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 »