Saturday, November 22, 2014

Should Venezuela Default?

CAMBRIDGE – Will Venezuela default on its foreign bonds? Markets fear that it might. That is why Venezuelan bonds pay over 11 percentage points more than US Treasuries, which is 12 times more than Mexico, four times more than Nigeria, and double what Bolivia pays. Last May, when Venezuela made a $5 billion private placement of ten-year bonds with a 6% coupon, it effectively had to give a 40% discount, leaving it with barely $3 billion. The extra $2 billion that it will have to pay in ten years is the compensation that investors demand for the likelihood of default, in excess of the already hefty coupon.

Venezuela’s government needs to pay $5.2 billion in the first days of October. Will it? Does it have the cash on hand? Will it raise the money by hurriedly selling CITGO, now wholly owned by Venezuela’s state oil company, PDVSA?

A different question is whether Venezuela should pay. Granted, what governments should do and what they will do are not always independent questions, because people often do what they should. But “should” questions involve some kind of moral judgment that is not central to “will” questions, which makes them more complex. 

One point of view holds that if you can make good on your commitments, then that is what you should do. That is what most parents teach their children.

But the moral calculus becomes a bit more intricate when you cannot make good on all of your commitments and have to decide which to honor and which to avoid. To date, under former President Hugo Chávez and his successor, Nicolás Maduro, Venezuela has opted to service its foreign bonds, many of which are held by well-connected wealthy Venezuelans.

Yordano, a popular Venezuelan singer, probably would have a different set of priorities. He was diagnosed with cancer earlier this year and had to launch a social-media campaign to locate the drugs that his treatment required. Severe shortages of life-saving drugs in Venezuela are the result of the government’s default on a $3.5 billion bill for pharmaceutical imports.

A similar situation prevails throughout the rest of the economy. Payment arrears on food imports amount to $2.4 billion, leading to a substantial shortage of staple goods. In the automobile sector, the default exceeds $3 billion, leading to a collapse in transport services as a result of a lack of spare parts. Airline companies are owed $3.7 billion, causing many to suspend activities and overall service to fall by half.

In Venezuela, importers must wait six months after goods have cleared customs to buy previously authorized dollars. But the government has opted to default on these obligations, too, leaving importers with a lot of useless local currency. For a while, credit from foreign suppliers and headquarters made up for the lack of access to foreign currency; but, given mounting arrears and massive devaluations, credit has dried up.

The list of defaults goes on and on. Venezuela has defaulted on PDVSA’s suppliers, contractors, and joint-venture partners, causing oil exports to fall by 45% relative to 1997 and production to amount to about half what the 2005 plan had projected for 2012.

In addition, Venezuela’s central bank has defaulted on its obligation to maintain price stability by nearly quadrupling the money supply in 24 months, which has resulted in a 90% decline in the bolivar’s value on the black market and the world’s highest inflation rate. To add insult to injury, since May the central bank has defaulted on its obligation to publish inflation and other statistics.

Venezuela functions with four exchange rates, with the difference between the strongest and the weakest being a factor of 13. Unsurprisingly, currency arbitrage has propelled Venezuela to the top ranks of global corruption indicators.

All of this chaos is the consequence of a massive fiscal deficit that is being financed by out-of-control money creation, financial repression, and mounting defaults – despite a budget windfall from $100-a-barrel oil. Instead of fixing the problem, Maduro’s government has decided to complement ineffective exchange and price controls with measures like closing borders to stop smuggling and fingerprinting shoppers to prevent “hoarding.” This constitutes a default on Venezuelans’ most basic freedoms, which Bolivia, Ecuador, and Nicaragua – three ideologically kindred countries that have a single exchange rate and single-digit inflation – have managed to preserve.

So, should Venezuela default on its foreign bonds? If the authorities adopted common-sense policies and sought support from the International Monetary Fund and other multilateral lenders, as most troubled countries tend to do, they would rightly be told to default on the country’s debts. That way, the burden of adjustment would be shared with other creditors, as has occurred in Greece, and the economy would gain time to recover, particularly as investments in the world’s largest oil reserves began to bear fruit. Bondholders would be wise to exchange their current bonds for longer-dated instruments that would benefit from the upturn.

