Archive for May 17th, 2009

The Chavez bubble: The increasing probability of the country’s default

May 17, 2009

A year ago, Venezuela’s finances looked reasonable and the probability of the country defaulting on its external debt seemed remote, despite the lack of transparency of the country’s finances. With no bond maturing until 2010 in the amount of US$ 1.5 billion and then again another one until 2011, it seemed ludicrous to talk about the country’s default.

This is no longer the case.

The Chavez Government continues to act as if oil prices had not dropped and continues to acquire liabilities, despite the fact that it has issued no debt so far in 2009. But its aggressive style is simply to not acknowledge reality and act irresponsibly. In the recent case of the Government taking over the oil service companies, the Government simply decided that it could not pay a good fraction of the US$ 13 billion owed by PDVSA contractors and took them over as if this eliminated the liabilities. But it does the opposite, as the Government now has to pay for them and much of the debt owed to them is owed in return to a long chain of their suppliers.

Thus, on top of the US$ 13 billion, the Government will have to face suits and arbitration processes that one-day will come home to roost. Add to this those processes already in hand, like ConocoPhillips, Cemex and ExxonMobil (Around US$ 12-14 billion) and the numbers add up.

Then there is the increasing debt with local banks and companies, which are owed some US$ 450 million in travel expenditures on credit cards by CADIVI and some 2 billion US$ in letters of credit. It may be in the end that the solution will be the same: take over the banks and nothing is owed in Chavez’ simplistic mind.

And the Government continues to take over institutions like Banco de Venezuela, which are unnecessary and are likely to be driven into the ground much like Banco Industrial has been bankrupted three times in the last ten years.

But this is an increasing house of cards, you pile debt on top of debt, liability on top of liability and one day the whole thing will crash.

Whether the trigger will be lower oil prices or arbitration decisions going against the Government is unclear, but unless oil process rebound dramatically in the next two years, it is likely to all come crashing down to the point that Hugo Chavez will have no recourse but to decide to default on the country’s debt.

Much like the bursting of the housing bubble in the US, the hard part is predicting when this will happen. Besides the oil price uncertainty, there is that of lowering oil production, made worse by the recent decision to take over the service companies and, of course, the fact that the Government has taken few measures to save foreign currency in the face of lower income. This will one day have to be paid.

Imagine, for example, that an arbitration decision goes against the Government, as many are likely to go and a payment of US$ 2 o 3 billion has to be made to either ExxonMobil or ConocoPhillips. It will be easier for Chavez to say forget it and stop making any payments on foreign debt and arbitrations in the name of a revolution.

This will of course create a chain of events, including the seizure of CITGO in the US which will only bring joy to Chavez as he can then say he is doing this as part of his revolutionary process and against the imperialistic and capitalistic forces of the world.

A year ago, I thought the probability of such a scenario was quite low and largely unnecessary for the Government. Even three months ago, it seemed somewhat remote. But adding the new liabilities with the oil service companies, Chavez’ increasing radicalization and the total mismanagement of the country’s economy and liabilities indicate that this probability is not only finite, but increasing day by day.

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