Can Venezuela restructure its way out of disaster?

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London. — Despite a wealth of natural resources, Venezuela has turned into an economic and humanitarian disaster zone. As it teeters on the edge of default, Silvia Pavoni examines what may become the most complex sovereign debt restructuring in modern times — and a test of how China handles troubled foreign investments.
Venezuela is blessed with resources, from the largest proven oil reserves in the world, to bauxite, iron ore, gold and diamonds. Besides strategic minerals such as cobalt, which is used in hi-tech industries, it has Caribbean beaches and natural wonders such as Angel Falls.

It has the potential to be an economic paradise, yet the country is teetering on the edge of default, leaving the world wondering how a debt restructuring would work in the internationally sanctioned country, and how its most powerful partner, China, would deal with local investments turning sour.

“How do you destroy a country that has all these natural resources?” asks Russ Dallen in disbelief, the head of investment bank Caracas Capital and publisher of local newspaper the Latin American Herald Tribune.

An oil-fuelled collapse
Venezuela has based its economy on oil. The drop in prices of recent years — from $100 per barrel in 2014 to as low as $26 in 2016, and currently hovering at $60 — coupled with productivity issues, have hit its most important export. And despite the size of its reserves, Venezuela produces less than one-fifth of that oil that Saudi Arabia does, with volumes steadily declining too, according to analysts.

Reduced oil revenue translated into recession and in cuts to imports in Venezuela. The government has been funding its growing deficit through the central bank’s printing machine, resulting into hyperinflation. The country’s gross domestic product has dropped by 45 percent since 2014, according to Caracas Capital.

The vicious foreign exchange black market is just one example of the woeful economic situation. “If you give the government a dollar, they’ll give you 10 bolivars. If you give a dollar to a man in the street, or at the airport when you come in, they’ll give you 100,000 bolivars right now,” says Mr Dallen.

Venezuelans’ lives have been affected. “Imports are about one-quarter per capita of what they used to be,” says Ruth Krivoy, a former governor of Venezuela’s central bank and an adviser with management consultant GlobalSource Partners. “I don’t think anyone could have forecast that imports could fall [so drastically] and that lives would be as they are.” A study by three Venezuelan universities, called ‘the National Survey of Living Conditions’, found that in 2016 nearly three-quarters of respondents had lost an average of 8.6 kilograms in weight in 2016 because of food shortages.

Political footballs
Krivoy adds that food scarcity and its controlled distribution have created a vicious cycle that has granted stronger power to the current political leaders. The government provides basic goods at subsidised prices through a state-sponsored distribution system whereby every citizen gets a card to buy items, but is forced to enter into a registration process.
“There’s a link between this card and its access to goods and the voting process,” says Krivoy. In December, at the municipal elections, the ruling party allegedly set up kiosks next to or inside polling stations asking voters for their cards, adds Krivoy, “with the fear that the government would know whom they voted for”. After the victory at the local elections, the government might set an early date for the 2018 presidential elections.
While many observers wonder how much longer it will be before the economy collapses under the current circumstances, others are not so sure it will. Eric Farnsworth, vice-president of the Council of the Americas and the Americas Society, says: “Zimbabwe survived, and it didn’t have oil.”

As more Venezuelans leave the country in desperation, its fate becomes even more precarious, however. “You’ll continue to see people leave,” adds Mr Farnsworth.
“This is human capital that is not easy to replace. It’s the middle class, the managerial class, the petroleum engineers and the people who make the economy run. [But] once the middle classes depart any country, the pressure for political change reduces.”

Staying away
Ricardo Hausmann, director of the Centre for International Development at Harvard University and a former minister of planning for Venezuela, has described his country’s international debt issuances as “hunger bonds” and warned investors against buying them, as the cash-strapped government appears to be sacrificing the imports of food, medicines and other essential goods to keep payments up.

Meanwhile, the country might soon run out of foreign currency to repay its debt. Both the sovereign and PDVSA, the state-owned oil company, have missed payments in late 2017; rating agency Standard & Poor’s officially placed Venezuela in selective default and the International Swaps and Derivatives Association (ISDA) announced conditions had been reached to trigger the credit default swaps on both entities. Some estimates have the total of Venezuela’s foreign debt as high as $150bn; foreign reserves are believed to have dropped to below $10bn in July.

