Sunday, 20 January 2019

The Toilet Paper Economy

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The declining price of oil means Venezuelan president Nicolas Maduro is unlikely to survive if there is a bond default at the end of the year.

By any stretch of the imagination, Venezuela has problems. Under the stewardship of former bus driver, president Nicolas Maduro, the country is falling apart. It has the distinctly dubious honour of both the world’s worst inflation and GDP figures. Despite central bank assurances in mid-February that the country’s inflation rate in 2015 was only 180.9%, the International Monetary Fund believes that the real figure is closer to 700%. The IMF also reckons that the economy is likely to contract by 8% this year, following last year’s decline of 10%.

Since Maduro took over from Hugo Chavez in 2013, it is hard to describe how far the country has fallen. A cause celebre is that toilet paper has become an almost unaffordable luxury and one of which the country has almost run out on several occasions. Slightly more prosaically, power rationing and water shortages have become a way of life. So too has queuing, in a manner reminiscent of the darkest days behind the Iron Curtain, to the extent that it is much parodied and discussed in local newspapers.

Maduro has been doing a perfectly good job of running the country into the ground by himself, but what has changed the perpetual crisis into a potential disaster is the collapse in the price of oil. Thanks to its decline, Venezuela’s exports have dropped from US$97bn to US$37bn over the past three years, according to Bank of America. And this has raised the spectre of a sovereign default.

There has been much debate over the past few months when and if that might happen. The good news is, not in the short term.

“The debt on the sovereign bonds is manageable and the government is likely to manage its near-term principal payments,” said Erich Arispe, director at Fitch in New York.

The most recent payment was on February 26 for the US$1.5bn 5.75% 2016s. In actual fact, no one had any genuine doubts that that would be repaid and in the fortnight before it was due, the bond was trading around 95. More to the point, the next sovereign principal payment is not until 2018. “That gives the sovereign some breathing space,” he said.

Trouble brewing

But in the medium term, the outlook is not quite so rosy. Venezuela’s state-owned oil and natural gas company Petroleos de Venezuela, better known as PDVSA, has two bond payments due in the second half of the year. It has a US$1bn payment on its 5.125% 2016s in October and then a US$2.05bn payment as part of its amortising 2017s in November.

It is virtually impossible to disentangle PDVSA from the sovereign. It is not just an oil company, it is the main route for the country to get US dollars. No wonder then that analysts describe the industrial behemoth as the main lifeblood of Venezuela. And, as Casey Reckman, Latin American economist for Credit Suisse in New York, pointed out, “there is a high probability of default by Q4 unless some sort of liability management operation is conducted”.

A further problem – though one played down by analysts – is the lack of collective action clauses on some of Venezuela’s bonds. These clauses are helpful in the case of a bond default as they normally allow a restructuring to take place with a 75% approval from investors. A lack of these clauses can cause problems and delays. This is what happened to Argentina, which is why its default remained stuck in the courts and why the country was isolated from the capital markets.

Some of Venezuelan bonds are issued without collective action clauses. These include all of PDVSA’s US$35.6bn debt, as well as the sovereign’s US$4bn 9.25% September 2027s and its US$300m 13.625% August 2018s. The other 14 sovereign bonds outstanding, however, have them.

Analysts are not especially concerned about these clauses coming into play, partly because the amounts of money are small beer compared with other debt in the Venezuelan economy, but also because the debt is small when compared to that of other economies.

“A lack of collective action clauses can be problem. They need good faith negotiation and an ability to build consensus,” explained Stuart Culverhouse, global head of research at London-based brokerage Exotix. “This is what the Ukraine did and Argentina didn’t,” he said, though to put it into perspective he pointed out that Venezuela’s debt is smaller than that of both Argentina and Greece.

Until now, Venezuela’s knight in shining armour has been China. Between 2006 and 2014, it took on US$50bn of oil-backed Venezuelan debt, and several years ago extended the tenor of any three-year debt indefinitely.

But there is a sense that Chinese patience might be wearing thin. Alejandro Arreaza, analyst at Barclays in New York, estimated that Venezuela needs to pay around US$7bn this year.

“This amount is supposed to be paid with Venezuela’s daily oil deliveries,” he said. At current prices, the country needs nearly 800,000 barrels a day to satisfy its loan payments, more than three times the 228,000 that was needed when oil was at US$100 a barrel.

There is limited transparency with the arrangements with China. It is expected to renew a tranche C loan for US$5bn this year, but that could be as far as it goes. Indeed, there are unsubstantiated rumours that Venezuela has already asked for a two-year grace period, which China has declined.

“China has made a rod for its own back,” said Culverhouse. He reckons it is notable that Venezuela has not been as aggressively demanding as it was last year with Russia and China.

Economic Pollyannas have pointed – pace OPEC – to a potential rise in the price of oil. And it is certain that US$60 a barrel would make life slightly less painful, but bankers call a price rise like that a false hope. Quite aside from the fact that it takes several months before any movement in the price of oil hits finance ministry coffers, they point out that Venezuela’s difficulties are hardly new. “Venezuela had problems when oil was US$100 a barrel,” said one. “Even if oil goes up to US$60 a barrel, you are still going to have a scarcity of basic products, a high fiscal deficit and massive inflation.”

Trouble at the top

There is no getting away from the fact that Maduro is the real problem.

In mid-February, the president devalued the currency by 37% and raised the price of petrol in an attempt to stimulate the economy. The move was described by more than one observer as rearranging deckchairs on the Titanic.

“It is a milestone that petrol prices have risen, but they are still below the cost of production,” said Fitch’s Arispe. He argued that the fact it has taken Maduro and the government three years to do so is a sign of government weakness and, given the new economic reality, is a mere “drop in the bucket”.

It is true, for example that the exchange rate will drop from Bs6.3 to Bs10 to the US dollar. But any official move in currency is artificial. According to, which tracks the unofficial rate, one dollar on the black market at the end of February equalled Bs1,071, up from Bs190 a year previously.

And even though the price of petrol has gone up an eye-watering 6,000% to Bs6 a litre, one analyst dryly noted that “Venezuela’s oil went from being the cheapest in the world to the cheapest in the world”.

There has been some hope of the new government. In December, the Democratic Unity Round (MUD) opposition party won a crushing victory in legislative elections, winning 99 of 167 seats that were up for grabs and giving it control of the National Assembly for the first time in nearly 17 years. National Assembly president Henry Ramos Allup has boasted that the opposition will use constitutional means to remove Maduro within six months.

No one thinks that this can work.

“The MUD opposition coalition is trying to use the institutional channels. Chavista-controlled bodies like the Supreme Court and National Electoral Council could frustrate their efforts, though, so the end game could be messier,” warned Credit Suisse’s Reckman.

Certainly, courts are packed with Maduro loyalists. And while the country has shown some signs of democracy – a recent cabinet reshuffle as well as the election itself – many see this as sound and fury signifying nothing. It is still a very presidential system. A better sign of Maduro’s lack of grasp of reality is that one of the policy initiatives he trumpeted in February was that he had joined Facebook.

“This is a tyranny, which has been very successful in disguising [itself] as a democracy and has even allowed itself to lose an election,” said Moises Naim, former Venezuelan minister and fellow at the Carnegie Endowment for International Peace, recently.

Whether there is a formal bond default or not – and many people believe that Venezuela will probably muddle through as it has done for the past few years – there is growing noise both internally and internationally that Maduro must go. There are hopes that the end game will be civilised, but the fears are that it will not be.


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