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Montag, 18. April 2016

LatAm in Focus Francisco Rodríguez +1 646 855 9689 Does Venezuela need to restructure its debt? Predictions about the likelihood of a Venezuela default appear to implicitly combine at least two very different scenarios1 .

LatAm in Focus Francisco Rodríguez +1 646 855 9689 Does Venezuela need to restructure its debt? Predictions about the likelihood of a Venezuela default appear to implicitly combine at least two very different scenarios1 . In the first, authorities maintain the current policy mix – overvalued official exchange rate, large deficit monetization, and sizable relative price distortions – and one tries to predict for how long they can continue to pay their debts. In the second, they eventually implement a package of macroeconomic adjustments and reforms, and one tries to predict whether a restructuring will be part of that package. Assessing the likelihood of default in the second scenario can appear closer to a normative than a positive question. The key question to us is whether a government that carries out the reforms necessary to restore macroeconomic sustainability and long-term growth should include debt restructuring in its policy mix. When there is a will but there is just no way… The first step in trying to answer this question is to assess whether Venezuela can pay its debt. If a country is fundamentally insolvent, then it should not try to continue paying a debt that cannot be paid. Rather, it should ask its creditors to accept the reality that this debt will not be paid and facilitate a transition to a lower yet sustainable debt level. At a fundamental level, we find the case for insolvency very hard to make. The Venezuelan sovereign owns the world’s largest oil reserves. If each of its 297bn barrels of oil were worth US $0.41, that would be enough to pay off its entire foreign debt. From a balance sheet perspective, the country’s assets clearly outweigh its liabilities. Venezuela has had difficulty in the past in extracting the oil rapidly enough to continue servicing its debt without sacrificing import levels. In a certain sense, this is a liquidity problem. It could in effect be characterized as a “political liquidity” problem: the country’s political system has failed to generate the necessary consensus to adopt the decisions that would allow it to take full advantage of its productive capacity. It is clear that one of the key economic policy priorities of an administration seeking to restore long-term growth would be to reframe the investment regime in the oil sector in a way that is consistent with generating a sizable increase in oil production. Many oil industry experts have argued that with the right policy and property rights framework, Venezuela should be able to raise production to 6mbd over a 5-10 year horizon. Even at current oil prices, the value of the incremental oil production would then be three times that of the annual service on Venezuela’s foreign currency bonds. It is difficult to argue that the country would have a solvency problem if it were implementing full-fledged policy reforms that include an opening up of the oil sector. Imperfect timing Increasing oil production will nevertheless take time, so the country may still have acute liquidity needs in the interim even if it implemented the above measures. Furthermore, oil prices are below their long-run equilibrium (according, say, to futures markets at a five-year horizon), adding to the temporary financing needs. So there would appear to be a good argument for extending current maturities to give time to carry out the reforms needed to raise production and growth. 1 Venezuelan bond and CDS prices currently price in a very high probability of default, as do many analysts. Our baseline view is that Venezuela will not see a credit event this year and is likely to change policies before a default becomes inevitable, yet it is an out of consensus view among analysts. See for example “Venezuela Credit Event is Inevitable, Roubini Glbal Says,” Bloomberg News, 2/25/16. Venezuelan authorities have repeatedly denied that they are considering a default or involuntary restructuring. GEMs Daily | 14 April 2016 3 But does this make a forcible restructuring necessary? Imagine that the Venezuelan government announced that it will unify and float the currency, eliminate price controls, raise gasoline and electricity prices to international levels, replace the system of indirect subsidies by a direct transfer program, open up the country’s oil and mining sectors, privatize unprofitable state-owned enterprises and bring fiscal and current account deficits to levels compatible with long-term sustainability. Assume also that markets view these policy commitments as credible – perhaps because they are being made by a new administration backed by a solid majority in the legislative branch and a strong electoral mandate. Would Venezuela regain market access if it