The Venezuela debt saga continues to confound investors, with many wondering what exactly the government is hoping to accomplish with its current strategy. The possible explanations range from a search for a new scapegoat for the ongoing economic crisis (with the initials DJT), to a savvy maneuver to reduce the country’s liabilities. Trying to read the tea leaves in Caracas is always hard – but let’s give it a try.
To recap: On Nov. 2, Venezuela’s President Nicolás Maduro made an announcement that sent shockwaves through the emerging markets debt investment community. Maduro said he would seek to restructure the country’s external debt, subsequent to servicing a maturing $1.2 billion from Petróleos de Venezuela (PDVSA), the state oil company. Bond prices, already trading at heavily distressed levels, collapsed in the subsequent trading session and the country’s yield curve became highly inverted, implying significant risk of near-term default. In other words, markets now price in what observers have long been considered a major risk: the largest sovereign credit event in emerging markets since the Argentina default of 2001.
Venezuelan authorities invited bondholders to Caracas on Nov. 13, ostensibly for a discussion on how each side could proceed. Instead, attendance from creditors was minimal, not surprising since Vice President Tareck El Aissami, who is on the U.S. sanctioned persons list, was tasked by Maduro to lead the “negotiations.” Nothing of substance came out of the event in Caracas, and no true dialogue actually occurred. Furthermore, on Nov. 14 credit rating agency S&P placed Venezuela in the selective default category for apparently failing to make coupon payments on two sovereign debt issues within the 30-day grace period. The International Swaps and Derivatives Association (ISDA) is now in the process of determining whether a credit event has indeed occurred, which would trigger payments on credit default swaps contracts.
Meanwhile, there is much market debate, as observers digest the latest news and events and are left to wonder… what next?
To start, it is important to clarify what Maduro actually said in his initial statements, and then examine the political ramifications of his announcement. On the first score, Maduro did not declare a default nor did he repudiate the country’s debt. In fact he said that, “Our intentions are to continue to satisfy our international obligations.” But, he also stated his intention to restructure the country’s debt load, as part of a “complete reset” of external debt. Heretofore, the Maduro administration had always expressed a willingness to pay its external debt obligations, even as the country’s economy imploded. The statements on Nov. 2 were the first sign that this willingness to pay needed to be questioned – even if ability to pay has been a major doubt for a long time. Indeed, no one disputes that the country faces a very strained liquidity position.
Given sanctions imposed by the Donald Trump administration, a typical restructuring is impossible – and the Maduro regime likely knows this. The U.S. government has issued an executive order that restricts certain debt transactions with the Venezuelan government and with PDVSA. New securities of any kind cannot be purchased from the government of Venezuela, thus making it impossible for a restructuring to occur. U.S.-domiciled investors cannot negotiate with sanctioned individuals in the Venezuelan government, including Maduro and El Aissami. Even without the sanctions, the chances of a successful restructuring would be minimal, as the Maduro government has shown zero appetite to adopt a more reasonable set of economic policies. Investors are unlikely to accept new bonds from the Venezuelan government without a full-scale rethink of the current economic policy mix, which has resulted in hyperinflation (prices are now increasing 50 percent month-on-month), a massive increase in the money supply, and a destructive economic depression, perhaps the worst ever seen in Latin America.
So why declare an intention to restructure when you have no chance of actually making it happen? Why now, after the government has made billions of dollars of debt payments in recent years, even after the economy has imploded?
There are several explanations. One possible rationale is that Maduro will use the sanctions as an excuse and blame Trump and the U.S. government for the inability to restructure. The narrative goes: “Look, we invited investors down to Caracas. We wanted to restructure our crushing debt load. But Trump won’t let investors speak to us. Just like the U.S. sanctions crushed Cuba… history is repeating itself.” This line of thinking would set the stage for an actual default, with Venezuelan officials suggesting that the U.S. forced their hand.
Another line of thinking is that Venezuela (along with potentially its Russian and Chinese patrons) will buy back bonds that are now trading at a fraction of face value, in the aftermath of the collapse in market prices. The total market value of Venezuela’s outstanding debt is minimal, even as a percentage of the country’s highly depressed GDP. This would be a backhanded, devious and perhaps very profitable way to reduce the debt stock.
Any economic decision needs to be viewed through the prism of politics – and the survival of the regime. Perhaps Maduro wishes to use precious hard currency to increase imports in the months ahead, to increase his chances of re-election as president. Imports have fallen significantly over the last half decade. Passing on debt payments for the purpose of addressing food and medicine shortages could indeed be the government’s calculation. Attempting to increase imports in the short-term would fit well with the suggestion that the government could move presidential elections up to early 2018, on the back of its success – albeit tainted – in last month’s gubernatorial elections. With the opposition at its weakest point in several years, Maduro’s debt strategy is surely related to his attempts to secure another term in office.
A final possibility is that Maduro’s statement is just part of a cat and mouse game. Ultimately the cost of a hard default on the country’s debt remains very high. The decision makers in Caracas are well aware of the risk of asset seizures, and the potential operational impact on PDVSA that can result from a debt default. Investors and observers should keep in mind what Maduro said: a debt moratorium has not occurred. Indeed, Venezuela has been using its grace period to service its obligations even as the country faces a massive liquidity problem. With any real restructuring unlikely in the near future, a possible scenario is a continued game of Venezuela using its grace period (and beyond) to service coupons and amortizations in the near term – but no actual full-scale default. The government’s approach to its debt crisis is likely to remain haphazard, confusing to investors and handled in an unorthodox fashion. Any true renegotiation of the debt, as Maduro apparently hopes for, is farfetched for now.
Rosen has 20 years of experience in the Latin America financial markets, at both leading investment banks such as Goldman Sachs, and asset managers including Trust Company of the West. He has lived and worked in both Argentina and Brazil.