Many had tried but failed. Then Nicholas Brady devised a plan to help developing countries pay off their debt – a Brady bond came to the rescue. By Philip Alexander
At the end of the 1980s, Nicholas Brady came up with a plan to relieve defaulted developing country debt. In doing so, Brady – then US Treasury secretary under the incoming Bush administration – became, in many respects, the man who breathed real life into the concept of emerging market debt, laying the foundations for an enduring and not uncontroversial asset class that has since helped turn the fortunes of many developing countries.
He wasn’t the first to try. At the end of a period commonly known as the “lost decade” for Latin America – in which the region lurched from one debt crisis to the next – several attempts had already been made to hammer out market-based solutions to developing world debt problems.
In 1982, a mass default by many Latin American governments cut them off from much-needed bank lending. Three years later, James Baker, Brady’s predecessor, had himself tried to mobilize the vast savings in the Japanese economy to help bail out the bankrupt emerging market sovereigns. But the Baker Plan too had failed to reduce debt or allow the target countries to grow their way out of debt.
What was different about Brady’s idea was how its originator put to use his long experience in the banking sector itself, previously as chairman of Dillon Read. Brady proposed converting the loans that had been granted to defaulted sovereigns – and which, in turn, had burned holes in banks’ balance sheets – into bonds that could be traded, depending on each institution’s risk appetite.
The game continues
The Brady bonds, in effect, turned a stalemate into a liquid market. “Once markets are engaged, they stay interested. They’re institutionally engaged, it’s not as if we have to start all over again,” says David Mulford, US Ambassador to India and, at the time, the US Treasury’s assistant secretary for international affairs under Brady.
Of course, the innovation also made some creditors nervous, recalls Jerome Booth, head of research at leading emerging market investor Ashmore Investment Management, who worked as an economic consultant on developing countries when Brady’s proposal was unveiled in March 1989.
“There is always a lot of arm-twisting in any government debt restructuring. But at the end of the day, this was after 10 years of nothing working, and the Baker plan having failed,” he says.
Mexico became the first sovereign to exit default via the Brady Plan, in 1990, and its example encouraged a rash of other governments to follow. The plan even extended beyond Latin America, and took on unexpected political significance. Poland and Bulgaria participated, to clear an unsustainable debt burden that threatened to undermine their transition from communism to market economy.
Two further elements helped make the plan a success. First, the relatively short-term bank loans were exchanged mostly for 30-year bonds, removing each sovereign’s roll-over risk in the event of tighter liquidity at the banks themselves. Second, the launch of the new bonds was facilitated by the provision of zero-coupon 30-year US Treasuries as collateral for part of the principal, to ensure that the return demanded by investors would be affordable to the issuing governments. “The whole package was highly attractive to investors, as long as they were happy with the initial haircut,” says Booth.
New partners
In addition to establishing the emerging debt asset class, Brady helped entrench the role of the IMF, World Bank and regional development banks as advocates of economic reform. The IMF provided loans for some of the countries to buy the T-bond collateral, and accession to the plan involved a tacit agreement to abide by multilateral recommendations. Issuing bonds also created a sound market incentive to work with the international financial institutions, says Booth.
“It was very much a public-private partnership, where the governments agreed to get their act together and undertake structural reforms, that catalyzed multilateral assistance, and investors then saw improved creditworthiness and increased their private sector flows,” he says.
The IMF aspect to the deal was not set in stone, however. After Brady left office, the new US Treasury secretary Robert Rubin had become concerned about what he considered the multilateral’s unconstructive stance. At this point, the flexibility of the Brady Plan – where each country tailored its own arrangement with creditors – became a significant advantage.
When Brazil moved to issue Brady bonds in 1994, the IMF refused to back the country’s existing economic policies, and was therefore reluctant to fund the purchase of T-bond collateral. But Brazil already had enough reserves to buy its own collateral, says Gustavo Franco, who was at the time director of international affairs at the Banco Central do Brazil. “So we bought the collaterals sort of in disguise,” Franco tells Emerging Markets.
The IMF eventually became more supportive of Brazil’s policies, but the rise in private capital flows was not straightforward for any of the Brady Plan participants, Mulford notes. “It is an uneven development because markets have their ups and downs. But the events of the last 20 years or so in emerging markets have shown what can be accomplished when countries introduce genuine domestically generated and supported economic reforms that open markets for freer trade, investment and capital flows,” he tells Emerging Markets. A key architect of the plan, Mulford has, like Brady himself, moved between the official and private sectors, becoming chairman of Credit Suisse in 1993 after he left the Treasury.
Today, most of the original Brady bond issuers have redeemed the obligations early, aiming to unlock the underlying US Treasury collateral and issue fresh paper with lower servicing costs. Also, adds Booth, many of the first generation of investors who sank their money into EM external debt now regard it as rather staid, setting off in search of higher yields from local markets or new sovereign issuers.
It is a testimony to their steady progress that so many former Brady clients can now attract private capital without the need for US guarantees, and the man himself has said he is more than happy to see the bonds he invented gradually disappearing. After Brady left office, his attention shifted to opening another frontier of emerging market investment, with the creation of Darby Overseas Investments in 1994, which has pioneered private equity in developing countries.Among the countries that still have to repay their Brady bonds is the West African state of Cote d’Ivoire, in default since 2000. It is a sharp reminder that while Latin America, Asia and eastern Europe have graduated from collateralized debt to the mainstream Global and Eurobond markets, Africa has barely even begun to tap international capital. Is it time for a new-model Brady Plan for Africa?
“The term is a useful one to highlight the big-picture thinking of the past,” says Booth. “But it would take a very different form in the detail, and it would need to be led by the Africans.”