Oil Sky-Rockets, Venezuelan Bonds Plunge


It takes a minute or two to fully absorb this Bloomberg chart:

It shows the correlation between oil prices and Venezuelan sovereign bond prices. Venezuela’s ability to pay its debts is tightly bound up with PDVSA’s earning power, so oil prices and Venezuelan bond prices usually move in lockstep. In normal times, the more money oil brings in, the less international investors perceive Venezuela as a default risk, the more Venezuelan bonds they’re willing to buy.

But these are not normal times: the republic and PDVSA have been issuing new debt at such a dizzying rate – $10.8 bn just since last August! – that not even the Oil Boom of 2011 can sustain investors’ faith in Venezuelan paper. And so, as oil jumps to over $100 a barrel again, that longstanding correlation between the price of oil and the price of Venezuelan bonds has broken down.

To my mind, this all comes back to Giordani’s batshit-crazy Forex policy: thanks to his convoluted Sitme mechanism, Venezuelan dollar buyers are forced to keep selling sovereign bonds abroad to gain access to dollars – a steady and “artificial” source of downward pressure on bond prices that, arguably, is not directly related to the country’s capacity to pay. And since the system can only remain “liquid” with a steady supply of fresh paper people can buy for bolivars and sell on for dollars, the only way the government can keep the Forex market supplied is by issuing more and more and more debt.

It really is madness.

So do those tanking bond prices show Venezuela really is the riskiest place to buy sovereign bonds on earth?

Not necessarily. To put it an Austrian spin on it, government intervention always distorts prices and distorted prices always carry faulty information about underlying economic realities involved. Just like the government’s ham-fisted intervention in the market for sanitary towels makes the sticker price on a pack of Kotex convey faulty information about their scarcity, forcing women to scurry all over town trying to find one during their time-of-month, its ham-fisted intervention in the currency market distorts the sovereign bond market, leaving bonds with prices that convey screwy information about their own riskiness.

El librito – the standard macroeconomic textbook – has nothing very specific to say about the twisted nexus of distortions that goes by the name of Sitme: it’s too weird a mechanism to have received a lot of theoretical attention. (I don’t know of any other country that’s ever tried anything quite like it, actually.) So I’m leary of making grand ponouncements on the basis of a mechanism that nobody understands all that well.

My sense is that reading Venezuelan bond prices too literally as an indicator of default risk is not quite right under these circumstances.

Yet it’s also clear that any currency control regime that depends on an endless supply of new bond issues is…let’s say, “suboptimally sustainable”.

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    • Is sort of does, in a screwy way. The new bonds aren’t (mostly) about paying off the old bond holders…they’re about letting more people flee with their capital!

      Granted, that’s pretty Ponzi-ish too…

    • That’s the impression I get too. If there is one word that describes Venezuela’s government it is recklessness. They are in a constant survival mode, digging holes all over the place to fill up massive craters that their irresponsibility has formed. This means that they are not concerned at all about mortgaging the whole country or even defaulting on their payments at some point. The goal right now is to survive until the 2012 election (and win it, of course). It is so preposterous what they are doing that it is difficult to believe. But it is not too complicated and in my opinion is even worse than a Ponzi scheme. One thing is clearly apparent: The country depends on oil exports but PDVSA is progressively becoming more inefficient and has seen its production capacity drastically reduced. On the mean time, the government has established an insane system of subsidies that has progressively crawled to become an unsustainable burden for the budget (namely the gasoline and food subsidies). In a scenario where expenses increase and revenues decrease (even with an oil barrel scraping the $100 mark), the only option they have is to keep loaning money at whatever cost. The question of how the country will pay is for the revolutionary government completely irrelevant, not because it is not important but because they don’t have a clue about what else to do. They will soon replace the plagiaristic “Patria o Muerte” by a much more adequate motto coined by Eudomar Santos: “Como vaya viniendo, vamos viendo”.

  1. I have never given that much thought to the connection between the exchange rate and the huge debt. I mean, it’s obvious that all that debt is needed to allow some importers and/or good friends of the chavismo some access to the ca$h. I get that. But how about mid/long term effects?

    The official currency rate is fictitious and a new government in 2012 will have to get rid of it, but how could the huge national debt affect that decision? Where would that all this debt leave a potential new government in 2012? Should that make the decision easier, harder, or are they totally unrelated?

  2. Here’s what I don’t get.

    You state, and I’m sure most readers would agree: “government intervention always distorts prices and distorted prices always carry faulty information about underlying scarcity of the products involved, with screwy consequences down the line. Just like the government’s ham-fisted intervention in the market for sanitary towels forces women to scurry all over town trying to find a pack of Kotex once a month, its ham-fisted intervention in the currency market distorts the sovereign bond market, leaving bonds with prices that convey screwy information about their own riskiness.”

    I get that. But then the very people who believe the above can’t seem to generalize that same proper thinking to all government actions regarding market spending or policy. For example, that the government using oil money to “do good things” for the country causes prices that convey just as screwy information about their values than what you describe for bonds or sanitary towels.

    The same way that most people agree that giving all the oil money to a single or a few industries, is clearly screwy, those same people can’t see that it’s still screwy to give it to many, or even to all. It’s screwy to give money to a business when it’s not in exchange for a competitive sale of good or service freely chosen by an interested conusmer.

