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Venezuela | Debt Crisis | Default Looming

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Issue 34 | May 2016

Global Economics Monthly

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Venezuela’s Descent Into Crisis

Robert Kahn, Steven A. Tananbaum Senior Fellow for International Economics

Bottom Line: The crisis in Venezuela continues to escalate, with no recovery or relief in sight. A messy and chaotic default looms, and the rescue will likely involve a tough adjustment program, large-scale financing from international policymakers, and deep sacrifices from Venezuela’s creditors and, most of all, the Venezuelan people. China’s role, as Venezuela’s largest creditor, will be critical and precedential for other emerging market commodity exporters with too much debt.

The economic and political disintegration of Venezuela has reached a critical moment. Economic activity is falling sharply and the seeds of hyperinflation have been planted, a downward spiral reinforced by political paralysis, widespread electricity shortages, and a breakdown in social order. Reserves are falling sharply, driven by capital flight and a fiscal deficit that has swelled to over 20 percent of gross domestic product (GDP). Although the government has made enormous efforts to continue making debt payments, a default now appears likely sooner rather than later, and possibly even ahead of large debt service payments due this fall (see figure 1).

A great deal of uncertainty lies ahead, but four things can be said with some confidence, courtesy of Game of Thrones.

Winter Is Coming 

While the domestic economic and political crises have worsened, the Venezuelan government has made an impressive effort to delay default, running down reserves to $12.7 billion (not all usable) from nearly $20 billion a year ago, selling assets (often for pennies on face value), and running arrears to suppliers. In part, these actions may reflect the view that default could be politically devastating for a government already losing authority; in part, it is a gamble for resurrection should oil prices recover dramatically. But such delaying tactics come at a high cost: extending policies that are disruptive and clearly unsustainable are resulting in social and economic distress. The government has reaffirmed its commitment to pay but the numbers simply do not add up. As my son once told me, “Math is hard.” 

Many Venezuelan analysts still see room for a smooth transition away from the Maduro government, perhaps to one based on national unity, and for a recovery in the economy that might require some refinancing of the debt but not a default. Indeed, a recent investor survey by JPMorgan found more than 50 percent of investors expecting no restructuring and a continued muddling through this year; only 15 percent foresaw a disruptive default and deep haircut. I find such optimism misguided. Indeed, if the history of emerging market crises is a guide, the coming default—whether this year or next—will be chaotic and disruptive.

In October, the state-owned oil company PDVSA faces a $1.3 billion debt repayment (including $1 billion in principal). In November, additional interest payments totaling $2.9 billion are due (although some of this debt may already have been bought back by the government). Add in payments to China and arrears to suppliers, and a financing gap in excess of $20 billion is possible for this year. The outlook for 2017, when more large debt payments are due, is no better. The timing of default is difficult to predict, as the government will likely continue to seek delaying the inevitable. But economist Rudi Dornbusch’s injunction was never more relevant: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.” That’s exactly the Venezuelan story. It will take forever and then it will happen overnight.

Chaos Isn't a Pit. Chaos Is a Ladder.

The current government in Venezuela has signaled strongly that it is uninterested in working with international policymakers on a rescue program, and these policymakers have returned the favor. Absent a dramatic change in the political environment, there would need to be a change in government, and a green light from the United States, before officials from the International Monetary Fund (IMF) would board a plane to Caracas to begin negotiations on a rescue program. By then, the chaos could be severe. Read more »

 

Looking Ahead: Kahn's take on the news on the horizon

Puerto Rico

The Government Development Bank for Puerto Rico declared a moratorium on most of its $422 million debt payment, which was due on May 2. To date, the negotiation between Puerto Rico and creditors has made limited progress, while slow action from the U.S. Congress is delaying a comprehensive plan to restructure the island’s debt. The debt crisis could deepen as the next big payment of $2 billion comes due in July.

Saudi Arabia

The Saudi government unveiled its reform program Vision 2030, including partial privatization of the state oil company and restructuring of its sovereign wealth fund. Persistently low oil prices and widening fiscal deficit provide political momentum for reform, but political hurdles appear high.

Argentina

After fifteen year of isolation, Argentina returned to international capital market with its triumphant issuance of $16.5 billion in sovereign bonds. JPMorgan estimates that Argentina could issue $30 billion of debt this year, including instruments of provincial governments and the corporate sector. The country could return to growth (2.8 percent) in 2017.

 

FROM THE MACRO AND MARKETS BLOG

G20 Hopes for a Cure
 

Robert Kahn 

The communiqué of the G20 meeting of finance ministers and central bankers candidly acknowledges growing threats to the global economy, and signals a desire for stronger growth at a time when “downside risks and vulnerabilities have risen.” It is about as much as can be expected in the current environment—a commitment to stay the course, combined with a recognition of the risks and a promise to do more if needed. Read more »

 
Venezuela on the Edge
 

Robert Kahn 

A default of Venezuela's debt increasingly appears to be a question not of “if,” but “when.” For now, there is not much that international policymakers can do. The current government is unlikely to seek help from the international financial institutions or cooperate with Western governments. But when conditions warrant, international policymakers should move fast rather than let the crisis fester. Read more »

 
Economic Optimism in the State of the Union
 

Robert Kahn 

The central economic message from President Obama in his State of the Union (SOU) speech was that the U.S. economy was on a strong footing and well prepared to prosper in a dynamic and rapidly changing global environment. This is hardly a surprising message, but notable coming at a time when the 2016 presidential campaign is being driven by populist messages of economic decline and aversion to globalization. Read more »

 

ABOUT CGS

The Maurice R. Greenberg Center for Geoeconomic Studies (CGS) works to promote a better understanding among policymakers, scholars, journalists, and the public about how economic and political forces interact to influence world affairs.

 
Michael A. Levi
@levi_m
Director of the Maurice R. Greenberg Center for Geoeconomic Studies

Edward Alden
@edwardalden
Bernard L. Schwartz Senior Fellow

Thomas J. Bollyky
@TomBollyky
Senior Fellow for Global Health, Economics, and Development

Willem H. Buiter
Adjunct Senior Fellow

Blake Clayton
@bcclayton
Adjunct Fellow for Energy

Heidi Crebo-Rediker
@heidirediker
Senior Fellow

James P. Dougherty
Adjunct Senior Fellow for Business and Foreign Policy

Jennifer Harris
@jennifermharris
Senior Fellow

Miles Kahler
@MilesKahler
Senior Fellow for Global Governance
Robert Kahn
Steven A. Tananbaum Senior Fellow for International Economics

Sebastian Mallaby
Paul A. Volcker Senior Fellow for International Economics

Meghan L. O'Sullivan
Adjunct Senior Fellow

Peter R. Orszag
@porzsag
Adjunct Senior Fellow

Kenneth S. Rogoff
Senior Fellow for Economics

Varun Sivaram
@vsiv
Douglas Dillon Fellow

Matthew J. Slaughter
@MattJSlaughter
Adjunct Senior Fellow for Business and Globalization

A. Michael Spence
@amspence98
Distinguished Visiting Fellow

Benn Steil
@BennSteil
Senior Fellow and Director of International Economics
 
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