Most risky sovereign defaults:Venezuela and Ukraine
Most risky sovereign defaults:Venezuela and Ukraine
A CENTRAL bank that takes a visiting economist down to its vaults to prove that it does indeed have the reserves it claims must be very worried about market sentiment. And so Venezuela’s should be: the price of insuring the country’s bonds against default has risen by 80% over the past two months—suggesting they are the world’s riskiest (see chart). Bond yields over 16% also imply that markets are bracing for a crash. Last month Standard & Poor’s, a ratings agency, downgraded Venezuela, saying there was a one-in-two chance of default within two years.
Venezuela’s main rival for the title of riskiest sovereign debtor is Ukraine, rated worst in class by all big credit-rating agencies. An ongoing conflict on the eastern border with Russia is playing havoc with its economy and public finances. Ukraine’s economy is expected to shrink by a stunning 8% this year, and the price of insuring its debt against default has nearly doubled since June.
Venezuela’s difficulties were precipitated by a spending spree around elections in 2012, when it borrowed heavily from foreigners at short maturities. Those bonds are now beginning to come due. Servicing this external debt will cost $7 billion this year and at least another $10 billion a year for the next three years. Against these obligations Venezuela has thinning reserves of just over $20 billion (including the gold in the central bank’s vaults), down by about half since 2008. Less than $2 billion of that is in foreign cash.
In theory, Venezuela’s oil exports could generate the income to pay its foreign creditors. Last year they brought in an estimated $86 billion. But the oil price is falling, and the fiscal deficit has ballooned to 17% of GDP. The government has resorted to rationing and price controls amid a scramble for foreign exchange. Inflation is over 60%. New forecasts from the International Monetary Fund (IMF) project that Venezuela’s economy will shrink 3% this year and a further 1% in 2015.
Painless policy responses are as scarce as dollars. An aggressive devaluation might help close Venezuela’s current-account gap, but at the cost of fanning inflation. It is also an unpopular solution, which will not appeal to politicians; elections to the legislature loom next year. Default looks more attractive, especially since the publication of a fiery argument in favour by Ricardo Hausmann and Miguel Angel Santos, both of Harvard University. The markets seem to think that Nicolás Maduro, Venezuela’s president, may well plump for the populist option, despite his insistence that international creditors will be paid “to the last dollar”.
If stiffing “foreign devils” is the expedient choice in Venezuela, it may be simple necessity in Ukraine, which remains in dire straits despite striking a $17 billion, two-year financing deal with the IMF in April. War has battered an economy that was already limping. Ukraine’s current-account deficit has grown from wide to yawning, causing the hryvnia to plunge by a third against the dollar since the start of the year. In January public debt looked just about sustainable at 40% of GDP; it is now considerably less bearable at an estimated 60% of GDP and may rise to 80% next year. The IMF based its bail-out on much rosier forecasts.
International aid has done little more than buy Ukraine time. It must pay external creditors $9 billion by the end of next year (including $3 billion to Russia), plus an additional $5 billion in 2016 and $8 billion in 2017. There is also domestic debt coming due and billions of dollars in overdue bills for gas from Russia. Foreign-exchange reserves are drying up fast, having fallen from $37 billion in 2011 to $16 billion now. Last month the IMF admitted Ukraine might need another $19 billion if the fighting did not end. Most analysts believe that a top-up is needed regardless.
Ukraine has little room to manoeuvre. The coming months will bring falling temperatures—not to mention parliamentary elections, an IMF check-up and the possibility that Russia may exercise a clause in its loan agreement allowing it to demand early repayment when debts rise above 60% of GDP. A Russian threat last month to call in Ukraine’s debts early pushed yields on Ukrainian bonds to their highest levels in months.
The good news is that Ukraine still has time to pull off an orderly restructuring. Kenneth Rogoff and Carmen Reinhart, two Harvard economists, argued in “This Time is Different” that defaults need not be catastrophic, so long as haircuts are administered speedily and fairly. Ukraine’s government may be best advised to pre-empt jittery markets and start haggling with bondholders, rather than wait until default is imminent.
Yet Ukraine is more likely to cling to faint hopes, not least to avoid the humiliation of having to negotiate with Russia. The IMF may oblige by increasing its bail-out by just enough to get Ukraine through this winter. The country might even limp through to the next one. But with no oil to pump or other treasures to sell, it is hard to see how Ukraine’s shrinking economy can service its current debts, let alone the new ones the IMF is providing. The longer it delays, the greater the pain will be when its credit finally does run out.