Sat | Dec 3, 2016

Venezuela: A tough adjustment

Published:Friday | February 20, 2015 | 12:00 AM
File An aerial view shows PDVSA's Puerto La Cruz refinery complex at Anzoategui, Venezuela. Walter Molano says that after 2008 countries such as Venezuela spent massively on energy subsidies, taking the form of virtually free gasolene.

Driving through Caracas can be a nightmare. Traffic jams, street vendors and political protests can transform a 15-minute jaunt into an hour and half crawl.

Scheduling business meetings must be an exact science, taking into consideration the proximity of locations and the time of day.

However, traffic is no longer an issue. Cars move gracefully from one side of the city to the other, without interruptions and regardless of the time of day.

The reason for the lack of congestion is the draconian adjustment that the government has imposed. Imports are probably going to be down two-thirds from their peak two years ago. The decline in oil prices is probably going to translate into a GDP contraction of more than eight per cent y/y in 2015.

Most of the adjustment is coming through the import bill, as the government slashes the amount of hard currency available for foreign goods and services. Not only is this manifesting itself into long lines outside government-owned supermarkets and higher inflation, it is triggering an import-substitution industrialisation (ISI) effect.

Filling the void

It is true that the government nationalised and dismantled much of the country's productive capacity. Still, Venezuelan entrepreneurs are filling the void. Domestically made sundries, such as shampoo, are appearing on store shelves. Local staples, such as fruit juices and instant coffee, are also on display.

The ISI process is encumbered by acute shortages of imported intermediate goods and machinery. Nevertheless, changes on the exchange rate front should provide some relief. The government will retain the CENOEX system and allow about US$9 billion of PDVSA revenues to be used to purchase highly subsidised food items and pharmaceuticals, but more resources should become available for the parallel market.

These measures will significantly reduce the country's funding gap, but it still will be forced it to rely on its dwindling stock of international reserves and foreign assets.

That is why an interesting alternative would be to engineer a bond swap. We have examined and modelled the exercise, and it is quite compelling.

PDVSA is the real challenge for the government. It has more than US$11 billion in amortisations coming due before the end of

2017. Nominally, the biggest concentration are that year, with the 2017 8.5%'s - also known as the 2017 new's - comprising the lion's share (US$6 billion). However, they begin to amortise starting at the end of this year, with a third coming due in early November.

The oil company has a US$3-billion amortisation in mid-April of 2017. Therefore, the prudent thing to do is to launch a tender offer during the next few months and induce bondholders to extend their maturities. For example, PDVSA has a bond maturing in 2035, or 20 years from now. Holders of the PDVSA 2017 new's could be offered a consent fee of 15 points to extend 20 years.

Estimating the exit yield is not difficult, since the 2035s are actively traded. The same could be done for the PDVSA 2016s. It would make no sense to offer the swap on the PDVSA 2015s since the yield on the 2035s are higher.

There are only two sovereign maturities between now and the end of 2017, with the largest one occurring in less than two months. Therefore, there is no point in offering the swap to sovereign bondholders.

If everyone tendered their bonds, the entire operation would cost less than US$2 billion. Of course, not everyone will participate. In order to make the operation more attractive, the government could add oil warrants. For example, it could offer a detachable instrument with a strike price above US$135 per barrel and offer to pay a penny per barrel up to a maximum amount per year for the life of the bond. Such an option would be well within the government's debt-servicing capacity, particularly if oil prices were to reach that level.

Another idea would be to set a strike price to buy back debt. Whatever is the case, such an operation would provide a prolonged period of debt relief for the government during which oil prices could move higher.

But, we cannot forget that any sustainable liability management exercise requires a good implementation team and strong leadership. The current economic team has been more receptive to new ideas and proposals, but the ideological core remains intact.

corruption a problem

Moreover, corruption has not gone away, and the opposition remains completely divided. The fact that there are almost no street marches or demonstrations is more a sign of resignation than acceptance.

No one can deny that oil prices collapsed and there are fewer resources to spread around, but the opposition has no alternate policies or suggestions. Therefore, the population has thrown in the towel.

This is making it a little easier for the government to implement its draconian adjustment process.

• Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com