After being effectively shut out from global financial markets – a situation that was made more precarious by US sanctions prohibiting purchases of Venezuelan debt (unless you’re buying them off Goldman Sachs, should the bank’s asset-management arm desire to liquidate its $3 billion “hunger bond” position) – Venezuela is drawing ever-nearer to what the Financial Times describes as potentially the “messiest debt restructuring in history.”
So far, Venezuela has managed to forestall a default by stripping assets from its state-owned oil company, Petroleos de Venezuela, commonly referred to as PVDSA, and shaking down local institutions of spare dollars – not to mention the explicit financial support of China and Russia. Recently, Rosneft, the largest Russian oil company, helped support its troubled ally, which enjoys the largest crude reserves in the world, by offering billions of dollars in advance payments for future crude supplies. Thanks to a deal brokered by deceased former President Hugo Chavez, Venezuela has for years been Rosneft’s largest foreign supplier of crude. Last year, the oil giant accepted a 49.9% stake in PVDSA’s US-based subsidiary, Citgo, as collateral for a $1.5 billion loan.
Venezuelan President Nicolas Maduro
However, thanks to the US sanctions, which prohibit purchases of newly issued debt and existing bonds that have so far not been sold outside of Caracas, the country will once again need to innovate or risk sliding into bankruptcy. Making matters all the more urgent, the country recently suffered a loss in US courts after a judge ruled that Canadian miner Crystallex can seize Venezuelan money held in a custody account at Bank of New York Mellon to cover a $1.4 billion judgment awarded by a World Bank tribunal.
Crystallex’s victory could further embolden the country’s creditors, who collectively may be owed as much as $3.7 billion.
“Venezuela has been taken to the World Bank’s ICSID tribunal 43 times. Only Argentina has been subjected to more claims. Of these 24 are still pending, including claims from Anglo American, ConocoPhillips, Air Canada and Vestey. The Eurasia Group estimates that Venezuela owes a total of $3.7bn as a result of ICSID rulings, and Crystallex’s progress is likely to embolden other creditors.”
Adding to the country’s troubles, a major US clearing house has said it will stop settling some Venezuelan bonds, and Cantor Fitzgerald has stopped trading them altogether.
After months of rhetoric, the US – which for years maintained an uneasy business relationship with Venezuela, formerly South America’s wealthiest economy – has severed the country’s last tenuous ties to the global financial system…
“The message is that the US doesn’t want its financial system enabling the Venezuelan government in any way,” says Charles Blitzer, of Blitzer Consulting, who is a former International Monetary Fund official.
…And with the Crystallex ruling compounding the country’s troubles, its government is being set up for a “slow burn” leading ultimately to financial insolvency as creditors root out and seize whatever foreign assets they can find.
“Crystallex is the camel’s toe under the tent,” says Mark Weidemaier, a law professor at the University of North Carolina. “It will be a slow burn, but I wouldn’t be surprised to see people use the courts to ferret out where Venezuela’s assets are . . . and break down the barriers between the government, PDVSA and other entities.”
Typically, in a sovereign bankruptcy, creditors negotiate some kind of debt relief and trade their old, defaulted bonds for less valuable new ones. However, US sanctions may preclude this as an option for Venezuela, as the FT explains.
“…such a debt exchange would fall foul of the US sanctions regime, precluding any US banks from arranging one and any US bondholders from tendering their debts. In practice, it would mean indefinite financial purgatory for Venezuela until the US administration decides to lift the prohibition.
“If these sanctions stay in place, then Venezuela cannot restructure and it goes into limbo,” says Edward Al-Hussainy, a senior analyst at Columbia Threadneedle."
Since Venezuela’s economic crisis began four years ago, imports have fallen precipitously, leading to dire shortages of essentials like medicine and foodstuffs as the country's currency depreciated to the point of worthlessness. Unless the country can find some way to circumvent the sanctions, it will be forced to decide between countenancing further import declines, or a disorderly default.
According to Torino Capital, a Latin American-focused investment bank, Venezuela could choose the latter.
“Torino Capital…argued that this might counter-intuitively make a restructuring less likely. ‘It is possible that, faced with this choice, Venezuelan authorities end up deciding that the negative effects of a disorderly default on PDVSA’s capacity to generate export revenue are worse than the contractionary effects of further import cuts,’ the bank wrote in a note to clients.”
To be sure, a default could still be years away. And investors, for one, aren’t worried. The country’s debt has been largely unperturbed by the recent developments: PDVSA bonds have largely traded sideways, despite the recent developments.
“In the near term the impact will probably be minimal. Given Venezuela’s messy finances, the country is in practice already shut out of the international bond market. And while Crystallex won a legal skirmish, it is far from winning the war. It is unclear how much money Venezuela holds at BNYM and it may still be protected by sovereign immunity. Underscoring the investor view that little has changed, Venezuela and PDVA’s bonds have largely traded sideways.”
Still, a default, whenever it arrives, could signal the last gasp of the country’s embattled government. The country's foreign reserves have already fallen below $10 billion (though they received a boost following the Goldman deal...).
“If they default, they will be out of government within three months,” says Federico Kaune, head of emerging market debt at UBS Asset Management. “The calculation is that they’re either in government, in exile or jail.”
With the fate of the Maduro regime hanging in the balance, we imagine Washington will do everything in its power to force Venezuela into bankruptcy, allowing the US to claim victory over yet another foreign adversary.