Venezuela, A Bond Holder's Dream?

Venezuela’s bonds are among the highest-paying investments in emerging markets, offering today an average yield of 26 percent. That’s in dollars -- in a world where many developed-nation bonds are yielding close to zero (or even less). And since Chavez swept into office 17 years ago, the country’s bonds have handed investors a total return of 517 percent.from Bloomberg

It’s been almost two years now since the renowned Harvard economist Ricardo Hausmann caused a stir in his native Venezuela by posing an uncomfortable question.

Why does a country that’s so starved for cash keep honoring its foreign debts? In other words, how does it justify shelling out precious hard currency to wealthy bondholders in New York when it can’t pay for basic food and medicine imports desperately needed by millions of impoverished citizens? “I find the moral choice odd,” Hausmann concluded.

He was, predictably, skewered by the administration back in Caracas -- President Nicolas Maduro labeled him a “financial hitman” and an “outlaw” on national television -- but today the question feels more urgent than ever. Prices for oil, Venezuela’s lifeblood, have fallen almost by half since Hausmann first spoke out and the country’s cash squeeze has deepened dramatically. The chaos has reached unprecedented levels -- food rationing, looting, mob lynchings, collapsing medical care -- yet through it all, bond traders have received every dime they were owed, billions and billions of dollars in all.

“There are two worlds,” said Francisco Ghersi, a managing director of Knossos Asset Management in Caracas. “The world of the bondholders and the world of what’s happening in Venezuela.”

The 21st century has produced a slew of government defaults across the globe, from Argentina to Ecuador to Ukraine. In almost every instance, the country in crisis hit the default button long before the situation got as dire as it has in Venezuela. The only similar case that economists point to is Zimbabwe back in the early 2000s. But even that comparison is flawed, says American University professor Arturo Porzecanski, because Venezuela was significantly wealthier than Zimbabwe before crisis struck and so the South American country’s collapse has been of a much greater magnitude.

What makes this pay-the-debt-at-any-cost approach all the more curious is that it comes in a country run by self-proclaimed socialists who have railed for the better part of two decades against foreign capitalist powers. There are endless theories, spawned in part by Hausmann’s public pronouncement, as to why the Maduro administration has stuck so doggedly to this policy. The main ones fall into three rough categories.

Food Riots

The first of them is an argument that’s been floated publicly by high-ranking government officials themselves. It states that Venezuela can wait it out till oil prices rebound. Why rock the boat, the thinking goes, if salvation is potentially just weeks away? (Prices have been rallying of late, climbing to near $50 a barrel.)

The next argument is something of a conspiracy theory born in part out of the opaque nature of the country’s finances. It posits that close associates of the administration are major holders of the country’s bonds and that the government fears it’d lose their much-needed support if the payments stopped coming in. Efforts to obtain comment from government press officials on this and other aspects of the story were unsuccessful.

The third theory, and it’s one that ties back into the first idea, states that even though Venezuela lost access to international capital markets a long time ago, a default could still deepen the government’s cash squeeze by triggering legal action from creditors that would undermine the country’s ability to export. If fewer petro-dollars flow into the country, the savings from the default could be washed away, making the situation on the ground even worse.

It’s frankly hard to imagine what a further deterioration would look like. After shrinking an estimated 7.5 percent in 2015, the economy is forecast to post an even bigger contraction this year. Food shortages are now so acute, and lines outside stores so long, that spontaneous protests are popping up everywhere. In one episode in the 500-year-old coastal city of Cumana, hundreds were arrested and a middle-aged man was shot to death, one of three fatalities at food-related demonstrations in June alone. There have been so many vigilante justice-style lynchings -- more than 70 in the first four months of this year -- that the supreme court has banned Venezuelans from sharing video recordings of the gruesome events on social media.

Default’s Benefits

To Hausmann and to legal experts who have studied the country’s oil operations, the risk of angry creditors blocking exports after a default is actually small. The way that PDVSA, as the state oil company is known, structured sales contracts makes it difficult for them to be interrupted by a legal challenge, according to Francesca Odell, a partner at Cleary Gottlieb in New York. What Hausmann and others see instead from a default is the opportunity to free up a big chunk of cash that could be re-directed toward imports.

The government is due to make $1.5 billion in foreign debt payments in the second half of this year. Include PDVSA’s tab and the figure swells to $5.8 billion. It’s a staggering sum of money in a nation that has bled its hard currency reserves down to just $12 billion. And while few, if any, bondholders would embrace a default, they certainly wouldn’t be caught off-guard by it. For the better part of the past 18 months, the government’s benchmark bonds have been trading under 50 cents on the dollar, a price that in essence signals to a debtor: “We’re prepared for a restructuring, go ahead and do it if you must.”

“It’s fairly shocking that they have decided to service the debt over all else,” said Risa Grais-Targow, an analyst at Eurasia Group in Washington. “But I do think the commitment is fairly strong.”

Venezuela’s bonds due in 2027 fell 0.37 cents to 48.48 cents on the dollar as of 2:24 p.m. today in New York.

Maduro, the man handpicked by the late Hugo Chavez to succeed him, has spoken frequently about his determination to keep paying the debt. In a speech back in May, he proudly explained how the country had doled out $36 billion to creditors -- “a huge amount of money” -- over the previous 20 months. The payments were made, he went on to say, “with dignity, without accepting preconditions from anyone, maintaining the country’s independence despite the pain.” These are references to multilateral lenders like the International Monetary Fund and World Bank, institutions that are despised by the Latin American left.

As long as Maduro continues to pay, there will be investors willing to own the debt. Venezuela’s bonds are among the highest-paying investments in emerging markets, offering today an average yield of 26 percent. That’s in dollars -- in a world where many developed-nation bonds are yielding close to zero (or even less). And since Chavez swept into office 17 years ago, the country’s bonds have handed investors a total return of 517 percent.

“It is one of the most miserable, mismanaged, hopeless countries on the planet,” said Jan Dehn, head of research at Ashmore Group Plc, which manages $50 billion of emerging-market assets. “But that doesn’t mean you can’t make money.”
Hausmann, meanwhile, is more incensed than ever.

In a recent interview, he called the government’s insistence on paying the debt, coupled with a church’s claim that it rejected offers of international aid, “a crime against humanity.” There’s a history here, it should be noted, between the professor and the Chavistas. Some two decades ago, he served in the business-friendly government that Chavez tried to overthrow in a coup attempt that effectively launched his political career. Perhaps that explains some of the enmity between the two sides. Regardless, this is what Hausmann wants to ask the folks on the other side: How can they sleep at night? “It’s beyond belief.”