Maduroa

The talk all now seems to be about how, rather than if, Venezuela will default on its sovereign debt. The almanis crowd have it at just a 36% likelihood to happen this year though, suggesting they think the government can hang on in the short-term.

First a minute to make sure we all know what is meant by a default, at least for the purposes of the almanis market. A default will not require Venezuela to renege on all of its debt. It merely has to fail to pay some of its debt, or to restructure the terms of its debt without the full acquiescence of its creditors. For a recent and memorable example, look at the Greek debt restructuring of March 2012.

We will be looking to the three main ratings agencies to make the call here. The Venezuelan government will be said to have defaulted is either Fitch assign a “D” (Default) or “RD” (Restricted Default) rating, Standard & Poor’s assign a “D” of “SD” (Selective Default), or if Moody’s assign a “C” rating to their long-term foreign debt. Greece achieved all three of these criteria.

A word of warning, don’t look too closely at Credit Default Swap (CDS) markets here, even though “implied default probabilities” derived from them are often quoted in the press. Notably, Greek Sovereign CDS contracts did not trigger payouts in March 2012. Deutsche Bank calculate that Venezuelan sovereign CDS prices currently imply only a 19.8% chance of paying out in the coming year, but that will almost certainly underestimate the chances of a Greek-style restructuring.

Similarly, bond markets can be hard to read as not all the bonds Venezuela have issued are alike – some are protected against the sort of restructuring Greece imposed on creditors and some aren’t. My suggestion would be to follow the 12.75% Aug’22 issue which appears both relatively liquid and carries a high sensitivity to any imminent default event – just beware that bonds that trade in this distressed state tend to have yields that are very similar to their prices. Make sure you know which one you’re looking at because they move in opposite directions.

I also like the weekly Venezuelan market and political updates available through BancTrust & Co website. They’re a boutique investment bank specialising in lower quality (“high beta” in market parlance) assets.

Finally, China appear to be the power who have most to lose in all of this after having lent considerable financial support to the Chavez regime. Just as Germany held the whip hand in Greece’s fate back in 2012, so China is likely to play the same roll this time around. Once again, politics and diplomacy may hold the whip hand over financial and economic fundamentals.

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