Brady’s Gift to The Emerging World

Many of us are familiar with the Brady Plan.  The idea was to convert loans owed by Latin American countries to major banks into bonds.  This would removed those loans from the banks book and start facilitating a working out process.  (Yes another banking crisis).  Well I was working around with debt issuance data and noticed that if you look at the outstanding bond debt of the emerging world it looks like the Brady plan not only help provide a means to work out the banks debt but also brought the developing world forward in terms of their access to markets, in that the amount of subsequent debt they were able to issue was larger than one would have excepted given the previous growth trend.  This makes sense to a degree in that once you have a certain amount of bonds you will achieved initial velocity…meaning their is likely someone is analysing it, likely a two way market for the debt and the infrastructure is there to facility the demand, so you – as a creditor – are now enabled to borrow more.  Another possible reason would be that the issues were big enough to deploy meaningful amounts of capital and thus attracted institutional investors.  Another plausible explanation would be that the Brady debt allowed developing countries to prove their creditability and thus gain acceptance to the bond markets.  This seems to jive with the fact that debt didn’t grow much during 91/92 (although it was positive) after the Brady jump in ‘90 (they worked off the old crisis), but then grows rapidly after ‘93. 

Let me explain the chart.  The blue line is the actual level of outstanding developing market debt; the red line is the level of debt before the Brady plan year grown by the historical growth rate (it eventually passes the blue line but that is not the point, of course growth will slow as the level gets higher…); the point is that the developing bond market got a jump start from the Brady issuance and thus became a market much faster than it would have otherwise.  If we say that 200 billion is the measure of a true market then it got their in ~94 but wouldn’t have gotten their until ~99 without Brady. 

Is this good or bad?  This is a cursory observations and not a vigorous analysis so who knows but it raises some interesting questions.  It seems good in the sense that capital could be deployed and that credit became more liquid but where these countries ready for capital markets (yes they were having petrol dollar sent their way via the banks before this) but did they have the financial system infrastructure to handle more capital inflows?  Did these markets encourage greater economic problems down the road?  Likely a mix of both and – depending on the country – I suspect a different answer would emerge but I think it is interesting to see how the Brady plan jump started the developing world debt markets.

Lack of Ability or Lack of Willingness?

Ecuador defaulted on its external government debt on December 15th.  It was decried by Curtis Mewbourne of Pimco as an unusually occurrence of default based on lack of willingness rather than lack of ability because the bill was a 30 million dollar coupon payment and the country has 5 billion in reserves.  Now he may be right but I’d like to consider why his presentation is too simplistic.  He suggests that the perceived cost of a default (loss of access to the market) had gone down because they had already lost access.  This is true but it is not clear to me that Ecuador had much market access to begin with and certainty wasn’t going to build the need credibility for future access through default. 

What about the existing debt stock?  From a quick scan on my Bloomberg I see about 6 billion in outstanding debt much of it due more than 10 years into the future.  From this perspective with billions in reserves the case for willingness over ability seems very plausible.  Curtis then goes on to talk about fx policy and the significance of the federal reserve swap lines to some emerging markets for $ debt and although I agree with him on that he moved on from the Ecuador story before it was over.  Ecuador is a dollarized country.  They have no local currency so the ~5 billion in reserve is not just to pay dollar debt and pay for import but also is the money need to be the lender of last resort in the banking system and a sharp decrease in the dollar reserves could ignite a run on the banks which would require those reserves. 

Ecuador may have look at the path of reserves and said to themselves, ‘we are going to default eventually because the deleveraging cycle is not going to turn around any time soon and thus our export value is not going to recover.  It would be better to default now (and dance with some rhetoric about the illegitimacy of the debt) and have some money to back the banking system than send out our remaining reserves igniting a banking system crisis and then have no dollars to fight it.’  So at least to me it is not clear at all that the Ecuadorian default was purely of the lack of willingness…but rather a future lack of ability.