The future of Venezuela: are reforms enough to guarantee solvency?

The latest escalation in the unfolding crisis in Venezuela occurred on October 26, as hundreds of thousands of Venezuelans took to the streets to demand the restoration of constitutional order. The intensifying political deadlock adds to the unlikelihood that a solution to the country’s economic woes will be reached in the near future.

In this context, the Brookings Global-CERES Economic and Social Policy in Latin America Initiative and the Brookings Foreign Policy Latin America Initiative recently hosted a discussion to explore solutions for Venezuela’s economic and humanitarian crises. The panel featured Ricardo Hausmann (director of Harvard’s Center for International Development, CID), Miguel Ángel Santos (senior research fellow at CID), Francisco Rodriguez (chief economist at Torino Capital), and Luisa Palacios (head of Latin America and energy research at Medley Global Advisors).

For the most part, the panelists agreed both on the diagnosis and on the end goal, but differed on how to get there. According to Francisco Rodriguez, “those differences have to do with [each one’s] assessments … and attitudes towards different types of risks.” While they all believe that a change in government combined with profound market reforms are necessary conditions for recovery, Ricardo Hausmann contended that these are not sufficient. He argued that Venezuela must restructure its external debt and request “extraordinary assistance” from the international community. Watch:

Yet Rodriguez contended that, for a country like Venezuela, “that has assets in the U.S., for a country that has receivables that can be attached,” defaulting is too risky a play. Thus, the debate has to do with whether Venezuela’s liquidity problem is simply one of credibility in the eyes of markets or rather a more structural issue. Watch:

The severe distortions present in the Venezuelan economy, such as price and currency controls, are certainly partly responsible for the humanitarian crisis the country is mired in. But it’s Venezuela’s unusually large stock of external debt together with the declining production capacity of the country’s oil sector that are fueling doubts about the country’s solvency. Therefore, Venezuela’s liquidity crunch seems to have structural roots, meaning that debt restructuring or even default may turn out to be unavoidable in the short term. This has become clear to markets, which likely interpreted the request by Petróleos de Venezuela, S.A., or PDVSA, for a debt-swap earlier this month as a sign of desperation. In trying to convince enough investors to swap their holdings, PDVSA extended the deadline for the deal several times and held nervous calls with bondholders, but the participation rate still fell short of expectations.

A PDVSA default might not be an ideal solution but it would be the result of over a decade of unprecedented mismanagement and not just of a temporary liquidity squeeze due to the sharp drop in oil prices. The fact is that a PDVSA recovery—which is crucial to avoiding a default in Venezuela—does not seem feasible in the near future, at least not without deep structural reforms. Between 2001 and 2013, oil production in Venezuela declined at an average yearly rate of about 50 thousand barrels per day. Since Nicolás Maduro took office in 2013, that rate has nearly doubled. Significant capital investments are needed to reverse course and stabilize production, but a cash-strapped and over-indebted PDVSA is far from being in a position to fill this gap. Even if Venezuelan oil production started growing at peak 1990s rates, it would still take over five years—and a whole lot of investment—to reach the 3.1 million barrels per day PDVSA was pumping out before 2002. As Luisa Palacios explained, “the extent to which you have to do debt restructuring will then depend on oil prices and your ability to generate cash flow on your own, which is a difficult proposition at the moment.” Watch:

Looking forward, and notwithstanding a PDVSA recovery, Miguel Angel Santos claimed that “oil [alone] is not taking Venezuela out of the hole.” That’s why he believes that Venezuela must diversify its economy. In addition, Venezuelans need to start thinking about “a different agreement on what the government will do for the people and what the people will do for the government and for themselves.” The crisis in Venezuela is “the failure of our way of thinking about development,” Santos claimed. Watch:

Watch the full event.