None of this will happen under Maduro’s government, which lacks the capacity, political capital, and will to move in this direction. But the fact that his administration has chosen to default on 30 million Venezuelans, rather than on Wall Street, is not a sign of its moral rectitude. It is a signal of its moral bankruptcy.

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    1. CommentedMadonnanın Zencisi

      If we gonna talk about morality, then can someone explain to me that why bondholders have to pay the cost of mismanagement of Chavez and Maduro. Venezuelans are what? They are the ones who back up then-Chavez now Maduro. Elections have consequences.

      Hair-cutting will help only those quasi-dictators not Venezuelans

    2. CommentedEduardo Benitez

      There is an industry which is not mentioned in the Hausmann/ Santos’ article i.e. Telecommunications / IT. How about the more than 3 USD billion repressed in Venezuela owed to Telefonica’s shareholders for unpaid annual dividends? (please note that this figure may be considerable higher). This is true also for other Telecom companies which invested in Venezuela or that have provided services in the country for years (satellite, DTH, ISPs, etc.). If you add that significant figures to the “internal” default, the situation is even more dramatic.

    3. CommentedDural Lexan

      President Nicolas Maduro will not default and will emerge victorious after the discovery that millions of tons of essential consumer products and millions of gallons of oil and gasoline were being smuggled out of the country to artificially destroy the economy. Who was behind this gigantic smuggling operation? The same who want Venezuela to default and invite economic collapse.

    4. CommentedAndres Hidalgo

      In 1998 Ecuador defaulted on its international debt, it was a logical decision vis a vis the internal caos, it later translated into a financial sector collapse with the consequential huge GDP decline. Ecuador lost its local currency, the government was overthrown.

    5. CommentedMario Saborio

      La inconmensurable capacidad sostenible de demolición económica y social demostrada hasta ahora, cada vez menos deja ver que estos conductores políticos sepan siquiera donde y como van a bajar ellos mismos del tren en estampida que han puesto en marcha.

    6. CommentedRoberto Garcia Prince

      The country could face a humanitarian crisis of unexpected proportions. In addition to debt service, Venezuela owes around $ 13 billion in imported goods, without considering the billions of dollars in debt due to expropriations, which obviously they won't pay, along with international lawsuits. So we are at the gates of an economic implosion with terrible consequences for the Venezuelan society.

    7. Portrait of Miguel Angel Santos

      CommentedMiguel Angel Santos

      Totally agree Douglas! The only way to keep on servicing debt would be to maintain the domestic chaos, given that credit from headquarters and int´l suppliers dried out. Analysts keep on insisting Venezuela has enough money not to default, but the truth is that a) it is not in international reserves (95% of the holdings are gold bars), b) it is not in the Fondo Estrategico (US$1.500 million is about one five of october`s debt service), and c) it is impossible to assess of the flow is enough because the Central Bank does not publish the balance of payments since IIIQ 2013. So how can they be so sure Venezuela`s got the money?
      Now, that does not mean default is imminent. Money can be raised by selling assets at a large discount (i.e. CITGO), issuing more private debt at 15% in US$, or cashing in future oil shipments to China. Is this any better?
      Analysts also point out that Venezuela has just a little problem with its relative prices, it is all a matter of inducing a large devaluation, in order to bring them to equilibrium levels (and keep on servicing debt). That would imply forcing a colossal contraction on internal demand, without any benefit (it is too late for Maduro to reinvent himself and change expectations) further than widening current account surplus to pay debt.

    8. Commenteddouglas ungredda

      The question reallly is can Maduro choose?
      Restructuring the economy imposes political costs so dire that Maduros government and its future is on the line.
      On the other hand, Venezuela's credit record has deteriorated to a point that contractors and suppliers won' t send anything unless its prepaid or against a L/C issued by a bona fide financial institutions.
      Assuming Venezuela is eventually brought to default on its foreign debt, thanks to ever diminishing oil production and fiscal income leakages and lax expenditure controls, the ensuing chaos in the domestic banking sector would prompt a IMF sponsored plan. Exchange controls would be eventually dismantled alongside a realistic equilibrium market exchange rate. Venezuela's GDP valued at today's US$ free market exchange rate shrinks down to Dominican Republic levels. Not a pretty picture!

