27/12/2016

Why Venezuela Should Default - The New York Times

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The Opinion Pages

OP-ED CONTRIBUTOR

Why Venezuela Should Default

By JOE KOGAN DEC. 21, 2016

New York Guess which country has recently shown the greatest willingness to
weather hardship in order to pay its foreign bondholders? Paradoxically, its 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 countrys 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, Venezuelas 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.

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Why Venezuela Should Default - The New York Times

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 ships 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 Argentinas 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.

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Why Venezuela Should Default - The New York Times

Considering Venezuelas 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 governments 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
Venezuelas 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 Venezuelas remaining assets.

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Why Venezuela Should Default - The New York Times

Joe Kogan is the co-head of Latin America Strategy at Scotiabank in New York.
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