The bullish case for South American bonds
During the past few weeks, numerous reports in the business press have suggested that Venezuela will default on its bonds. A Bloomberg News reporter stated that “it is not a question of if, but when” the government will default. Another Bloomberg article warned that Venezuela has $21 billion of debt due by the end of 2016 and only $21 billion in reserves – as if governments pay off their debt out of reserves. And CNN reported that “the spectre of default looms larger” for Venezuela, “which is deep in debt and has been burning through its foreign currency reserves.”
Should foreign investors believe these stories? When in doubt, it is usually a good idea to look at the numbers. There are two types of dollar-denominated bonds that these reports refer to: Venezuela’s sovereign or government bonds, and the bonds of the state company, Petroleos de Venezuela SA (PDVSA).
The totals for interest and principal due each year over the next three years are about $10 billion, of which roughly half is principal and half is interest. (After 2017, principal payments drop off to low levels.) Normally, Venezuela would be able to roll over the principal and issue new bonds for the principal coming due. That would leave approximately $5 billion in interest payments.Venezuela has about $50 billion in oil revenue at current prices of $55 per barrel; it is difficult to imagine that prices would fall low enough, and stay there long enough, for Venezuela not to be able to afford $5 billion in annual interest payment.
Apparently some people do. As of December 16, Venezuela’s sovereign bonds that mature in March were yielding a 76% annualized rate of return. PDVSA’s bonds maturing in 2017 were selling at 45 cents on the dollar. There are huge profits to be made for anyone who is willing to bet that Venezuela doesn’t default over the next three years and wins.
In fact, the prices of Venezuela’s bonds are so depressed that the government could buy up the whole stock of debt that comes due in the next three years, nominally worth about $14.3 billion, for less than $9 billion — and probably even less, since the government already owns some of that debt. And they have enough assets to sell – including $14 billion in gold – that they could do exactly this. If they are reluctant to sell the gold, they can swap it for cash.
And then there is China, which has loaned Venezuela $46 billion over the last 8 years, with $24 billion having been paid back. Would China, which considers Venezuela to be a “strategic ally,” let the government default on its debt for lack of a few billion dollars or less?
Argentina’s bonds provide another opportunity for a high return, thanks partly to media coverage reporting that the country has already defaulted on its sovereign debt. This is somewhat misleading, since Argentina deposited the full interest payment on its sovereign bonds for distribution to creditors on June 30, only to have payments blocked by a New York Federal District judge.
There are a number of ways to work around his decision and jurisdiction; since the government is determined to pay its creditors, it will be done. The Argentine government’s foreign debt owed to private creditors is about 7% of its GDP; it would not make sense for any government to default on such a small amount of debt.
It is always a good idea to read the business press with a critical eye. In the case of countries where media bias is unusually strong, it can also be quite profitable for investors to do so.