Question: When is a default not a default? Answer: When it is a “planned restructuring.”
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In the arcane and meticulous world of international finance, “default” is a dirty word when used to describe a sovereign state not paying its debts. Officially, when that happens, the euphemism “credit event” is preferred, as it sounds more polite.
In the case of Venezuela, November 2017 may prove to be the cruelest month since the international price of crude oil collapsed and the country began sinking into its drawn-out political and economic crisis. At the end of November, the grace period for payment expired on three different government bonds with interest payments due in October, a $1.1 billion obligation.
The expiration of the 30-day grace period is a credit event when the bank charged with receiving the funds and disbursing them to the creditors announces that the funds have not been received. On Nov. 14, 2017, that happened for the first of Venezuela’s three obligations: the interest payment on bonds issued by the Caracas power utility, Electricidad de Caracas (EDC or Elecar). By the month’s end, much larger payments were due on bonds issued by the government and the national petroleum company, Petroleos de Venezuela S.A. (PDVSA).
All of this matters for several reasons. First, there are geopolitical repercussions, because China and Russia had rushed in to shore up Venezuela’s finances and, in doing so, have created a situation that has every country in the Western Hemisphere on tenterhooks. The Chinese are the largest holders of Venezuelan government debt, sitting on a tad more than $60 billion of the $143 billion total, and stand to lose the most from a default. Beijing has been lying low during this tense period, except for joining the Russians in refusing to attend a special session of the United Nations Security Council called to discuss the humanitarian crisis in Venezuela.
The Russians, in contrast, have been far from quiet. They had been giving the Venezuelan government small credits over the past few years against future payments in crude oil. Then, in January 2017, the Russian oil company Rosneft agreed to take 49 percent of PDVSA’s subsidiary in the United States, CITGO, in exchange for a large portion of the accumulated debt. Any further increase in Rosneft’s CITGO holdings would trigger congressional action in the U.S. Any default would also put CITGO in play for American creditors, who would ask U.S. courts to seize Venezuelan assets.
Many European investors attended the event, but no restructuring plan was discussed
In the week before November 14, Venezuelan President Nicolas Maduro announced that his government would never default and invited foreign bondholders to a meeting in Caracas to discuss restructuring the country’s debt. Many European investors attended the event, but no restructuring plan was discussed. The chair, Venezuelan Vice President Tareck El Aissami, repeated Mr. Maduro’s assurances and blamed the country’s temporary financial difficulties on the “blockade” imposed by the U.S. Treasury Office of Foreign Assets Control. It is worth noting in passing that Mr. El Aissami himself is on the U.S. list of sanctioned government officials. The vice president has been accused of leading an expansion of the Colombian drug trade through Venezuela to Europe and the U.S.
In the immediate aftermath of the credit event, the ratings agencies declared Venezuela and PDVSA in default and the bourse in Luxemburg, where the bonds are traded, ordered a halt in trading. These actions, in turn, set the stage for bondholders to ask the International Swaps and Derivatives Association (ISDA) to recognize the credit event and thus open the door to the payment of Credit Default Swaps, which serve as a form of insurance against such events.
The default only adds to the crushing economic and humanitarian crisis Venezuela is going through. Since oil prices peaked and started falling in 2013, Venezuela’s gross domestic product (GDP) has fallen 35 percent. This is an economic catastrophe greater than the Great Depression in the U.S. (a 28 percent contraction) or the implosion of the Russian economy after the collapse of the Soviet Union.
Over the same period, a lack of cash for capital investments or necessary maintenance has caused PDVSA’s oil output to drop by a quarter, to its lowest level in 30 years. Venezuela’s poverty rate has gone from 48 percent of the population to 82 percent, while the homicide rate in Caracas is nearly 100 per 100,000 inhabitants, among the highest in the world. The estimates for 2017 indicate that inflation will approach 1,600 percent and the economy will continue to nosedive.
Throughout this debacle, the Maduro government has tightened its control over the state. The opposition, which as recently as April appeared to be capable of forcing the regime to hold free and fair elections, now seems fragmented and leaderless. The international community fumes and protests, but is in no position to make the government in Caracas negotiate.
Frankly, why would the regime cave in? It controls all three branches of government and what remains of government revenue. The opposition is impotent. Even as international pressure mounts – the EU began a program of sanctions last week – the exit costs for Mr. Maduro and his allies are climbing even higher. If the reports of drug trafficking are true, at least in part, not even Cuba will be eager to welcome a horde of former Venezuelan officials fleeing U.S. prosecution.