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The Economist: How long can Venezuela avoid default?

South America’s insolvent left-wing champion has been the star of sovereign-bond markets

THE mere mention of Venezuela should make most investors shudder. Its president, Nicolás Maduro, says that capitalism has “destroyed the planet” and vows to build a socialist Utopia. The country’s economic output has shrunk by more than a third since 2014, and it is suffering from dire shortages of food and medicine.

Nonetheless, one class of Venezuelan assets has delivered returns in recent years that would leave any investor licking his chops: bonds issued by the government and by PDVSA, the state oil company. Since January 2015 they have risen in value by nearly 60%, while every coupon has been paid at sky-high interest rates. “There has never been a bondholder’s better friend than Venezuela,” says Ray Zucaro of RVX Asset Management, a Florida-based investment firm.

The spectacle of foreign creditors growing fat off Venezuelan debt while the country’s people go hungry—on average, respondents to a recent survey said their weight had fallen by 9kg (20lbs) during the past year—should eventually prove both politically untenable and financially unsustainable. Mr Maduro’s government is indeed teetering ever closer to the brink of default. On October 27th PDVSA said it had made an $842m principal payment. However, investors did not start to receive the money until November 1st, and intermediaries handling the transaction told clients to expect a transfer on November 2nd—four days after the due date. Nomura, an investment bank, calls the episode a “near miss”. Another instalment, worth $1.2bn, was also due on November 2nd. To fulfil these obligations, Venezuela has delayed more than $700m of other payments, making use of a 30-day grace period.

As the insolvent government shuffles money from one pocket to another to stave off bankruptcy, investors expect the worst. The pricing of Venezuelan credit-default swaps corresponds to a 75% likelihood of some form of default within the next 12 months, and a 99% chance during the next five years. However, the markets have long underestimated Mr Maduro’s commitment to paying up: in March 2015 they put the odds of a default in the following year at 60%. And the same factors that have enabled Venezuela to stay afloat so far could help it to hang on for far longer than markets think is possible.

It is a testament to the magnitude of mismanagement in Venezuela that a country with more oil reserves than Saudi Arabia has reached such dire straits. During the presidency of Hugo Chávez, which began in 1999, the government systematically dismantled the private sector. He expropriated thousands of businesses, established byzantine controls on consumer prices and foreign exchange, let cronies loot the public purse and turned PDVSA, once a cash cow, into a make-work scheme. When he died in 2013 high petroleum prices still covered up the economy’s rotting foundations. But the oil boom ended the following year, leaving Mr Maduro, a former bus driver whose main qualification for office was his loyalty to Chávez, to run a country in economic free-fall. Mr Maduro doubled down on Chávez’s policies, turning a grim situation into a humanitarian crisis.

To finance the government’s domestic bills, Mr Maduro has revved up the printing presses, setting off a bout of hyperinflation. Venezuela’s foreign creditors, however, require payment in hard currency. As the country’s export revenues collapsed from $98bn in 2012 to a mere $29bn this year, the government has let the brunt of the adjustment fall on imports—even of necessities such as bread and toilet paper.

Venezuela’s surprising rectitude as a debtor stems from an unlikely confluence of factors. No democratic government could ever plunge its people into penury and hope to stay in power. Mr Maduro, however, has dispensed with any pretence of legitimacy: in August he installed a “constituent assembly” as a sham parliament to replace the opposition-controlled national assembly. His security forces have responded harshly to street protests: according to the UN, they have killed at least 46 people in 2017. In general, cash-strapped countries turn to the International Monetary Fund for loans during financial crises. However, Chávez froze Venezuela’s relationship with the Fundin 2007, and it would presumably require Mr Maduro to institute sane policies in exchange for its assistance.

Given the president’s leftism, his most ideologically consistent option would be to stop paying, as Argentina did in 2001. Unlike Argentina, however, Venezuela is a petro-state, with valuable assets abroad. PDVSA owns Citgo, an American refiner, as well as tankers that dock at foreign ports. If Venezuela defaults, international creditors will try to seize those assets. That in turn could bring PDVSA’s operations—and by extension whatever remains of the Venezuelan economy—to a halt.

Even though Mr Maduro appears dead-set on avoiding default, he is still struggling to cobble together enough hard currency. The biggest reason the government has stayed current so far is largesse from foreign patrons. During the past decade China has lent Venezuela more than $50bn, and accepts repayment in oil. Russia has also made a series of emergency loans to PDVSA, often just before sovereign-bond payments were due. In April Rosneft, an oil company whose majority owner is the Russian government, lent PDVSA $1bn. In return, according to an investigation by Reuters, a news agency, it has been offered partial-ownership of as many as nine Venezuelan oil projects.

What can’t go on

How long can Venezuela continue to make good on its obligations? On one hand, the country appears to be running out of financial wriggle room. Its foreign-currency reserves have dwindled from a high of $43bn in 2008 to just $10bn now, much of it in the form of solid gold ingots. By next year, they are expected to fall to just $2.4bn.

Moreover, the logistics of payment are growing increasingly difficult. As Mr Maduro has pushed the country into overt dictatorship, the United States has responded with sanctions. American entities are banned from doing business with dozens of senior government figures, including the president, vice-president, attorney-general and economy minister. They are also prohibited from dealing in new bond issues by Venezuela and PDVSA. Both measures appear to have spooked compliance officers in international banks, the more cautious of whom are advising against all dealings with Venezuela.

Nonetheless, if Venezuela had to live within its domestic means, it would have gone bust already. The recent recovery in oil prices, which now exceed $50 a barrel, could delay the government’s day of reckoning. And if Venezuela does fall behind on payments, its creditors may prove surprisingly flexible. Seeking redress from a Venezuelan default would be extraordinarily complicated. The complex ownership structure of PDVSA, a sprawling conglomerate, is likely to cause long legal battles over which assets belong to which entities. And because PDVSA has become indistinguishable from the Venezuelan state, even small holders of its bonds—which lack “collective-action clauses” that prevent individual creditors from holding the majority to ransom—might be able to press cross-claims against the government.

In Argentina’s case, litigious bondholders managed to block Argentina’s payments on its restructured debt nine years after those bonds were issued. With that experience fresh in mind, many creditors may prefer to cut Venezuela some slack and continue to collect what they can.

Even if bondholders do play tough, Venezuela’s allies could come to its rescue. According to Monica de Bolle of the Peterson Institute, a think-tank in Washington, both China and Russia “want to string this along”. The cost of maintaining Venezuela’s debt performance is trivial relative to the size of those governments’ budgets. In exchange they both gain a lasting foothold in a country with vast energy reserves, and get to vex Donald Trump by propping up an anti-American regime just 1,300 miles from the mainland United States.

That geopolitical equation might change if Mr Maduro were toppled. But bets on his ousting have so far proven just as fruitless as bets on default. His constituent assembly may draft a new constitution that will secure him in power. And the opposition, a fragile coalition of parties united only in their determination to defeat him, began to fracture visibly last month, following a rout in elections for state governorships (which appear to have been partly rigged by the government). Two of its best-known leaders, Henry Ramos Allup and Henrique Capriles, exchanged insults during consecutive press conferences.

Mr Zucaro predicts that the opposition’s “cannibalistic” tendency will keep Mr Maduro in office, and that investments in the black sheep of sovereign-debt markets will continue to pay off. He declares: “I don’t think the party is over yet.”

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