Ecuador's Brady Bond Default: Background and Implications

Ecuador faces its worst economic crisis since the 1930s, suffering from a deep recession, collapsed currency, and failing banking system. Together, these problems led to huge fiscal deficits and increased external borrowing. The fiscal shortfall took a dramatic turn on September 30, 1999 when Ecuador decided to default on its Brady bonds, effectively cutting off Ecuador from foreign financial resources. This proved to be a pivotal decision, contributing to the escalating social and political strife that resulted in the forced removal of a sitting president in January 2000. Brady bonds (named for former U.S. Treasury Secretary Nicholas F. Brady) were one answer to the lingering Latin American debt crisis. They combined partial debt forgiveness with a repackaging of the remaining debt into bonds that could then be traded on the securities markets. This met debtor country need for a reduction of debt and debt service, and the commercial banks' goal of removing this debt from their balance sheets without having to write off the entire amount. Ecuador currently has $6 billion of Brady debt in bonds with varying provisions, some collateralized with U.S. Treasury zero coupon bonds held in escrow. Citing its large budget deficit, Ecuador gave notice on August 26, 1999 that in an attempt to restructure its external debt, it would use the 30-day grace period provision in its Brady bond agreement to defer a $98 million payment that had come due. On September 30, 1999, Ecuador missed a $44.5 million interest payment on a portion of its Brady bonds. One month later, Ecuador defaulted on a $27 million Eurobond interest payment. The Brady bond default was a calculated move to pay off the non-collateralized debt, with the expectation that investors would be amenable to invoking the collateral clause on the discount bonds to cover the missed interest payment, thereby giving Ecuador more time to restructure its debt portfolio. With no viable plan to restructure its debt portfolio, investors voted instead to invoke the "acceleration" clause, requiring full payment of the Brady discount bonds. Ecuador has been unable to pay these bonds in full, leaving the two groups at an impasse. For Ecuador, defaulting on its Brady bonds worsened its financial crisis, causing creditors to shun requests for debt rescheduling. This has forced Ecuador into acute budget tightening, which may extend an already deep recession and exacerbate attendant social costs in this very poor country. New lending to Ecuador from either private or official lenders seems unlikely until an officially sanctioned structural adjustment plan is in place. Although Ecuador's Brady bond default is relatively small, it does have potentially broader implications for the precedent it set. The default effectively subordinated Brady debt to other international claims, raising questions in the international debt markets. In addition, Ecuador's inability to come to terms with either public or private international lenders escalated its financial hardship and the political and social turmoil that led to the ousting of a sitting president in January 2000. It is currently unclear how Ecuador will fare under a new administration that faces the same financial impasse and continuing deep economic problems.