Venezuela: Run Away
Walter Molano
Jun 9, 2010
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With bond spreads tight across the board, Venezuela and Argentina are the two countries that allow fund managers the ability to boost their performance. Of course, there are a slew of corporate bonds that also provide interesting yields—but they lack the depth and liquidity needed by many large fund managers. Both countries have decent credit metrics, but they have complicated political environments. With elections only a year away in Argentina, many people are hopeful that the political environment will improve. However, the situation in Venezuela is much worse—and quickly spiralling out of control. With the country’s infrastructure crumbling, inflation soaring and resources dwindling, President Chavez is starting to show signs of desperation. The electricity sector crisis was a stark reminder of the poor state of affairs in the country’s infrastructure. The same drought that crippled its hydroelectric facilities also wreaked havoc with the water system. Caracas found itself with such a shortage, that it was forced to introduce water rationing. Likewise, the lack of access to hard currency is making it more difficult to import goods, therefore food shortages are mounting. Moreover, fear of nationalization and confiscation is forcing more Venezuelans immigrate and send their assets abroad. As a result, the local production of essential goods is declining. All of this is pushing the country towards the brink of collapse. Therefore, there is only one recommendation—liquidate all Venezuelan positions before it is too late.
Many fund managers take comfort from Venezuela’s macroeconomic numbers. Venezuela’s debt to GDP ratio in 2009 was below 20%. The country posted a current account surplus of $9.7 billion—despite volatile oil prices. This year, the current account surplus should be more than twice as high. However, much of the improvement in the trade balance is due to declining imports. Thanks to the rationing of hard currency by CADIVI, importers are finding it more difficult to get the funds needed to secure foreign goods and services. This is one of the major factors behind the shortages that are mounting and the inflation rate that is soaring. It is also a major reason why the Venezuelan economy is imploding. The level of economic activity collapsed 5.8% y/y during the first quarter of this year. Industrial production plunged 9.9% y/y; largely due to power rationing. Transportation fell 15.9% y/y, commerce dropped 11.6% y/y and financial activity shrank 9.7% y/y. With the economy spinning out of control, Chavez is becoming desperate. In 2009, he issued $8.6 billion in local and international debentures. International reserves are down 25% since the start of the year—hovering around the $26 billion mark. Sensing the deterioration of the country’s macroeconomic indicators, some fund managers are opting for the bonds that were issued by PDVSA. They feel better about lending to the national oil company, since it has large holding abroad. Unfortunately, creditors are being subordinated by the recent loans given by the Chinese. These loans are repaid in oil production, which depresses the seniority of note holders. Likewise, CITGO, PDVSA’s major refining and distribution arm located in the U.S., recently issued $2.5 billion in notes, revolvers and loans, forcing Fitch to downgrade the company’s credit rating to B+ from BB-. Indeed, the refiner’s operating conditions are poor. The company lost $128 million during the first quarter of this year, and it was only able to get the deal done once it pledged the assets of its three refineries, oil inventories and accounts receivables. Therefore, the notion that PDVSA bond holders can gain access to the company’s international assets, such as the CITGO refineries, is pure fiction.
Therefore, the risks in Venezuela are huge, but they are getting worse. In addition to the country’s economic woes, social tensions are on the rise. Last week, President Chavez declared war on the “bourgeoisie.” He imprisoned many of the country’s top bankers, some of which are the so-called Boligarchs—associates who became incredibly rich under his Bolivarian regime. Most of the remaining bankers fled the country or are in hiding. He confiscated food stores owned by Polar, and many think it is only a matter of time until he intervenes the banks. Although he continues to enjoy the support of 50% of the population, he is creating an environment of class warfare—which could end up destroying the country. Such a scenario bodes poorly for bond holders, and any eventual debt restructuring will be ugly once the country destroys its productive assets. This, along with a major devaluation to above 10, would eventually lead to the collapse of the economy and the need to impose a massive haircut in order to stabilize the national accounts. Therefore, it’s time to sell everything in Venezuela and get out.
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