    To take it further, those same people don’t realize that instead of businesses, the money causes less screwiness if it goes to people, letting people be interested consumers with it. But even this is screwy with the prices of goods and services if you get screwy with the selection of the recipients. Most people don’t get that to help the market the most with non tax money, without screwing any information conveyed by prices, one needs to oil up the whole market machine with equal money to all consumers, eliminating poverty, to boot.

    That most people don’t get that is what I don’t get.

  3. Another way of explaining this is that the spread on Venezuelan bonds is not reflective of the risk assessment, but of the excess supply of Venezuelan bonds out there, which makes their price plummet. And the excess supply is caused by the government’s need to sell lots of dollars in the black market.

    Then again, that’s kind of what you’re saying, right? Perhaps it would be clearer if people understood the inverse relationship between the price of a bond and the interest it yields.

  4. There is excess supply and limited demand. Funds that invest or can invest in Venezuela are limited in number and have finite amounts of money to invest. Venezuela is not investment grade. I was actually thinking of quantifying emerging market funds this week to take advantage of Carnival, this would leave out hedge funds, but it would give an order of magnitude estimate. Except that there are sooooo many funds. I may still do it and compare that to the EMBI index fro Venezuela and get some sense of the oversupply.

  5. Quico,

    I haven’t looked at the numbers in too much detail but the government is essentially undoing its own capital controls and financing capital flight. I think of it as drawing on “negative” international reserves in order to maintain a fixed exchange rate. The main difference–relative to drawing down on reserves–is that you have to generate a high enough premium to make foreign investors willing to hold these new bonds. The magnitude of the spread clearly reflects there is little appetite for Venezuelan debt.

    When big chunks of this debt comes due, will a hypothetical future government have the balls to contract fiscal policy for a sustained period–to generate enough FX to repay? The premia has to reflect–to a large extent–the lack of credibility of the current government (which may, sigh, still be in power in ten years or so). How can this not be rational when we have a president that pesters constantly with diatribes against global capitalism? An economic system in which, by the way, the sanctity of debt contracts rank pretty high.

    Beyond the high premia, is this policy sustainable? I guess it depends on how many new foreign liabilities are being created–relative to existing liabilities (present and future large non-oil current account deficits Venezuela is used to, current debt–including the Chinese one) and assets (current and future oil revenues, reserves, all those misterious forex funds the government supposedly has). IMHO, given how the government and venezuelans have gotten used to living off the fat of the land, I think we are headed toward a balance of payment crisis. Even if (unless?) oil shoots to 150 dollars a barrel… There is no way the government is going to revert this policy now that we’re already in 2012 campaign mode.

  6. OK, did not have to do the work, somebody keeps track. The total amount of dedicated EM market $ bond funds is US$ 46 billion and another US$ 26 billion in “blended”. If you assume 50% in the blended, the total is US$ 59 billion. This leaves out non-dedicated funds, but you can see that a US$ 3 billion issue by Venezuela is a large issue, thus the sequential issuance (12.15 billion since last summer) is simply HUGE for markets to absorb.

  7. Thanks moctavio. I’m suprised by the small size of the EM market; I guess only a handful of EMs issue debt (twenty, thirty?) in international capital markets.

    That said, I would expect there to be quite a bit of appetite for EM debt right now: US interest rates are low, liquidity is abundant, capital flows are rushing into all emerging markets. The fact that, in this environment, the government is quickly running up against a very downward sloping demand curve for its debt is further proof the current exchange rate policy is clearly not sustainable. At what premium is Giordani going to realize this policy is insane? I mean, this policy would not be sustainable even if the government had a US$ 100 billion in reserves: losing dollars at such pace is a clear sign the currency is way off.

    Also, the fact that an oil producing country–which has received hundreds of millions of dollars of FX revenue in the last decade–doesnt have enough reserves to support its fixed exchange rate regime and must resort to expensive debt to do the job would send a chill down the spine of any rational foreign investor.

  8. And they don’t issue as often either. To give you an idea, Brazil’s bond’s in US$ are about 47 billion, Ukraine 8 billion, Colombia 15 billion, Indonesia 17 billion and Argentina 59, with most maturities in 2030-on. Republic+PDVSA is 52.

  9. Raspando la olla y que el que venga luego que resuelva…

    It should be sending the chills to Venezuelians and opposition leaders, but somehow, they are all bus fighting over primarias and 2012 elections…

  10. Rafael: Perhaps a better way of doing it is rather than use the data on funds, look at the nominal value of all bonds in the index, it may be more realistic. The nominal value of all bonds in the EMBI Index is 37 billion and Venezulea is 7.4% of that or US$ 27 billion. That means, that a 3 billion dollar issue is 10% of Venezuela’s existing weight in the index, that seems like a lot to issue at once.

  11. I’m not sure I understand this.

    Someone who has bolivars (B) wants dollars ($). Venezuela’s currency regulations prohibit exchanging B for $, except as permitted by CADIVI, which sells $ for B to persons holding quotas (i.e. people with chavista connections).

    Anyone else must buy a Venezuela government bond denominated in B. This bond can be then be sold for $. But why would anyone exchange $ for such a bond? Interest and principal come in B, and B can’t be turned into $. If B could be used to buy goods which could be exported and sold for $, maybe.

    But the only real exportable good in Venezuela is oil, and I don’t think PDVSA will sell oil for B.

    Anyone who pays $ for a B bond is betting that someday B will be convertible to $. What’s the discounted value of that expectation? 50%?

  12. muchas gracias y muy interresante – the spread over US treasury implied by dollar denominated 10 yr bond just looks too high versus, say Peru, which one is mispriced?


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