Investors have found a new buzzword to discuss Latin America’s high-beta, high yielding sovereign borrowers, Venezuela and Argentina.
Pragmatism, apparently, has helped drive yields on Venezuela's sovereign bonds several percentage points tighter in 2014. After hitting a dollar price low of 63.7 on February 19, Venezuela’s benchmark 2017s have rallied to hit a high for the year of 84.375 on May 8.
But local commentators receive talk of "economic pragmatism" with a chuckle and a resigned shake of the head, having dealt with the regimes at closer quarters, and for longer than their international counterparts.
Venezuelans who oppose Nicolás Maduro have no hopes of a friendlier (or more pragmatic) regime for now, but the country did manage to issue $5bn of amortising 2026 notes among Venezuelan public banks via state-owned oil company PDVSA.
On the surface, there are some elements of pragmatism in the bond. Firstly, PDVSA has timed the issuance infinitely better than its previous bond in November 2013. Back then investors were fleeing from Venezuelan debt. Now, they’re flooding in.
And when the company and sovereign went on their previous debt spree beginning in 2009, double-digit coupons were the norm. Hence the $732.5m of debt service payments PDVSA and the Venezuelan government had to make in February this year.
At a 6% coupon, the new deal sounds like a much more bearable interest burden for the borrower.
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The supposed pragmatism in recent Venezuelan economic policy involved the creation of Sicad II, a new exchange rate mechanism that pumps much-needed dollars into the economy.
The government’s two exchange rate systems for buying dollars set the exchange rate at 10 bolivars per dollar for Sicad I and 49 per dollar for Sicad II. The parallel free market rate is just over 72 bolivars.
In other words, the Bs31.5bn in bolivars that PDVSA will receive from the $5bn debt issuance would be worth under $650m in Sicad II, and under $450m in the free market. Therefore the proceeds of the bond are — for the company — a whole load of bolivars worth a lot less than the additional money it owes.
Oh, and of course no one will accept 6% for any Venezuelan bond – let alone for a 10 year.
So if the public banks sell the bonds into Sicad I or Sicad II at cash value in order to fund the exchange rate mechanisms, they will sell at around 60%-65% of face value to meet the 12%-13% yield on a 10 year Venezuelan bond.
Of course one cannot be sure of the ins and outs of how the dollars will leave investors’ pockets and pass through the system onto PDVSA’s balance sheet. But it is clear that Venezuela’s oil company is not receiving $5bn of money for investments, and that the cost will not be 6%.
The complexity of the exchange rate system and the lengths PDVSA must go to so that it can raise debt demonstrate chaos, not the supposed “pragmatism” that has driven Venezuelan bond yields tighter.
More importantly, PDVSA’s oil exports have fallen more than 100,000 barrels a day in the last year due to lack of investment, according to Barclays. This has been “one of the key drivers of the deterioration in the external position of the government during the past year”.
Oil revenues have almost entirely funded the Bolivarian Revolution. So even the staunchest Chavista would have to admit that there is little “pragmatism” in allowing PDVSA, the country’s greatest asset, to fall into decay.
PDVSA’s latest bond issue is detrimental to the company – loading it with debt for little benefit – and this shows that talk of pragmatism from Venezula is far off the mark.