Chavez's poisoned legacy

Pressure on President Nicolas Maduro continues, but Venezuela’s oil wealth will continue to support his regime – at least in the short term.

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In September last year Venezuela began to run out of toilet paper. President Nicolas Maduro ordered national price regulator Sundecop to take control of factories run by Manpa, the company whose products wipe 40% of the country’s bottoms. A crisis was averted, but a more potent symbol of Venezuela’s deep economic problems – the shortages, currency devaluations and the highest inflation in the world according to Reuters – is hard to find.

Those who expected a change when former bus driver Maduro took charge of the Latin American country in April last year, after the death of his mentor, President Hugo Chavez, have been disappointed. He has proved to be more Chavez than Chavez and continued to run the economy into the ground.

At the end of January, the current round of violence and protest kicked off in San Cristobal, a university town in the Andes. By mid-February it had spread to the capital Caracas. The government’s response was to put troops on to the streets and to lock down the media. There have been deaths too; almost 20 by the end of February.

The root cause of Venezuelan disenchantment has been the economy. It is unfair to blame Maduro directly for the economy he inherited. But massive government spending, years of nationalisation and an over-reliance on imports for the most basic of consumer goods means that inflation has risen to an estimated 56% in the oil-rich nation. Scarcity is so extreme that even by the central bank’s own measure, the shortage index hit a whopping 28% in January. This means that three out of 10 staple goods were not on the shelves.

Dollar shortage

Problems have partly been fuelled by the shortage of dollars to the private sector. Although the government made some moves to allow companies and individuals to buy and sell dollars in a regulated market in late February, the decline of the bolivar on the unofficial market has been virtually unstoppable.

Although the official exchange rate remains pegged at Bs6.287 to the US dollar, on the black market it has soared. At the beginning of the year it had risen to Bs64.1. By February 19 it had peaked at Bs87.92 though it had recovered slightly to Bs84.28 at the beginning of March, according to DolarToday, a website that tracks the exchange rate on the Colombian border.

The question that the international community has been asking itself is whether current problems are anything more than the familiar part and parcel of Venezuelan violence.

“It is foolish to be dismissive of the protests, though at the moment they still have not broadened to include large numbers of lower-income Venezuelans,” said Casey Reckman, LatAm economist for Credit Suisse. On the surface therefore it is business as usual. The working classes still (broadly) support chavismo, the ruling system named after the late President, and there is little sign that that is changing much.

Deeper down, it is a more nuanced story. “There is a sense that what we are seeing at the moment has a different element,” said Stuart Culverhouse, global head of research at London-based brokerage Exotix. What is different this time is the government’s response to the protests. Indeed so repressive has Maduro’s reaction been that even pro-government governors are complaining.

On February 24, Jose Gregorio Vielma Mora, governor of Tachira and a member of the ruling Partido Socialista Unido de Venezuela, publicly acknowledged that the economy was at the root of the protests and that the government response had been heavy-handed.

What has kept a lid on protests so far is the lack of signs of dissent and defection within the military, and an unco-ordinated opposition. At the moment government critics reflect a variety of complaints from those about shortages to more generalised repression. There has been no real figurehead since opposition leader Leopoldo Lopez was arrested towards the end of February, charged with inciting violence. “No political figure has yet taken up ownership of the protest,” said Erich Arispe, director at Fitch.

The danger sign to watch for, said analysts, was that if protests, currently the preserve of the middle classes, spill over to the government’s popular base. “The more people who die, the higher the risk of that happening,” said one country analyst.

With this continuous negative news, little surprise that Moody’s has the country at Caa1, S&P cut Venezuela to B– in December, and Fitch rates the country at B+ though with a negative outlook. Fitch is currently reviewing its rating and a further downgrade is expected by the end of the first quarter.

Strong appetite remains

The question on the lips of the financial community, is therefore whether Venezuela is going to default on its debt.This is extremely unlikely.

London-based brokerage Exotix estimates that Venezuela has sovereign bond repayments of US$1.5bn this year, US$741m in 2015 and US$1.5bn in 2016. The water is muddied somewhat by Petroleos de Venezuela SA (PDVSA), the government-owned oil behemoth and its economic golden goose. To all intents and purposes, the two are one and the same.

