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The New York Times: Why Venezuela Should Default

22kogan1-inyt-master768A sample bank note with the face of Venezuela’s President Maduro and the word “devaluated” is seen at a market in Caracas. Credit Jorge Silva/Reuters

New York — Guess which country has recently shown the greatest willingness to weather hardship in order to pay its foreign bondholders? Paradoxically, it’s the country that has been among the most vocal in its anticapitalist rhetoric. Venezuela continues to pay despite an economic crisis that would have stymied other sovereign borrowers long ago. Riots prompted by a shortage of cash are just the latest example of the country’s economic crisis. Although reallocating funds from debt service to the importation of much-needed food and medicine is tempting, the government fears that subsequent lawsuits could actually leave less money for imports.

These fears are overstated. Venezuela already faces the typical costs of sovereign default, such as the loss of access to international credit markets and a decline in foreign direct investment, even though it remains up to date on its debt service. With default seemingly inevitable, the country must eventually confront any other consequences, which are unlikely to include the dreaded seizure of Venezuelan oil tankers at sea. Meanwhile, postponing default is costly to the economy and unfair to long-term creditors.

The government has gone to extraordinary lengths to avoid default. For example, in order to secure a two-year reprieve on the repayment of $2.8 billion in bonds, Venezuela’s state-owned oil company PDVSA agreed to repay an additional 20 percent of that amount and also pledged as collateral half of Citgo, the American oil refinery whose value far exceeds the amount of debt refinanced. Similarly, in order to fend off a $769 million lawsuit by the Canadian mining company Gold Reserve over an expropriation, the Venezuelan government will not only honor the full claim, but also grant Gold Reserve the rights to 45 percent of a new mining company, essentially paying twice.

Some stakeholders argue, perhaps self-servingly, that the government should continue to resort to extraordinary measures to meet its international obligations. The government could sell its vast oil reserves, for example, as they are the largest in the world.

Such measures are typically justified by portraying the legal consequences of a default with a parade of horribles. Consider what happened to Congo. The hedge fund Kensington, a subsidiary of the distressed debt investor Elliott Management, purchased defaulted Congolese debt for cents on the dollar in the late 1990s. In 2005, Kensington managed to intercept the Nordic Hawk, a tanker ship carrying $39 million in oil, and proved to a British judge that the oil originated in Congo, despite elaborate efforts by Congolese government officials to disguise the source of the ship’s cargo.

Venezuelan oil exports, which are an order of magnitude larger than those from Congo, cannot be immediately seized. Instead, a legal cat-and-mouse game would ensue upon default. If creditors try to confiscate tankers of oil, Venezuela will ensure that, contractually, that oil is the property of the buyer before it leaves Venezuela. If creditors go after the money paid for that oil, Venezuela will reroute that money through China to evade them. Venezuela could also sell more oil through joint ventures and to China to further complicate matters for plaintiffs.

Litigation would surely take a long time. Congo defaulted on its external debt in 1985, but did not reach a settlement with Kensington until 2008. Similarly, Argentina managed to evade creditors like Elliott Management for over a decade before ultimately reaching an agreement to pay only 75 percent of the amount owed. Judge Thomas P. Griesa, the United States District Court judge handling the case, frustrated by Argentina’s decade-long intransigence despite a strong economic recovery post-default, ultimately forced Argentina to pay, but also quickly extricated himself from the case once Argentina had made a reasonable offer.

Considering Venezuela’s dire economic situation, a United States court is unlikely to grant any immediate preliminary relief to hedge funds ahead of a lengthy proceeding on the merits. In the meantime, Venezuela would save around $10 billion in annual debt service, an amount sufficient to restock empty supermarket shelves by funding an estimated 50 percent increase in imports. By alleviating shortages, these funds would give the current government, or a future government, some breathing room to enact economic reforms that would spur growth and assure long-term viability, reforms that have so far proved politically elusive. Venezuela may eventually have to pay what it owes, but that will be easier than overpaying now.

Whatever the consequences of default, they can only be postponed, not avoided. Central Bank reserves are dwindling, oil production is falling, and the economy faces recession and hyperinflation. Many bonds can be purchased for only 40 cents on the dollar because the market believes default is just a matter of time.

Despite the government’s extraordinary efforts, creditors are actually not being treated fairly. While short-term creditors are paid in full, long-term creditors may not be paid at all. Every time the country pledges assets as collateral or sells the rights to natural resources, it subordinates and dilutes the claims of typically unsecured long-term creditors. Now is the worst time to sell Venezuela’s natural resources, considering the uncertain political and economic environment.

The pension funds and other institutional investors that loaned Venezuela money over the past decade deserve to be repaid. Nevertheless, Venezuela does not need to take its assets to the pawnshop. Most investors would be happy to postpone debt service payments in return for a credible commitment to economic reforms, like exchange rate unification; default, or the threat of default, would discourage any holdouts.

Once the country stabilizes, the government can offer a restructuring that includes a maturity extension and deferral of interest payments in return for warrants that pay when oil prices rise, allowing bondholders to share in the upside. Incentives for litigation for hedge funds would be few if the restructuring were fair. Both the country and its creditors would be better off in this scenario than in a continued fire sale of Venezuela’s remaining assets.

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