October 24, 2014

VENEZUELA: Should Venezuela Default On Its Foreign Bonds?

Project Syndicate
written by Ricardo Hausmann and Miguel Angel Santos
September 5, 2014

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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