Venezuela: A nation in bondage

Posted on November 10, 2016

On a street corner in downtown Caracas, near the Miraflores presidential palace, Miriam Bolívar and other diehard supporters of Venezuela’s government tend what amounts to a shrine to chavismo — the socialist revolution founded by Hugo Chávez and continued since 2013 by his successor, President Nicolás Maduro.

Surrounded by pro-government graffiti and posters, Ms Bolívar says she and her comrades “will defend the revolution — even with our lives”.

“If the heroic revolution of commander Fidel Castro managed to last more than 50 years [in Cuba], the beautiful revolution of Commander Chávez can last for ever,” she says.

Ms Bolívar is in a minority. Polls show that 63 per cent of Venezuelans would be glad to see the back of the government after years of economic mismanagement that has led to triple-digit inflation, shortages of necessities from food to medicines, and rising crime.

Venezuela’s opposition is today holding a second round of talks with the government, mediated by the Vatican, to try to find a way forward for the
country.

$125bn

Venezuelan debt owed to bondholders, commercial creditors and China

But anyone who thinks this heralds the imminent end of chavismo is having to reconsider. That includes the holders of an estimated $125bn of Venezuelan debt, including bondholders, commercial creditors and China, on which the government depends for its survival. “A couple of months ago, everyone thought there would be a negotiated transition [of power] next year,” says Siobhan Morden, a Latin American strategist at Nomura. “That’s not going to happen.”

Emerging market magnet

That failure to dislodge the government could make a default more likely, downgrading investor views of Venezuela and potentially jeopardising the country’s access to finance.

It had all looked very different at the beginning of the year. Opposition parties had won control of parliament and were pushing for a recall referendum designed to remove Mr Maduro from power by January 2017.

Many bond investors had assumed that, even if a messy transition led to a debt default, they would recover a big part of their investment. Venezuela has the world’s biggest proven oil reserves and although gripped by an acute liquidity crisis, its long-term solvency is virtually assured.

Since then, however, the government has overridden parliament using a compliant judiciary and last month it blocked the referendum.

Caracas’ ability to service its debts has not improved. Oil accounts for more than 90 per cent of foreign currency earnings but crude prices remain depressed. Because of mismanagement, unpaid suppliers’ bills and under-investment at PDVSA, the state oil company, production has fallen by almost one-fifth this year to just over 2m barrels a day, according to Opec. If this rate of decline continued, the country’s solvency could be at stake. Instead of a risky but profitable recovery, investors would face a chaotic default and possibly severe losses.

Many investors have responded to this uncertainly by shifting their attention to short-term bonds and eschewing longer-dated paper that would stretch out their exposure and magnify the odds of suffering a default.

Investors who this year bought a PDVSA bond maturing in April 2017, for example, have made a 70 per cent profit, says Ms Morden, thanks to coupon payments and a price rise of 50 cents on the dollar as the bond approaches maturity. To get similar gains now, investors must buy later-maturing bonds at similarly depressed prices, and hope the government does not fall before their principal payments come due. Overall, Venezuelan debt is the highest yielding in emerging markets.


Venezuelan President Nicolas Maduro (right) talks with Eulogio Del Pino, Oil Minister and president of PDVSA © AFP

Longer-dated debt still attracts buyers, however. “Venezuela is potentially the best investment in the emerging markets universe,” says one Miami-based Latin American investor. “But you really need to get into the weeds of it and have a pair of steel you-know-whats to sustain your positions.”

Long demise

Venezuela’s economic problems began well before oil prices started falling in mid-2014. The economy shrank 1.5 per cent in 2010, even though Brent crude was nearly $80 a barrel. Now that Venezuela’s oil basket, which sells at a discount to Brent, trades at about $39 a barrel, it is more difficult to mask
profligacy.

The International Monetary Fund estimates annual inflation will top 470 per cent this year (the government has not published inflation data since December). The fund adds that the economy will contract by more than 10 per cent, after shrinking 6 per cent in 2015. To many outside the country, it is a mystery how the government remains in power. Imports in the first nine months of the year are a third the size of what they were in the same period in 2013. Government spending continues to contract.

Francisco Rodríguez, chief economist at Torino Capital in New York, who expects a modest economic recovery based partly on higher oil prices in 2017, says spending will rise “only” 151 per cent this year, a fraction of inflation rates. That suggests a significant fiscal contraction.

“One can argue that Venezuela’s adjustment is one of the costliest and most inefficient imaginable. Yet that does not mean that adjustment has not taken place,” he says.

Yet the fact that the state controls the main bulk of foreign earnings through PDVSA oil sales, as well as all hard currency imports via a complex licensing scheme, gives it a stranglehold over economic life.

The Maduro administration has begun to taken action to soften the social blow to the poorest. In some border areas, foreign exchange controls have been quietly relaxed. Goods that were unobtainable for years have come in from neighbouring Colombia and Brazil. Toilet rolls, beans, powdered milk and other scarcities have turned up on supermarket shelves in the capital, although at prices beyond the reach of most. In one Caracas shop this month, a bottle of cooking oil was priced at 7,000 bolívars, more than a quarter of the monthly minimum wage.

There has been relief for the less well-off. A government initiative known as Claps has been delivering a fortnightly basket of basic goods at regulated prices to the poor. This has helped restore government support, even in areas where it suffered defeat in elections last year.

