Nomura's Latin America Fixed Income Strategist discusses the current challenges facing Venezuela
After months of delays and weeks of fine tuning, PdVSA was able to encourage an overall 39% participation rate in a debt exchange that extends the 2017 bond maturities an average of two years.
The Citgo equity collateral was the main incentive for what bondholders perceived as a “distressed” debt exchange. There are not many options at this acute phase of cashflow stress with Venezuela exhausting creative sources of financing and already compressing imports an average 75% over the past two years. The oil shock has exposed an extremely fragile economic framework after years of heterodox market intervention and expropriate of the private sector that has systemically reduced production capacity across the manufacturing, oil and electricity sectors and reinforced chronic capital flight. The Maduro Administration refuses to meaningfully alter the economic framework and instead has shifted towards autocratic governance to politically survive the chronic stagflation with two years of consecutive double digit decline in GDP, hyperinflation that is near four digits and a widespread humanitarian crisis.
The bottom line for bondholders is not IF but WHEN is the timing for debt default?
It is difficult to understand the willingness to pay and why Venezuela and PdVSA have preferred to service external debt as opposed to allocate scarce hard currency for essential imports necessary for domestic consumption and investment. It is the widespread shortages of essential imports (food and medicine) that contributes to the scarcity shock with a huge dependence upon imports for the secular destruction of domestic production capacity. We assume the “willingness to pay” external debt reflect the fear of default and the risk of interruption in their oil exports or attachment of their physical assets offshore. Venezuela could theoretically prioritize payment of external debt for several years with annual oil exports near $25bn that still far exceed the annual payments of external debt. This extreme financing strategy requires two pre-conditions: 1.) politically surviving chronic stagflation and 2) ability to defer and restructure fiscal skeletons of China loans, ICSID claims and arrears to oil suppliers.
However, this is not a medium term strategy.
The years of mismanagement and underinvestment is taking its toll on oil production capacity while the country continues to accumulate arrears to oil suppliers and importers. Sooner or later the decreasing petrodollar revenues will be unable to finance the increasing USD liabilities that will either force a hard debt default or, hopefully sooner, a political and then economic transition that allows for a favorable growth/inflation tradeoff that reinforces debt solvency.