Roubini Global’s Walter
Molino Molano* seems to have forgotten a basic tenet of bond analysis. In his several paragraphs detailing the general crumminess of Venezuela’s economy and the non-recoverability of bond collateral, Molano never explains why exactly people should avoid Venezuelan bonds.
The bonds at issue, mentioned in the prior post, can give investors a theoretical 20% annual yield. That means that lenders (banks, investment funds, and some individuals) can buy a bond maturing in 5 years, for about half of face value, with a 5% annual coupon, and get back about 20% per year on the investment, as well as getting the original investment back upon maturity. However, Molano says everything is going to hell, headlining his article “Run Away.” He says to sell Venezuela holdings. His point seems to be, though he never spells it out, that 20% returns aren’t useful if the underlying country disappears, goes bankrupt, or otherwise defaults on its debt.
It’s a fair point, but Molano never gets around to addressing the probability of default. It’s like he has fun listing the potential downsides of a Venezuela bond holding, without ever estimating either the likelihood of default or the possible recovery value of the bonds — that is, how much money investors would get back in a default.
Nothing in the Bolivarian Republic is predictable. But there are a few principles that can help people make their decisions. First, skip the usual credit metrics. Sadly, our friends at S&P, Fitch and Moody’s frequently city Venezuela’s publicly stated debt-GDP ratio, among other “objective” standards, as evidence of creditworthiness. Both sides of the debt-GDP ratio are suspect: there may be billions of dollars more of off-the-books debt, along the lines of the advance sales of iron and oil to China and of aluminum to Glencore. And coverting GDP estimates to dollars is tricky in a country with four currency exchange rates and purchasing power parity that is subject to on-again, off-again government handouts, price controls and shortages. So let’s forget these guys, as their analysis works great for serious countries, and not so well for places that are run like a slightly more stoned UC Santa Cruz student government.
There is only one risk that really matters in Venezuela: Does President Hugo Chavez want to default? If so, it’ll happen. If not, it’s very unlikely.
The main argument that Venezuela won’t default is the list of projects in the prior post. A default would halt pretty much all of them by cutting off useful sources of financing. Sure, the country can get some money from advance oil sales to China or mortgaging the blood plasma of the unborn, for that matter, but so far even China and Brazil have been unwilling to expand lending to Venezuela to nearly the degree that Chavez has requested. Recent offers have all been for loans that never get to Venezuela, but rather pay for the work of Chinese or Brazilian companies in those countries’ currencies. That won’t work for joint ventures with private companies from Spain or the U.S.
Another argument is that Chavez’s cronies are the ones who are getting rich on the bond issues, and they are going to want to keep the gravy flowing. This is the sort of personalist, situational argument that people who have never lived in Venezuela often ignore. Those of us who must tolerate the daily corruption know how much inertia it can add to any system.
Finally, the country uses the international bond market as a substitute for a currency market, so as to maintain Chavez’s preference for currency controls without cutting Venezuela off completely from international trade. I don’t know if the current official system will last more thana week, but regardless, bonds have long been the only game in town for moving bolivar-denominated wealth into more liquid dollar or euro bank accounts.
I think that over the next 18 months, default is a minimal risk. However, I don’t know. And Walter Molano doesn’t know, or at least he doesn’t give any reason to think he knows. Election season 2012 and beyond? I doubt that anyone knows, including Chavez’s most trusted advisors like Fidel Castro. All we can do is look backward, as crises have come and gone. In a series of tight spots, Chavez has always chosen to remain current on the debt, even backing off plans to pull out of the IMF, for example, when it emerged that such a move would be a technical default. For all the bluster, Chavez has been obsequious to the bond market.
Finally, if you are a small investor thinking of buying PDVSA bonds, it may be that the best, albeit fraudulent, way to do it would be to buy your bolivars at 8 to the dollar on the black market and then tell the Central Bank of Venezuela that you need to buy bonds to get dollars to import food or medicine. If you can get the bonds for 2.3 bolivars per dollar of face value (the going rate at the Central Bank), you are going to get a yield well above 30% a year. I’m sure I’m not the only one who sees the potential profits here.
*Who’s the dummy now, pal? Thanks to reader DC for the correction, name fixed throughout.