did all these things? We believe the answer is an unequivocal yes. In fact, not lending to such a government would be a poor investment decision, given its credible commitment to policies that would help enable it to pay back creditors. But then there would be little reason to undertake a forcible debt restructuring, given that the liquidity gap could be filled by new issuance. A balancing act A decision to default has costs and benefits. The benefit is the savings in debt service payments; the losses are restricted access to credit for the sovereign and private sector. Yet Venezuela has already lost market access, as revealed by the prohibitive cost of financing of its current market yields. So it makes sense to pose the question: if it already has paid the cost, why not enjoy the benefits of a default? The problem that we view in this line of argument is that for Venezuela, the costs of default are likely to go well beyond the loss of access to credit. Venezuela is an atypical sovereign debtor in that the sovereign is at the same time, for all relevant purposes, the country’s sole exporter. The majority of Venezuela’s outstanding bonds are issued by PDVSA (the state-owned oil company), and a default would almost certainly generate attempts to seize the company’s external assets, including its 13 refineries and the receivables generated by its oil exports. This problem is rarely faced by sovereign debtors whose few external assets are typically covered by sovereign immunity. Whether Venezuela could successfully enact a forcible restructuring of its debt – if authorities were to decide to pursue that course – is an issue around which there is considerable legal uncertainty. The lack of collective-action clauses on PDVSA bonds allows even a small minority of bondholders to hold out against an exchange. Other changes in the terms of bonds could in principle be used to raise the incentive to accept an exchange, yet these alternatives remain legally contentious.2 A more aggressive option would be to strip PDVSA of its monopoly over the extraction and commercialization of Venezuelan oil, though it is hard to imagine that bondholders would not then go after the assets and flows of the new oil company. The path of forcible restructuring is paved with significant legal and operational uncertainties, generating a risk of potentially severely impairing the country’s capacity to generate export revenue. This risk appears to be the reason why the current administration has privileged debt service over many other commitments. In the absence of a fundamental solvency problem, it is unclear to us why the country should assume this avoidable risk. Will the IMF ask for a restructuring? A prominent argument for restructuring is that it will be a necessary condition for access to multilateral financing. Given estimated financing needs of $20-25bn this year 2 Exit-consent clauses could be used to change the non-material terms of the bonds to raise the incentive to accept an exchange offer. Such an avenue would remain legally contentious. Perhaps the most relevant non-material change would be a change of jurisdiction to Venezuelan law. However, PDVSA bonds contain a clause requiring unanimous consent for changes that impair the right of each holder to institute suit to enforce such payments (see, e.g., PDVSA 2017N prospectus, p.111), allowing bondholders to argue that a change of jurisdiction requires unanimous consent. This clause was not present in the Ecuador Brady bonds, a prominent example for the successful use of the exit consent strategy. 4 GEMs Daily | 14 April 2016 alone, Venezuela would have strong reasons to ask for IMF support of its macroeconomic adjustment program. Yet the IMF could balk at committing a large level of resources without requesting bondholders to do the same. We believe this argument is wrong. It is a mischaracterization of the IMF approach to claim that it requires debt restructuring to fund an IMF program. In the Fund’s words, “in most Fund-supported programs, a combination of policy adjustment and financing from the Fund catalyzes spontaneous external financing… As a consequence, the member is able to continue to service its debt in accordance with its original terms.”3 Even countries receiving large levels of financial assistance from the IMF are not necessarily required to undertake a debt restructuring. Of the 27 cases in which the IMF disbursed loans to in excess of 5% of recipient GDP in the 2002-15 period, 20 did not undertake a restructuring of their external sovereign obligations (Table 1). The IMF requires a restructuring only when it determines that the country’s debt is unsustainably high and restoring sustainability requires bringing the debt stock down to manageable levels. As we have shown elsewhere (Recovery matters), Venezuela’s debt stock is well within conventional sustainability thresholds calculated using standard IMF assumptions.

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