Restructuring Debt in the Dark

CAMBRIDGE – As the Annual Meetings of the International Monetary Fund and the World Bank begin in Washington, DC, one member country is conspicuously absent: Venezuela. Yet there is much to be discussed about the country’s finances. Indeed, a sovereign-debt crisis is inevitable.

All major sovereign-debt crises of the past – including in Mexico and Greece – have generated changes in the rules, jurisprudence, or strategies adopted by debtors, creditors, and international financial institutions. Most recently, Argentina’s 15-year legal battle with its creditors – in which holdouts did measurably better than creditors who had years earlier accepted a debt exchange – destabilized the international financial architecture and generated a new set of rules. Venezuela will be the first country to navigate the new rules; the country can ill afford to get it wrong.

Venezuela is in a severe crisis of its own making. The government used the period of high oil prices from 2004 to 2013 to quintuple its external debt, expropriate significant chunks of the economy, and impose draconian price, labor, and currency controls. As the price of oil collapsed in 2014, the government, having lost access to capital markets because of its profligacy, chose to continue servicing its bonded debt and default on its obligations to importers and most non-financial creditors.

The government also eschewed both advice and financing from the IMF, instead balancing its foreign-exchange flows by mandating the biggest import contraction in Latin America’s history. This caused output to plummet over 30% (owing to the cut in imported inputs), triggered 700% inflation, and led quickly to widespread shortages of essentials. Among other things, this unprecedented skewing of priorities led to a collapse in oil production, because the national oil company PDVSA failed to maintain its productive infrastructure and defaulted on payments to key contractors in order to pay its bondholders – thereby killing the goose that laid the golden eggs.