Venezuela bonds face uncertainty after Chávez's death

A transition period at a time when Venezuela's deficit doubled to 8% last year from 2011 is a somber prospect for investors

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Venezuelan government bonds had been rallying in recent months as it became clear that Chávez would be leaving office due to illness. Venezuela’s five year CDS has fallen from 1280bp in 2011 when he was first diagnosed with cancer, to 640bp today, though that movement is more representative of the huge global rally in EM bonds throughout that time.

EM bond traders saw prices rise 50c-75c on Tuesday morning as it was announced the president had contracted a respiratory infection. Momentum built through the morning as rumors mounted that vice president Nicolás Maduro would speak around lunchtime, said one trader.

However, Maduro’s speech did not report Chávez’s death as expected, but rather reiterated that the demise of Chávez did not represent the demise of Chavismo, his political movement . Maduro hinted that Chávez’s cancer was an attack by enemies, adding that he intended to expel a US embassy official for meeting military officers and “planning to destabilize the country”. But Chávez’s death was reported shortly afterwards.

“Ladies and gentlemen, this is your new Venezuela president!” said one trader referring to Maduro’s speech in a note, adding that a sell-off had followed the speech and the news of the president’s passing.

All of Venezuela’s B2/B+ rated bonds closed wider on Tuesday than 24 hours earlier. The 7.65% 2025 notes closed at 90.75/91.5 on March 5 versus 92/93 on March 4, while the longest-dated 7% notes due 2038 traded down to 82.1/83.1 from 82.9/83.9.

PRICED IN

In the short term, the effect of Chávez’s death itself is limited, as the market had been gearing up for the transition for a few months. As a February 26 note from Siobhan Morden, head of Latin America strategy at Jefferies, said, a run-off between Maduro and opposition leader was already expected, “it was just a question of timing”.

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Morden said in the research note that there had been “impressive gains” in Venezuelan bonds over the past few months, based on the expectation of Chávez’s death and the recent devaluation of the bolivar, Venezuela’s currency.

“What is clear to us is the shift towards more two-sided event risk surrounding the political transition and the economic policy management,” said Morden. “The recent price action suggests that most of the ‘good news’ is already discounted in terms of the Chavez departure and the policy adjustment on the recent FX devaluation.”

Chávez revealed he had a tumor 21 months ago, and had not been seen in public since emergency surgery in Cuba on December 11 last year.

“From our perspective, Chávez’s death just confirms what we’d been expecting for a long time. This just sets the wheels in motion for the transition,” Aaron Freedman, senior credit officer for Venezuela at Moody’s, told EuroWeek Emerging Markets. “Our view is that risks are weighted to the downside in the short to medium term, and that things are likely to get worse before they get better.”

The end of a government so dominated by one man in likely to cause high volatility.

‘“Institutions’ is a fraught term in Venezuela — really it’s been a case of the absence of institutions,” added Freedman. “There was a man, and that man is gone. It could be a case of ‘Apres moi le déluge’.”

The devaluation of the bolivar may have also played a part in the recent rally in Venezuelan bonds.

“For external bondholders, the devaluation should be net-net positive,” said JP Morgan in a presentation on February 26. “Devaluation helps fiscal accounts and the end of SITME (the secondary platform abolished in February through which local banks could sell the bonds to international investors in dollars) for now should limit new bond supply to international markets.”

NEGATIVE OUTLOOK

Since 2010, Venezuela sold dollar-denominated government and PDVSA (state oil company) bonds to local banks in exchange for local currency at a fixed exchange rate.

Moody’s placed Venezuela’s B2 rating on negative outlook on January 15 after viewing Chávez’s failure to attend his inauguration ceremony as a sign of imminent political transition. The sovereign’s rating has always reflected political event risk given the weakness of the institutions and the strong presence of the person in power.

However the timing of the transition is more problematic than anything, due to significant economic and fiscal challenges, according to Freedman.

“The government deficit ballooned in 2012 in advance of the presidential elections; the current account remains in surplus but shrank significantly last year; and there are widespread reports of dollar scarcity despite the current account surplus, driven by continued capital flight which is probably only going to pick up now,” he said.

Moreover, said Freedman, any incoming administration — whether it’s Chavista or an opposition administration — will have a hard time making the adjustments necessary to arrest the deterioration, “because the adjustments will be very politically painful, and any government’s authority will be shaky initially”.

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