    9. CommentedPer Kurowski

      Very good and brave article… but we should never forget that it takes two to tango so lets save some words for those immoral that lend to immoral government only because the risk-premiums are so juicy-right.

      We citizens, more than the credit ratings of sovereigns, we need markets to follow ethic and good governance ratings of sovereigns.

    10. CommentedMoises P Ramirez

      Thank you Ricardo and Miguel Angel!
      Your article addresses the economy not only as a technical problem, but also as a moral issue and that is not the usual economists discourse.
      To default poor citizens instead of rich ones is the mark of current chavo-madurista government. But, even worst than that, poor people in Venezuela truly believe it is the other way around...
      A decent government government shouldn't default on anybody. A decent government should replace the current one. And overseas decent governments shouldn't welcome representatives of a government such as the one described in your article.
      Capital flight such as the "Empresas de Maletín" have performed here in Venezuela, thanks to the four different exchange rates, should merit international prosecution as if they were narcos.

    11. CommentedNathan Weatherdon

      That's not really a fair argument.

      When a government is more beholden to Washington than its own citizens, as reflected through defaulting on its own citizens before it would default on debts owed to the US, a) you know that they are concerned about the impact of failures to repay on international markets, b) this stands testament to specifically the weight and ability of the US to screw with anyone who does not pay debts to US banks, and c) that a) and b) are such strong factors that even a socialist Venezuelan president would default on its own people before defaulting to the US.

      The moral bankruptcy is in the international system, not the decision to work within it.

      a) and b) are actually quite defensible in a number of respects. My point here is not to defend their good side. Some of the most effective wordsmiths and mind massagers are already highly active on that front.

      What I see here is that Venezuela is more accountable to Washington that its own citizens. I do not doubt that this makes a great many Venezuelans want to vomit all over the US flag then burn it. Hey, I'm not Venezuelan.

        CommentedIgnacio Alvarado

        Your argument is even more unfair. Venezuela is only accountable to Cuba but Castro is betraying the glorious bolivarian revolution when in alliance with the radical left, Iran and -believe it or not- Israel is contriving a devious plot to undermine the great Maduro. I hope this sounds to you as farfetched as saying that Venezuela fears Washington and the international system sounds to me.

        CommentedKevin Lim

        Clearly you did not read the article, or for that matter keep up with the news.

        The author writes "Venezuela has opted to service its foreign bonds, many of which are held by well-connected wealthy Venezuelans". And it is common knowledge that, whatever its other faults, one fault it conspicuously does NOT have is an inclination to kowtow to Washington. If anything, defiance of America is practically the ruling elite's raison d'etre.

    12. CommentedLorena T. Liendo Rey

      Mucho ha debido hacer Venezuela (y su gobierno) en los últimos años y meses, pero pareciera que la preferencia es seguir huyendo hacia adelante. Excelente reflexión, profesores. Gracias.

    13. CommentedGreg Keif

      Chavez wanted Venezuela to become Cuba. Looks like a job well done.

        CommentedMK Anon

        Cuba's health services are extremely good and drugs are available, despite embargo. Cuba also has no oil (or so little it doesn't matter) and the economic managment there si good, given the harsh circumstances: inflation is controlled (in both currencies), primary products are available for everyone, as well as housing, education and health services (unlike many "developped" countries ).
        I d prefer a million time to to live in Cuba than Venezuela.
        I hope Obama will stop the embargo and accept cuba in the OAS before he leaves office.. that would be totally justified, given the level of civil liberties other of his allies have.

        CommentedRodrigo Aguilera

        @Greg Kief
        At least in Cuba they don't murder you for a pack of gum. Anyway, the saddest part of this story is how a significant proportion of Latin American leftists continue to morally support this regime, as if being anti-US was enough to justify all the economic crimes it has committed to its own people. I'm a leftist and I find Chavismo appalling.