Asdrúbal Oliveros of Ecoanalítica, a Caracas consultancy, describes the government’s thinking like this: “For the poor, my power base, I have Claps, which eases tensions and gives me more social control. For the middle and upper classes, I allow people to import foods at crazy prices.”

How long the government can continue to improvise in its dealings with investors is open to question. For now, paying bondholders is the top priority. The reason is simple: in a default, creditor lawsuits could disrupt Venezuela’s oil exports, cutting revenues and threatening the government’s survival.


People queue to buy basic food and household items in a Caracas neighbourhood © AFP

So far the Maduro administration has shown tenacity in keeping up with its international debts. It has reportedly restructured up to $5bn of unpaid bills into promissory notes owed to oil services companies, such as Halliburton. Last month it bought time for itself with a PDVSA bond swap that lightened its repayments for this year and next by a combined $2bn. But it did add $3bn to repay further down the line, adding a net additional expense of $1bn.

Ms Morden at Nomura says that with oil revenues of around $25bn a year and bond repayments closer to $10bn, in theory the government could cling on indefinitely. But a comfortable revenues-to-payments ratio starts to slip when you add in other liabilities.

20%

Fall in oil production, to 2m b/d, blamed on mismanagement at state-owned PDVSA

Among these are a series of claims lodged by foreign businesses at the International Centre for Settlement of Investment Disputes, part of the World Bank. The claims already exceed $4bn and could easily double.

Then there is the $20bn-$24bn Venezuela owes of an estimated $65bn it has borrowed from China since 2007. Beijing has apparently been flexible this year in terms of repayments and extended maturities but it is reassessing ties to Caracas and is in talks with opposition parties.

At some point, says Ms Morden, the revenue-to-payments ratio will fall below 1:1 — “and then it is game over”.

Anxious mood

The opposition has said it will walk away from today’s talks and resume street action if the government does not meet its demands, which include a commitment to the recall referendum and the release of political prisoners. Street protests would increase the chance of state repression and more social unrest.

Such a scenario could stir the US. During a campaign rally in Miami in September, Donald Trump said he stood firm with “the oppressed people of Venezuela, yearning to be free” in a country that has been “run into the ground by socialists”. The president-elect may well prefer to let Venezuela lie, but before the US election some analysts were gaming scenarios such as what it might mean if the US were to cut off its imports of Venezuelan oil, currently 715,000 b/d according to the US’ Energy Information Administration.

476%

The rate of annual inflation in Venezuela this year, according to the IMF

All this uncertainty has left bond investors anxious. “The market verdict is that it [the debt swap] is a disaster, an unqualified disaster,” says Edward al-Hussainy, a senior analyst at Columbia Threadneedle, which has invested in Venezuelan bonds. “There is still enough oil money and assets to keep things afloat, but we’re going to be nervous before every principal repayment.”

Doug Rediker, chairman of International Capital Strategies and a former US representative on the IMF executive board, struggles to see how the country can avoid defaulting on its debts.

“They have already crossed into the red zone. Their reserves are down to single digits and it’s unclear if they are liquid enough to use,” he says. “The policy has been to continue to pay international bondholders while the people eat arepas and beans … At some point, there might be an outright collapse.”

Mr Rediker says that the IMF has been barred from the country for years and it would take staff at least six months to be able to help with an adjustment programme. “Almost any IMF programme will be a complete anathema to the Chavistas,” he says.

On the streets of Caracas, Ms Bolívar and her comrades are testament to that. “Listen well, local and foreign plotters, speculators and financial saboteurs,” says Teodoro Cortéz, leader of a 300-strong collective called Rebellion and Resistance. “We are going nowhere. The revolutionary government will stay on and it will radicalise.”

With a government whose modus operandi is best described as one of constant improvisation, Venezuela’s revolution looks unlikely to outlast the Cuban one. But those willing its end should not hold their breath.

The prices for Venezuelan bonds show how investors’ perceptions have changed since the start of the year: they think an imminent default is less likely than before but that, when it comes, the result could be worse.

PDVSA’s $3bn bond maturing in April 2017 is trading at a two-year high of 87 cents on the dollar, up from a record low of 36 cents in February. A government bond due in August 2018, is trading at 79 cents on the dollar, up from its 2016 low of under 50 cents.

Both show that investors believe the recent PDVSA bond swap has bought the government time. But longer-dated bonds highlight their fears for the future. Venezuela’s $3bn 2022 bond is trading at about 58 cents on the dollar, compared with almost 70 cents when the PDVSA swap was announced in September.

Prices are also being driven by the peculiar characteristics of many Venezuelan bonds, analysts and lawyers say. Some of those issued before 2003 do not have “collective action clauses” — contractual devices that mean bonds can be restructured only if a majority, and not necessarily all, of bondholders agree. Without CACs, restructuring is much tougher.

The older bonds also have “pari passu” clauses, similar to those on Argentina’s old bonds, which guarantee that all investors be treated equally. The clauses can be potent weapons in the hands of creditors.

There are signs that hedge funds have cottoned on. Venezuela has two bonds issued in New York with identical coupons maturing in 2027 and 2028. One is trading at 46.5 cents on the dollar, giving an annual yield of 22.4 per cent. The other, older bond — which has no CAC but does contains a problematic pari passu clause — is trading at 52 cents, or a yield of 20.5 per cent. Its buyers clearly value it more highly.

Robin Wigglesworth

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