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Venezuela Refuses to Default. Few People Seem to Understand Why.

Its been almost two years now since the renowned Harvard economist Ricardo Hausmann caused a stir in his native Venezuela by posing an uncomfortable question.

Why does a country thats so starved for cash keep honoring its foreign debts? In other words, how does it justify shelling out precious hard currency to wealthy bondholders in New York when it cant pay for basic food and medicine imports desperately needed by millions of impoverished citizens? I find the moral choice odd, Hausmann concluded.

Nicolas Maduro
Photographer: Carlos Becerra/Bloomberg

He was, predictably, skewered by the administration back in Caracas — President Nicolas Maduro labeled him a financial hitman and an outlaw on national television — but today the question feels more urgent than ever. Prices for oil, Venezuelas lifeblood, have fallen almost by half since Hausmann first spoke out and the countrys cash squeeze has deepened dramatically. The chaos has reached unprecedented levels — food rationing, looting, mob lynchings, collapsing medical care — yet through it all, bond traders have received every dime they were owed, billions and billions of dollars in all.

There are two worlds, said Francisco Ghersi, a managing director of Knossos Asset Management in Caracas. The world of the bondholders and the world of whats happening in Venezuela.

The 21st century has produced a slew of government defaults across the globe, from Argentina to Ecuador to Ukraine. In almost every instance, the country in crisis hit the default button long before the situation got as ugly as it has in Venezuela. The only similar case that economists point to is Zimbabwe back in the early 2000s. But even that comparison is flawed, says American University professor Arturo Porzecanski, because Venezuela was significantly wealthier than Zimbabwe before crisis struck and so the South American countrys collapse has been of a much greater magnitude.

For a QuickTake explainer on Venezuelas economy, click here.

What makes this pay-the-debt-at-any-cost approach all the more curious is that it comes in a country run by self-proclaimed socialists who have railed for the better part of two decades against foreign capitalist powers. There are endless theories, spawned in part by Hausmanns public pronouncement, as to why the Maduro administration has stuck so doggedly to this policy. The main ones fall into three rough categories.

Food Riots

The first of them is an argument thats been floated publicly by high-ranking government officials themselves. It states that Venezuela can wait it out till oil prices rebound. Why rock the boat, the thinking goes, if salvation is potentially just weeks away? (Prices have been rallying of late, climbing to near $50 a barrel.)

A worker walks through a looted store in San Felix.
Photographer: Wilfredo Riera/Bloomberg

The next argument is something of a conspiracy theory born in part out of the opaque nature of the countrys finances. It posits that close associates of the administration are major holders of the countrys bonds and that the government fears itd lose their much-needed support if the payments stopped coming in. Efforts to obtain comment from government press officials on this and other aspects of the story were unsuccessful.

The third theory, and its one that ties back into the first idea, states that even though Venezuela lost access to international capital markets a long time ago, a default could still deepen the governments cash squeeze by triggering legal action from creditors that would undermine the countrys ability to export. If fewer petro-dollars flow into the country, the savings from the default could be washed away, making the situation on the ground even worse.

Its frankly hard to imagine what a further deterioration would look like. After shrinking an estimated 7.5 percent in 2015, the economy is forecast to post an even bigger contraction this year. Food shortages are now so acute, and lines outside stores so long, that spontaneous protests are popping up everywhere. In one episode in the 500-year-old coastal city of Cumana, hundreds were arrested and a middle-aged man was shot to death, one of three fatalities at food-related demonstrations in June alone. There have been so many vigilante justice-style lynchings — more than 70 in the first four months of this year — that the supreme court has banned Venezuelans from sharing video recordings of the gruesome events on social media.

Defaults Benefits

To Hausmann and to legal experts who have studied the countrys oil operations, the risk of angry creditors blocking exports after a default is actually small. The way that PDVSA, as the state oil company is known, structured sales contracts makes it difficult for them to be interrupted by a legal challenge, according to Francesca Odell, a partner at Cleary Gottlieb in New York. What Hausmann and others see instead from a default is the opportunity to free up a big chunk of cash that could be re-directed toward imports.

The government is due to make $1.5 billion in foreign debt payments in the second half of this year. Include PDVSAs tab and the figure swells to $5.8 billion. Its a staggering sum of money in a nation that has bled its hard currency reserves down to just $12 billion. And while few, if any, bondholders would embrace a default, they certainly wouldnt be caught off-guard by it. For the better part of the past 18 months, the governments benchmark bonds have been trading under 50 cents on the dollar, a price that in essence signals to a debtor: Were prepared for a restructuring, go ahead and do it if you must.

Its fairly shocking that they have decided to service the debt over all else, said Risa Grais-Targow, an analyst at Eurasia Group in Washington. But I do think the commitment is fairly strong.

Protesters push a police line during demonstrations in Caracas, on June 7, 2016.
Photographer: Carlos Becerra/Bloomberg

Maduro, the man handpicked by the late Hugo Chavez to succeed him, has spoken frequently about his determination to keep paying the debt. In a speech back in May he proudly explained how the country had doled out $36 billion to creditors — a huge amount of money — over the previous 20 months. The payments were made, he went on to say, with dignity, without accepting preconditions from anyone, maintaining the countrys independence despite the pain. These are references to multilateral lenders like the International Monetary Fund and World Bank, institutions that are despised by the Latin American left.

As long as Maduro continues to pay, there will be investors willing to own the debt. Venezuelas bonds are among the highest-paying investments in emerging markets, offering today an average yield of 26 percent. Thats in dollars — in a world where many developed-nation bonds are yielding close to zero (or even less). And since Chavez swept into office 17 years ago, the countrys bonds have handed investors a total return of 517 percent.

It is one of the most miserable, mismanaged, hopeless countries on the planet, said Jan Dehn, head of research at Ashmore Group Plc, which manages $50 billion of emerging-market assets. But that doesnt mean you cant make money.

Hausmann, meanwhile, is more incensed than ever.

In a recent interview, he called the governments insistence on paying the debt, coupled with a churchs claim that it rejected offers of international aid, a crime against humanity. Theres a history here, it should be noted, between the professor and the Chavistas. Some two decades ago, he served in the business-friendly government that Chavez tried to overthrow in a coup attempt that effectively launched his political career. Perhaps that explains some of the enmity between the two sides. Regardless, this is what Hausmann wants to ask the folks on the other side: How can they sleep at night? Its beyond belief.

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