Investors are gearing up for potential restructuring negotiations, which are currently impossible because of the necessary issuance of new bonds, as part of any typical restructuring, which investors are prohibited from acquiring under the current sanctions. Furthermore, Venezuela’s government has tasked vice president Tareck El Aissami to lead potential discussions and he himself is an individually sanctioned person accused of drug trafficking by the US, along with other officials. Canada has also imposed similar measures. Bondholders were summoned to Caracas in November to discuss a possible restructuring but any US investors and corporate officers dealing with Mr El Aissami would run the risk of fines and prosecution resulting in as much as 30 years in prison.

“As things stand, there isn’t a chance of a debt restructuring with the Maduro government,” says Robert Koenigsberger, chief investment officer at investment specialist Gramercy

Funds Management.
“There is no way we at Gramercy or any US fund can participate in talks, given the sanctions. If you violate sanctions you don’t get to sleep in your own bed at night.”

Restructuring or litigation?
Investors seem to have their hands tied. Hung Tran, executive managing director at the Institute of International Finance, says that, following requests by members that own Venezuelan paper, the institute is bringing bondholders together to exchange information and try to understand the situation better, but that “conditions are not in place to even think about a restructuring”.

If debt restructuring is not an option, will litigation be a reasonable alternative?
“Now that we’re beginning to go down the default territory [following the S&P and ISDA announcements], I think you’ll see creditors assessing their strategy by reference to the rush to the courthouse — who’s going to get there more quickly?” says Deborah Zandstra, partner at law firm Clifford Chance.

But she adds that, as a restructuring practitioner, the preferred outcome would always be a rearranging of the debt that allows the sovereign to regain access to the market and get back on its feet without unduly damaging bondholders.

It is encouraging that most Venezuelan notes, at least the ones issued from 2004, include collective action clauses that — although requiring a high threshold of either 75 percent or 85 percent of votes, depending on the bond series — would help eliminate holdout issues and, therefore, further litigation.

Others believe that resorting to the courts is inadvisable as Caracas might manage to continue paying and that obtaining a court authorisation to seize the country’s or PDVSA’s foreign assets might end up amounting to very little.

Losing allies?
In December, PDVSA settled in a US court with Sinopec, China’s state-owned oil company, less than a week after the five-year-old dispute became public through Dallen’s newspaper.
The $21,5m sum agreed — without any admission of fault or liability — would be converted into renminbi and paid in two instalments, highlighting PDVSA’s cash troubles. Venezuela’s ability to pay remains unclear, as it emerged that obligations from previous settlements had not been met following the introduction of US sanctions.

Sinopec, China’s largest producer and supplier of refined oil products, and the country’s second largest crude oil producer, entered into a partnership with Venezuela’s oil company in 2010. And in its lawsuit, Sinopec had accused PDVSA of engaging in “intentional misrepresentations, deceit and concealment of material facts” involving “wilful deception” and a coordinated conspiracy among several of its subsidiaries, as reported by the Financial Times.

Sinopec is one of a number of oil producers still active in the country, including Chevron of the US, Italy’s ENI and Russia’s Rosneft. Moscow has been a supportive ally of Venezuela and has already extended loans and renegotiated conditions to help Caracas.

But China is the key player. Since 2007, it has lent a total of more than $62bn to Venezuela through its policy banks, China Development Bank and China Ex-Im Bank, according to the Inter-American Dialogue. There are further funds being channelled through foreign direct investment projects. Until recently, the loans had come without conditionality and were not tied to a particular use.

This began to change a couple of years ago, according to Margaret Myers, director of the Latin America and world programme at policy analysis centre Inter-American Dialogue, when the Asian giant started becoming concerned about deteriorating oil production. “We’ve had this debate among people who follow these loans and it seems like the $5bn loan disbursed in 2015 was linked, or [at least China] tried to link it, to oil production,” she says, adding that the subsequent 2016 $2.2bn loan was specifically directed at that aim, while no financing took place in 2017 up to mid-December, when The Banker went to press.

Sinopec’s lawsuit may be the most obvious sign that China is losing patience with its South American partner. Experts doubt, however, that this would lead to any action that would affect local politics because of Beijing’s well-known policy of non-interference in the domestic affairs of foreign countries. — The Banker.

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