, stepped coupons, recapture clauses and more, to best meet debtor countries’ repayment profiles and offer better risk management tools.

The indebted country’s government plays a key role in creating the type of transaction. They need to consider the feasibility of carrying out structural adjustment or policy reforms and negotiate with creditors collectively, while examining the net effect of Brady bond restructuring on their balance of payment (BOP) and general liquidity situation to ensure macro-economic stability.

It is important to note that Brady-style transactions alone cannot solve all existing challenges within the sovereign debt landscape, including those related to creditor coordination, domestic barriers to economic reforms and the increased prevalence of domestic debt, among others.

Today’s debt market for developing countries is much deeper and more diversified. Brady bond restructuring can be well designed and experimented within today’s market to help put debt-distressed countries back onto a sustainable path, while the specific bond structures and terms can help enhance credit ratings, reduce the cost of issuance and improve tradability. Additionally, variable interest payments can be linked to state-contingent instruments (SCIs) including prices of primary commodities,  in which many developing countries are dependent upon. The recent IMF Special Drawing Rights (SDR) allocation can be used as a credit enhancement for Brady-like transactions.

There are several features that distinguish the Brady bonds of today from those of the 1990s. To start, Brady-like bonds can be denominated in currencies beyond US dollar, such as the renminbi (RMB), as overdue loan repayments to Chinese creditors are soaring. Various forms and modifications of the original Brady bond model could  be used for restructuring loans held by Chinese lenders through Brady-like RMB bonds. A coordination mechanism, informally known as the “Shanghai Club,” could be established to facilitate the issuance of Brady-like RMB bonds, which, in addition to alleviating debt distress, could also lead to the establishment of off-shore RMB bond markets. There is also great potential to link Brady-like debt restructuring with green and inclusive bonds by adopting related international standards and by mobilizing grant funding through debt-for-climate swaps.

As the international community approaches critical moments for assessing progress towards the Paris Agreement climate targets and the United Nations 2023 Sustainable Development Goals, it is important for policymakers in developing countries and their development partners to seek out innovative approaches to resolve the ongoing debt crisis. Indeed, in order to look to a brighter, more fiscally stable future, they should seek inspiration from the Brady bond transactions of the recent past.

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