Brady Bonds and the Potential for Debt Restructuring in the Post-Pandemic Era

The COVID-19 pandemic has led to unprecedented global economic and human crisis, with many developing countries facing serious challenges in continuing to service ballooning levels of sovereign debt. Half of all low-income countries are either already in debt distress or at high risk. Against this backdrop, creditors and the international community have been contemplating various means for debt restructuring and relief in the post-pandemic era.

In a new working paper, Ying Qian reviews the historical context of the Brady bond – its transaction structure, value-added by respective partners, different variants of applications – and case studies, as well as a summary of results and implications for China’s bilateral loans. In the paper, Qian explains why Brady-bond-like transactions should be considered for today’s distressed debt restructuring, arguing that the general principles applied in the 1990s for Brady bonds, such as granting debt relief in exchange for greater assurance of collectability, linking debt relief to economic policy reforms and making resulting debt highly tradable, are still valid today.

The recent additional allocation of Special Drawing Rights at the International Monetary Fund (IMF), along with expanded lending and guarantee capabilities of the IMF and the World Bank are all favorable factors. State contingent debt instruments, such as commodity-linked bonds, which serve the needs of both debtors and creditors well, can also be introduced under the auspice of a Brady-bond-like restructuring. Lastly, Qian argues tapping into the available funding for green and climate change finance has great potential, but adds that policy and institutional development and project pipeline preparation needs to be done to attract investors.

Policy Recommendations:

• The general principles, such as debt relief in exchange for greater assurance of collectability, linking debt relief economic policy reforms and making resulting debt highly tradable, should still be applied in today’s market conditions.
  • However, there will not be a standard, quick and easy solution in most situations, careful case-by-case analysis and deliberation will be needed for deciding the best transaction structure.
  • Modifications may be necessary to meet debtor and creditor needs, including the guarantee mechanisms for both principal and interest and themes and terms of the bonds to be issued by the developing country.
• Using SCDIs, such as CLBs, in distressed debt resolution under the auspice of Brady-bond like transactions can be beneficial for both debtor and creditor when they have natural hedge positions. The timing of the post-pandemic era is ‘good,’ in that both parties are sufficiently incentivized given today’s market condition.
  • Green and climate bonds have great potential, as evidenced by existing swaps of distressed debt to green finance. But more work needs to be done to qualify bonds as green, or climate finance bonds by global certification bodies and to ensure tradability.
• Close coordination with the IMF, the World Bank and other development agencies, as well as international forums and groups, will be needed to structure sustainable and executable transactions for distressed debt resolution, while minimizing potential risks.
• Chinese creditors should not look at distressed debt resolution as a one-shot deal, but as an ongoing collaboration with partners to engage and work with debtor countries on broader policy and institutional development issues. Doing so would help debtor countries regain stable economic growth and become a contributing factor in the global drive for sustainable growth.

Qian explains the good news is that there will be strong willingness, available funding and institutional arrangements globally to tackle distressed debt situation in developing countries in the post-pandemic era. These include additional SDR allocations, expanded lending and guarantee facilities made available by the IMF, the World Bank, regional development banks and other multilateral and bilateral agencies. Though applying the Brady-bond-like transactions in today’s post-pandemic era may require modification and deviation from the original model, Qian argues they may be the most direct answer to today’s post-pandemic debt crisis.

Ying Qian is a freelance consultant and researcher. Prior to his retirement, he was with the Asian Development Bank and worked in countries and subregions of Central Asia, South Asia, Southeast and East Asia. As the Director of Public Management, Financial Sector and Regional Cooperation Division, he and his colleagues implemented programs and projects in areas of public finance, financial market development, trade and investment. Ying Qian also worked at the World Bank and the American Express Co. He holds a Ph.D. in Economics from Duke University and an undergraduate degree in Computer Science from Renmin University, China.