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Harvard economist says Venezuela default is inevitable

Harvard economist says Venezuela default is inevitable

Posted by Dubraswka Aguilar on October 14, 2014

Venezuela will probably default on its foreign debt as a shortage of dollars makes it impossible for the government to meet its citizens’ basic needs, Harvard University economists Carmen Reinhart and Kenneth Rogoff said.

The economy is so badly managed that per-capita gross domestic product is 2 percent below 1970 levels, the professors wrote in an column published by Project Syndicate yesterday. A decade of currency controls has made dollars scarce in the country with the world’s biggest oil reserves, causing shortages of everything from deodorant to airplane tickets.

“They have extensive domestic defaults and an economy that is really imploding,” Reinhart said in a telephone interview from Cambridge, Massachusetts. “What they really need to do is get their house in order. If an external default would trigger such a possibility, that’s not a bad thing.”

The suggestion that the country stop servicing its bonds comes a month after Harvard colleagues Ricardo Hausmann and Miguel Angel Santos wrote that Venezuela should consider defaulting given that it was piling up arrears to importers. Venezuela owes about $21 billion to domestic companies and airlines, according to Caracas-based consultancy Ecoanalitica.

Venezuelan debt is the riskiest in the world, yielding 15.42 percentage points more than similar maturity Treasuries, according to data compiled by JPMorgan Chase & Co. The cost to insure the country’s bonds against default with credit-default swaps is also the highest for any government globally.

“Given that the government is defaulting in numerous ways on its domestic residents already, the historical cross-country probability of an external default is close to” 100 percent, Reinhart and Rogoff wrote in their piece.

Bond Decline

The country’s bonds lost 1.9 percent on Sept. 5, the day Hausmann and Santos published their article, and 4.4 percent on Sept. 8, the next trading day.

The two-day decline was the steepest in more than a year. President Nicolas Maduro dubbed Hausmann a “financial hitman” and “outlaw,” and instructed the attorney general and public prosecutor to take “actions” against the Venezuelan-born professor for seeking to destabilize the country.

For Venezuela to recover, Maduro must unwind policies that have fueled annual inflation of 63 percent and eroded wages, Reinhart said. The poverty rate has risen since Maduro came to power 18 months ago, climbing to 32 percent at the end of last year from a record low 25 percent in 2012, according to the National Statistics Institute.

“They’re paying no one,” Reinhart said. “At those levels, inflation is certainly expropriation.”

Debt Payments

Discontent over rising prices, soaring crime and mounting shortages sparked nationwide protests in February that were put down by soldiers and police. Forty-three people will killed in clashes, according to the public prosecutor’s office.

Venezuela paid back $1.5 billion of debt that matured Oct. 8. It dipped into its international reserves to make the payment, pushing them to an 11-year low of $19.8 billion. The payment didn’t end the decline in the country’s bonds, which have lost 22 percent in the past three months.

State-owned oil company Petroleos de Venezuela SA is due to repay $3 billion of bonds maturing on Oct. 28. It has already bought back 60 percent of the debt, a company official said Oct. 10. The company will also pay interest on bonds due in 2017, 2027 and 2037 on Oct. 14, it said in an e-mailed statement yesterday. Rogoff is the former chief economist at the International Monetary Fund and author of a 1985 paper suggesting central banks should focus more on low inflation than spurring employment.

Debt Ratios

Rogoff and Reinhart wrote the 2009 book “This Time Is Different: Eight Centuries of Financial Folly,” which predicted that the recovery from the financial crisis would be a “protracted affair,” featuring extended declines in asset markets, large contractions in output and employment, and an explosion of government debt -- similar to the aftermath of past financial crises. Reinhart and Rogoff argued in a 2010 paper that high government debt depresses GDP growth. In developing countries, high debt-to-GDP ratios may also spark inflation, they wrote.

In 2013, the professors acknowledged they had inadvertently left some data out of their calculations for the paper, which had been used by some policy makers to justify austerity in the U.S. and Europe, after researchers at the University of Massachusetts at Amherst questioned their methods. The professors said the error didn’t change the thrust of their research.

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