Even if the combined sovereign and PDVSA repayments are added up for the year, they reach US$5.5bn for 2014. Oil production from LatAm’s largest oil producer and exporter might have dropped by 20% over the past decade to 2.2m barrels a day, according to Reuters, but as one London-based banker said: “US$5.5bn is still only roughly a month’s oil revenue”. Exotix estimates that US$17.5bn is due by end-2017. Difficult, but manageable.

It is for this reason that credit default swaps for Venezuela are elevated but not catastrophically so when compared with compatriot emerging markets. At the end of February, five-year sovereign CDS were around 1,371bp. The probability of default for the country this year is rated around 19.5%, which is almost half of where Argentina, at 35%, sits.

No surprise then that there is growing interest in Venezuelan paper. Both the sovereign Venezuela 8.5% 2014s and the PDVSA 4.9% 2014s have been heavily bid over the past few weeks. From a yield of around 20% at the start of February, by the end of the month, the sovereign bonds were at 98 cents in the dollar and yielding 11%, while the PDVSA 14s were at 94.5 and yielding 14%.

The appetite for Venezuelan paper is not just coming from opportunistic investors. “There is a broad-based interest in the paper – from hedge funds to real-money accounts,” said Daniel Chodos, LatAm strategist for Credit Suisse. “In February, in the midst of the protests, Venezuelan bonds returned on average 9.2%, the second-best performing sovereign credit in EM after Argentina.”

Sovereign eight-month paper with a double-digit return does not require much explanation, but there is interest further out on the credit curve too. “Hedge funds are looking at low dollar priced bonds. There has been a significant rally in those recently – up to four points,” said one London-based trader.

Three bonds in particular rose in the two weeks from mid-February until the beginning of March. There was interest in the Venezuela 27s, which were up from the mid-60s in mid-February to 72.28 at the end of the month. But the PDVSA 27s are up to 53.75, and even the PDVSA 35s are now trading at 66.5.

Given the economic and political background, it is perhaps curious to consider whether Venezuela might be able to tap the international markets for money this year. Certainly in June last year Venezuela did contemplate a sovereign issue and met with banks, though it was little more than Kaffeeklatsch.

Although many bankers expect some form of issuance this year, the state of the economy and Venezuela’s ability to service its debt is too unclear to be able to see especially far out. Credit Suisse’s Reckman pointed out: “We don’t have meaningful visibility beyond the next 12 months”.

With PDVSA it is a different matter. “PDVSA always keeps the window open,” said Alejandro Grisanti, co-head Latin America economics, strategy and FICC, at Barclays, adding that the market expects between US$4bn and US$8bn issuance this year.

The company sold US$4.5bn of new 6% 26s in November last year in a private deal via Citigroup. About US$1.5bn was placed with the central bank while the rest went to pay PDVSA suppliers.

“It is likely that any new issue from PDVSA will be similarly structured and sold in the domestic market,” said one banker. The problem with it though is that the real coupon is difficult to calculate given both the FX gains and the inevitable discount. The same banker suggested that the real coupon might be as high as 50%.

In one sense Venezuela is both better and worse off than headlines suggest. It is better off as no one is expecting a dramatic crisis in the short term, nor are there expectations of a default. “Venezuela has the capacity to pay as long as the oil prices do not decline. And we do not expect an oil crisis,” said Barclays’ Grisanti.

It is slightly further out that doubts start to creep in – something clearly articulated in the inverted yield curve. “It is the medium term that I am worried about. It is harder to see through the two to four-year window; it becomes more difficult to roll over debt,” said Exotix’s Culverhouse. It is a view backed up by Siobhan Morden, head of Latin American strategy at Jefferies. “There is no confidence about how Venezuela is going to exit this stagflationary environment or improve policy,” she wrote in a recent note.

Optimists point to the National Assembly elections next year. Maduro won the elections last year by only the slimmest of margins and the hope is that, guided by a new National Assembly, his more totalitarian moves might be tempered. But given the political ructions at the moment, pessimists fear any transition. “How do you get from A to B?” asked one economist.

The more realistic expect little to change. Rather than any form of revolution they see Venezuela’s wealth simply being eroded away.