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Saturday, 20 December 2014

Rekindling the love

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A lack of credible policies make an imminent return to the financial markets for Argentina and Venezuela, Latin America’s principal proponents of heterodox economics, unlikely. Both aroused much attention in the secondary markets during the second quarter of 2008: investors shunned emerging markets in general, but particularly those perceived as especially risky. Jason Mitchell reports.

In the short term, Argentina faces bigger financing problems than Venezuela. It is approaching the amortisation of US$23bn of debt next year and during 2010, while the latter can rely on its vast ‘petrodollars’. However, if the price of crude remains below US$100 per barrel for a sustained period, Venezuela may have to find external financing within two to three years.

Peter Hakim, president of the Inter-American Dialogue, a Washington DC-based thinktank, said: “Argentina is being forced to move closer to the international financial community, as it can no longer depend on Hugo Chavez for external financing and faces a spike in amortization payments. Currently, Venezuela does not need to tap the international markets but that could change within the next few years.”

According to JP Morgan’s EMBI index, Venezuela and Argentina have two of the highest spreads in Latin America: on 23 September, Argentina’s spread was 785 basis points while Venezuela’s was 838bps. Only Ecuador, one of the other main followers of heterodox economics in the region, has a higher spread, at 910bps. In comparison, Chile’s spread was 195bps while Brazil’s stood at 290bps.

Argentinean and Venezuelan spreads have worsened, and displayed among the highest volatility during the past three months, as international financial turmoil deepened. On July 7, Argentina’s spread stood at 627bps while Venezuela’s was at 585bps.

Argentina’s problems were caused, at least in part, by Hugo Chavez’s decision to churn a US$1bn bond issued by Argentina in August this year. The Argentine government faced considerable criticism from local commentators for issuing this bond at 15% interest, but it faced even more attacks when the Venezuelan government decided to churn it the following day. It led to a big drop in the price of sovereign Argentine paper.

Chavez’s move prompted the government, led by Cristina Fernández de Kirchner, to review its dependence on the Venezuelans. A total of US$6bn of debt has been bought by its tropical neighbour during the past few years. On September 2, the Argentine president surprised the international financial community by announcing that the government would use Central Bank’s reserves to re-pay US$6.7bn of Paris Club debt. However, on September 22, Cristina Kirchner had an even bigger surprise: before the Council on Foreign Relations in New York, she said that she was keen to reach an accord with the hold-outs on US$29bn of defaulted sovereign debt. On September 25, Barclays Capital was awarded the mandate by the government to work out a deal with the hold-outs.

It is not yet clear what the government will offer the hold-outs, but the bond-holders are demanding something more generous than the 76% hair-cut under the 2005 restructuring of US$88bn of debt. It is likely to offer them a longer-dated obligation, which could include a warrant linked to economic growth. However, economic growth is expected to slow to around 4%-5% next year, from highs of more than 8% during the past few years.

International investors saw settlement of issues with the Paris Club and the hold-outs as major hurdles in Argentina’s path to re-entering international capital markets, which have largely been closed to it since its 2001 to 2002 economic meltdown. But analysts said they are not the only hurdles.

“Cristina Kirchner, and her husband Néstor, realised they were being taken for a ride by Chavez after he churned this bond,” said Claudio Loser, former head of the western hemisphere at the IMF. “However, I think the Paris Club announcement was not handled in the best of fashions. The Argentine government did not sit down with the organisation before the move; they did not present it jointly. Furthermore, within a few days, the Paris Club said the true sum amounted to US$7.9bn after accrued interest.

“The move on the hold-outs is a necessary condition for the Argentines to access the markets but it will not be enough.”

In February 2007 the government began manipulating inflation statistics. Now, nobody in the country believes the official figures: in September official inflation stood at 9.1%, while local economists estimated it at 25%. Closer said clearing up the statistics is another key obstacle to the restoration of Argentine credibility. Even if the government is successful, it is unlikely to be enough to enable it to access the financial markets under current international conditions.

“Sorting out the inflation problem and ending the manipulation of the statistics is an absolute priority,” said Mario Blejer, a former president of the Argentine Central Bank. “The problem is that with no credible official figures, people’s expectations of inflation could well be higher than what the number is in reality, but this in itself is leading to a rise in inflation.”

The fact that a large proportion of ‘guaranteed loan’ obligations, issued in a mega-debt swap at the height of the 2001 crisis, mature next year has also pushed the Argentine government closer to international investors. Under the terms of the swap, bond-holders tendered their paper, most of which was coming due in 2001 and 2002, in exchange for the guaranteed loans – longer-dated obligations with a higher yield backed by taxation revenues.

Under Argentine law they are treated as loans and were unilaterally ‘pesified’ by the government in 2002, but never defaulted on. The government now wants to roll over this debt. It believes that, if it reaches an agreement with the hold-outs at the same time, it will be able to put its default status behind it, enabling it to issue new paper at lower and more affordable yields.

“The Argentine government has realised that its window for tapping the international markets through placements with the Venezuelan government has narrowed considerably, and that is why it is making these moves,” said Eduardo Levy-Yeyati, head of Barclays Capital's Latin America research. “Sovereign bond yields of 15 per cent are just not politically acceptable in the country.”

You go, Hugo

Venezuela is in a totally different situation. Surprisingly, unlike its southern neighbour, it does not manipulate official inflation, which now stands at a hefty 35% – one of the highest rates in the world. At US$100 a barrel for crude, Venezuela enjoys a petro-dollar income of US$70bn a year. The Central Bank and state-owned companies like oil company PDVSA have reserves north of US$200bn. (Argentina’s Central Bank reserves, by comparison, will be around US$40bn, following the re-payment of the Paris Club debt).

“Venezuela’s total external debt is US$60bn, and servicing it costs US$9bn a year,” said Domingo Maza, a former director of Venezuela’s Central Bank. “If the price of oil remains above US$100 for a long period, Venezuela will not need to tap international financial markets. If it drops below US$100 for an extended period, it would probably have to do so.”

“The economy faces many imbalances,” said Alberto Ramos, an analyst on Venezuela at Goldman Sachs. “Inflation is far too high, it needs to control spending on subsidies, the unofficial exchange rate is more than two times the official one, and imports have shot up. These policies are unsustainable. If the oil price were to drop for a long period, the country would face a financial crisis within two to three years.”

Venezuela churned the Argentine bond while executing its currency controls – there is a big shortage of the greenback. It also issues its own paper, to the tune of US$10bn a year, for the same reason. The official exchange rate is 2.15 bolivars to the US dollar but the unofficial rate is five bolivars to the dollar. At the end of last year it reached seven bolivars.

Venezuela buys bonds from Argentina before appointing an investment bank to turn them into a note, which is sold to local banks at the unofficial exchange rate. These banks transfer the notes to their overseas accounts and then sell them to the investment banks that originally structured them at the official exchange rate. The domestic banks, carefully selected by the government, earn large sums from this form of arbitrage; the government loses out, but obtains hard currency. The investment bank merely acts as the intermediary.

The Venezuelan press is currently speculating that the government will undertake an external debt buyback shortly. It could reach US$2bn, centred on global bonds due in 2010, 2013, and 2027 – higher than the US$1.5bn figure previously discussed in the market. The government will then issue new, longer-dated paper at a lower yield.

Inflation rates illustrate the more troubled waters into which Argentina and Venezuela have sailed: both are dependent on high prices of commodities, be it oil for Venezuela or soya for Argentina. Commodity falls have hurt them both.

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