Daily Management Review

How soon will a default occur in Venezuela?


Last week, the government of a country, which possesses the world's largest oil reserves, failed to make payments on coupon income on bonds totaling $ 586 million. However, these payments have preferential periods of 30 days, which Venezuela used. The country is trying to find means to pay off payments on this Friday, October 27, and next Thursday, November 2.

State-owned oil company PDVSA should pay $ 985 million this week, and another $ 1.2 billion - in six days. These payments of about $ 2.2 billion do not have grace periods, and their absence can lead to the fact that bond investors will start to call for default. Such a result will result in a plunge into an even deeper crisis and, possibly, a half of oil production, which has already declined last year due to lack of investment.

Not only does oil production decline; the quality of oil in Venezuela is also deteriorating due to the lack of funds for PDVSA to handle heavy oil.

Analysts came to the conclusion that Venezuela will make payments this week and after that, at any cost. But experts also believe that ownership of Venezuelan bonds is more incompatible with socially responsible investment. There are many assumptions on the market regarding payments missed last week.

Does Nicolas Maduro have no money? Is he saving cash from these earlier payments with grace periods to make payments that cannot be missed? Or did the recent US sanctions hamper the banking system?

Regardless of the reason for the missed payments, all but creditors hope that Venezuela will handle these two payments within the next 10 days.

Venezuela has reached a turning point, says Nathan B. Sandler, co-founder and managing partner of ICE Canyon, an investment management company specializing in emerging markets, including Venezuela.

Capital markets are the most important moment for the Venezuelan regime, but given the current situation in the country, "we believe that the ownership of Venezuelan bonds is morally incompatible with socially responsible investment," Sandler said.

The expert also suggests that the current sanctions are rather weak and do not give the intended results, and the US should tighten sanctions by banning the import of oil from Venezuela and expanding the list of sanctions.

According to Sandler, Venezuela uses cash and credit from China and Russia in oil-for-cash transactions, which helps to avoid default.

According to the rating agency Fitch, despite the fact that the regime needs Russia's support, Venezuela's international reserves fell to less than $ 10 billion in August.

"The report on the authorities’ payments demonstrated the strong willingness of the country to service the debt on the background of serious economic and political stresses, but the expected reduction in the international reserve position in the context of sanctions will seriously affect the ability and readiness of the government to continue timely debt servicing," Fitch said, having downgraded Venezuela's sovereign rating after the latest US sanctions.

Only this month, Venezuela should already conduct a series of payments on debts with grace periods. Regardless of whether Venezuela will conduct payments without a grace period, the next 10 days will reflect a real and financial willingness, including whether the country is able to continue to service the debt. According to experts, even if the government does not make two forthcoming payments, one cannot be sure that bondholders will want to cause a default.

"Most of the bonds are linked to US funds or local investors who will not have the incentive to initiate a default," said Lutz Röhmeyer at Landesbank Berlin Investment, the 13th largest registered bond holder of the PDVSA of 2017.

Nevertheless, credit default swaps show that investors expect PDVSA default in the next 5 years with a probability of 99% and in the next 12 months with a probability of 75%.

The default may not happen next week, but it is definitely on the horizon of this oil-rich country, which is struggling to pay for gasoline imports and feed its own people.

source: cnbc.com