The Brady bond is an instrument issued by emerging countries to restructure their debt with foreign commercial banks. In this way, governments are able to repay the loans received more easily over long periods, for example, thirty years.
These bonds were born as part of the Brady Plan, proposed in 1989 by Nicholas Brady, the US Secretary of the Treasury at the time. His project sought to avoid a massive cessation of payments to North American financial entities.
Creation of the Brady bond
The creation of the Brady bond occurred in the context of the Latin American debt crisis. This episode, which began in the early 1980s, was characterized by the inability of the governments of countries such as Brazil, Argentina and Mexico to deal with their external credit.
The Latin American debt crisis was caused by the fall in raw materials. Thus, the incomes of developing countries that depended mainly on the sale of their natural resources fell.
In sum, the decline in raw materials put nations that had contracted large loans between 1960 and 1970 in trouble. In those boom decades, many emerging economies acquired financing to invest, for example, in infrastructure projects.
Brady bonus features
Among the characteristics of the Brady bond are:
- It had the support of the International Monetary Fund (IMF) and the World Bank.
- To accept the Brady bond as a means of payment, debtor countries were required to follow the guidelines of the Washington Consensus. This involved macroeconomic stabilization, trade liberalization, facilitating investment, and reducing the size of the state through privatization.
- From the above, we can conclude that the bonds were only part of a plan that required economic reforms to ensure the payment of the foreign debt in the future.
- Maturities are long. They can reach up to thirty years.
Mexico was the first country to join the Brady Plan. With the agreement, he was able to extend the payment of US $ 42 million for almost thirty years. As a condition, the Aztec nation deposited US $ 3,500 million as collateral in the Federal Reserve System (FED), the equivalent of 18 months of interest generated by the bond. These papers were paid off in 2003, as the loan was prepaid.
In addition to Mexico, other countries that followed the Brady Plan were Costa Rica, Venezuela, Uruguay, Argentina or Peru. They were even issued by some nations outside of Latin America, in Asia, Africa and Eastern Europe.
Brady bond types
Among the types of Brady bonds, the following stand out:
- Bond at par: Bank debt is exchanged, in its entire nominal value, for fixed income bonds, establishing an interest rate below the market. In addition, the debtor country must offer a guarantee equivalent to between 12 and 18 months of accrued interest. Such collateral is generally deposited into a cash account at the FED from where it is usually invested in US Treasury bonds.
- Bond below par: The issue or trading price of the paper is less than its nominal value. The guarantees are the same as in the previous case. However, in this opportunity, the loan is exchanged for a bond with floating coupons and not with a fixed return.
- New money bonds: They are generally variable income, short-term and unsecured.
- Front-loading reduced interest bonds (FLIRB): The country's bank debt is exchanged for medium-term bonds.An interest rate is agreed that is initially below the market, but then increases during an agreed period. After that period of time, a floating interest rate works.
- C Bonds or capitalization of default interest: Interest is calculated not only on the principal of the loan, but also on a part of the interest generated in previous periods. That is, a compound interest rate is used. This methodology was followed by Brazil, Argentina and Ecuador.
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