Business

What happens in a default?

Wednesday, November 15, 2017

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MONTEVIDEO, Uruguay (AFP) — Venezuela has been declared in “selective default” by Standard and Poor's after failing to make interest payments on bond issues as it tries to refinance its US$150 billion foreign debt.

This is a look at the concept of default and its consequences.

HOW DOES A COUNTRY DEFAULT?

A country is in default when it cannot repay due loans — bonds, in financial jargon — or when it can no longer pay interest accrued. The creditors involved may be international institutions like the International Monetary Fund.

In the case of Venezuela, which cut ties with the IMF in 2007, it is borrowing on the financial markets from private investors.

By year's end Venezuela is supposed to repay a total of around US$1.47 billion in debt, and about US$8 billion next year.

It has foreign reserves of only US$9.7 billion.

Both S&P and Fitch have declared Venezuela in “selective default” after it failed to make US$200 million in payments on two global bond issues by Monday, when a 30-day grace period came to an end.

Last Friday was also the deadline for it to pay US$81 million on a bond issued by the state oil company PDVSA.

Meanwhile, a committee of an organisation called the International Swaps and Derivatives Association (ISDA) is weighing whether holders of US$1.161 billion in PDVSA debt with default insurance — credit default swaps — can collect payment from that insurance.

If a selective default spreads to other bond issues, in particular the nation's sovereign debt, it likely would be declared in full default.

Default has occurred happened 26 times around the world since 1999, S&P says, and some countries have done it more than once.

WHO DECLARES A DEFAULT?

While a bankruptcy court acts in cases of individuals or companies, no such mechanism exists for states.

So a government can self-declare a default by announcing that it will cease repayments on its debt.

The announcement can also come from one of the ratings agencies, which then determine either a partial or full default.

Similarly, a private creditor can publicly disclose that Venezuela has stopped paying it.

Another possibility is an official announcement by the ISDA which maintains a global watch on sovereign debt.

WHAT ARE THE CONSEQUENCES?

In cases of a full default, the nation is immediately cut out of international financial markets. In Venezuela's case, Washington has already banned any new debt transactions in the US market.

Creditors are in theory entitled to seize assets located abroad. Venezuela's state oil company has a subsidiary, the Citgo oil company, in the United States that has refining activities. Its tankers and oil shipments abroad could also be at risk.

Venezuela's main creditors include China and Russia, but there are also American lenders, attracted by the current high yields on its bonds.

Default could expose it to commercial retaliation by creditors' countries of residence. Venezuela's reputation would suffer, complicating its credit rating for years.

HOW DOES RESTUCTURING WORK?

Restructuring a debt means rescheduling repayments, and most often, lowering debts or canceling them altogether. It means the country cannot pay, but hopes to reach an agreement with its creditors.

Vice President Tareck El Aissami met with creditors in Caracas Monday, but offered no way out of the impasse.

An agreement has already been reached with Russia on US$3 billion of debt but altogether Moscow holds a relatively small portion (approximately US$8 billion, including debt picked up by the Rosneft oil company) of Venezuelan debt.

Venezuela says it is making progress in talks with China, which holds US$28 billion.

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