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Bond investors and the Venezuelan saga

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Over the past years, investors have continued to speculate whether the government of Venezuela will default on its debt obligations, mainly conditioned by the lower oil prices and lately due to the persistent political turmoil, which have recently resulted into violent protests and also some casualties. Surely, these recent events have led urgency to the exercise of whether the country will default on its interest payments. Following Hugo Chaves’ demise, under Maduro the country failed to manage its finances efficiently and now it appears closer and closer to running out of money.

In addition, the recent anti-democratic move to rewrite the constitution and strip power from congress has been met with U.S. sanctions. That said, for all the recent turmoil, Venezuela has a track-record of paying its debts, and investors who’ve held on through the worst of times have been rewarded with some of the world’s best bond returns.

However, the situation now seems to be at its worst and as expected, the recent turmoil is being priced-in by investors with huge bond value depreciation across the ladder maturity, with long-dated issues being the most vulnerable. It seems now more than ever investors are very much concerned that the political saga will eventually lead to a default.

Furthermore, over the past years, the country’s economy showed recurring signs of weakness, and economic data releases continued their negative trajectory, with foreign reserves dwindling to a 15-year low of about USD10 billion. This is a very concerning figure for bond holders when considering Venezuela and the state oil company known as PDVSA are due to pay about USD13 billion in debt before the end of 2018. Combining that with oil prices at half of what they were just three years ago, slumping crude output in a country that gets 95 percent of its export revenue from that one resource, triple-digit inflation and a rapidly shrinking economy, there is not denying that a tough road lies ahead.

In my view, the major issue being faced by investors is also the lack of key economic statistics in order to gauge the country’s creditworthiness. For instance, looking at the country’s current account, a measure of trade that looks at the movement of money, including interest payment, shows a notable deficit which varies. The sure case is the fact that the country over the past years has slashed imports to keep on paying its debts. Surely, technically speaking this is an unsustainable situation.

Possibly, Venezuela can buy itself some time by continuing to take advance payments for its oil, as it did recently from China and Russia, while it can keep reducing imports. However, the economy depends on foreign manufacturers for everything and shortages have already become severe, so the humanitarian costs are significant.

Recently the country also used PDVSA’s Houston-based refining arm, Citgo Holding, as collateral to back some bonds. However, same as the imports situation, this is an unsustainable plan going forward to fulfill its debt obligations.

One other detrimental factor is the recent U.S. sanctions. Despite the recent sanctions are not directly effecting the country since they are limited to freezing assets of individuals, other possible sanctions might come into play. In fact, speculation has grown that the U.S. could impose steeper sanctions, such as a ban on oil imports from Venezuela. Such measure is a direct implication which will certainly affect the country’s revenue stream and thus be pushed further into dire straits. Just for the record, 40 per cent of Venezuela’s petroleum exports go to the U.S.

In conclusion, as pointed out earlier despite investors might have gained impressive returns in such turmoil situations; this time round the situation seems to be more critical. Surely, over the past days, the probability of default has increased drastically and investors should be made aware that a possible debt restructuring by the country will be a complicated one. In this regard, in my view investors should possibly take a harsh decision and move out by cutting their losses. The risk-reward ratio now seems to be quite unbalanced.

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