Still Two Sets To Go, Quico

Federer of Switzerland hits return to Djokovic of Serbia in their semi-final match of the Paris Masters tennis tournament in Paris(This is a guest post by a long time reader, MacPapas Medianas, who is writing from the second floor of what was once the highest grossing McDonalds in Latin America — a.k.a., el McDonalds de La Castellana).

The consensus in the opposition is that the Venezuelan government is full of incapable bureaucrats who are steering the economy off a cliff and to certain external default. That’s not surprising. We love nothing better than a good fatalistic narrative, and the conventional wisdom has been hardening around this one. Quico went as far to describe the debate as “over”, with default the clear winner.

But then the question is, when?

Most of the Wall Street types who get paid a lot of money to have informed opinions about Venezuela agree that at current oil prices, the government will have the capacity to pay its debts through 2015. Analysts also have their opinions about 2016 but mostly keep quiet about them. 2016 is too far out to make predictions; a lot could happen between now and then.

In the longer run Venezuela will, of course, need to earn more dollars than it spends; otherwise the debt it takes out to make up for the difference will become too big to pay off. That’s just common sense. But given its reserves and its cash flows, Wall Street types think that if shit hits the fan and Venezuela defaults, it will be in 2016 or beyond.

Still, if you watch the news, Chavismo seems crazy.

Why is Wall Street so confident about their continued willingness and ability to pay through 2015? Simple.

Ever since oil began to fall from its $109 high in June, all the way down to $75, where it is now, the government has been adjusting. Because they haven’t announced the adjustment measures together or called them a strategy, we often fail to see that they amount to a strategy.

But here are the facts. Since June, the government has:

  1. Reduced oil shipments to Petrocaribe and Cuba (the portion Cuba resells for a profit) and improved financing terms for Venezuela (more upfront cash, less loans). This could net Venezuela 100,000 barrels a day which amounts to about $3 billion dollars cash a year.
  2. Cut public sector spending. Although the government could certainly use the popularity from additional spending with Maduro’s approval at 30%, it reduced its budget by $2-3 billion this year.
  3. Cut dollar allocations to the private sector. Virtually no bidders are getting CENCOEX at 6.30 VEB/USD, and allocations to Sicad-I and Sicad-II (at 12 and 50 VEB/USD, respectively) have been meager. The reductions have saved the government a one or two billion this year.
  4. Managed payables. The PDVSA pension fund has been buying bonds that mature in 2014 and 2015 to reduce payments when bonds mature and the moneys are due. As much as 60% of the PDVSA 2014’s that matured this October were already owned by the pension fund or the government.
  5. Renegotiated the terms of Chinese loans. The disclosures have been opaque, but word on the street is that Venezuela managed to remove or modify the requirement for a minimum amount of barrels to be shipped to china every day—freeing up an additional $2-3 billion in cash per year.
  6. Delayed or cancelled costly infrastructure programs. This also saves the government precious dollars.
  7. Explored a possible sale of CITGO. Although various government spokespeople are on tape saying that CITGO is no longer for sale, executives from foreign oil companies toured the facilities just last week. PDVSA might want to have a bidder ready in case of an emergency.

I don’t know about you, but that looks to me like a relatively organized and coherent set of measures you would undertake only in order to make sure you could service your foreign debt.

Is that all? Hardly. There’s plenty of talk of other measures in the pipeline, though not yet agreed. For instance:

  1. Securitizing some of the $20 billion plus Venezuela has in receivables from Petrocaribe members and putting those bundled securities up for sale. Depending on the scale and characteristics of the securitization, it could raise the government from $1-5 billion.
  2. Giving foreign oil companies access to the Sicad-II rate so they can buy Bolivares for less to cover operating expenses and increase the profitability of their investments. There are literally billions of dollars in investments lined up. Giving foreign oil partners better terms could unleash that.

The external adjustment has never been announced, but it’s real.

Sure, the government’s management of the internal economy has been a disaster. Free gasoline, sky-high inflation, a broken exchange system, bachaquerópolis and a fiscal deficit of 15-20% of GDP (financed with printed money) are just the tip of the iceberg. But externally, in terms of its dollar inflows and outflows, Venezuela is closer to kosher than crazy.

And however erratic domestic policy-making gets, some facts don’t change. Key among them: the government cannot afford to default.

After all, what would it gain? Not much. It might be able to cut annual payments of principal and interest of around $10 billion a year to about $5 billion a year after it restructures the debt. But this is an economy that brings in $60-90 billion Venezuela every year from oil sales. Really, it’s going to cut itself off from international debt markets to save $5 billion? It doesn’t make sense.

On the other hand, what does the government have to lose from a default? A lot. First, the government will lose access to the credit markets it now uses to finance imports (by selling dollar-denominated bonds for Bolivares through Sicad-I and Sicad-II). A sudden stop to imports could worsen the already critical goods scarcity and be a severe shock to the economy, lowering the government’s popularity to dangerous levels. They could bypass this problem by issuing local-law, dollar-denominated bonds to pay importers (like Argentina) did but I don’t know if any importer would be crazy enough to trust Vene law after they just defaulted.

Second, PDVSA owns CITGO, a handful of other refineries in the Jamaica, Curacao and elsewhere, 23 oil tankers containing 30 million barrels of oil and a fleet of corporate jets: all of that could also be seized by defaulted bondholders. That’s not to be taken lightly, they need those corporate jets…how else are they supposed to get their nannies around?

What’s more, Chavistas have a lot of their own proceeds from corruption and influence peddling in Venezuelan bonds. If their investments tanked, god knows what these people could do (mutiny?). And then the public sector would come under serious financial scrutiny in a default, almost certainly revealing, fraud, corruption, and narco complicity.

Finally, the restructuring negotiations and media firestorm that characterize defaults would divide the government’s attention between default management and taking steps to ensure they stay in power—something they need to focus on at 30% approval.

If the government has the slightest clue what’s good for it, it will avoid default. That is why I think Venezuela will maneuver as much as it can before missing a payment. Maybe Chavez could have pulled off a default with minimal damage—he had the political chops to do it with grace, and maybe even come out on top. But Maduro, at 30% popularity? Please…

I should say this: if oil falls another 15 dollars, then all bets are off. At 60 dollars per barrel, Venezuela might not be able to pay the debt even if it wants to. But if oil hovers around these levels, I think it’s safe to say that the government likely can and likely pay through 2015.

We have to admit that some Chavista decision-makers are minimally rational and competent. They understand the basic cost-benefit outlook. They don’t want to default. They will avoid it while they can.