Venezuela debt talks: Caracas plays its last cards

Restructuring negotiations will feature a complex geopolitical poker game involving the US, Russia and China

John Paul Rathbone in Miami and Robin Wigglesworth in New York




Last week, at the invitation of President Nicolás Maduro, a group of international financiers flew to Caracas to begin what has been called the world’s most complicated debt restructuring, also one of its biggest, and certainly one of the strangest.

In a capital city blighted by the highest homicide rate in the world, investors filed into a white ice-cream cake of a building opposite the Presidential Palace. Heightening the unreality of a socialist economy underpinned by the world’s largest oil reserves, but mismanaged into near-collapse, the government rolled out a red carpet for its guests and laid on a ceremonial guard.

Venezuela seeks a “win-win” solution for all, Tareck El Aissami, the vice-president, told the investors. The country would continue to service its $150bn of foreign debt, the 43-year-old socialist militant stressed — although rating agencies issued a slew of default notices even as he spoke. The speech ended half an hour later. Participants left with gifts of coffee and fine chocolate, but none the wiser. The government, meanwhile, declared the meeting a success.

“We’re all just trying to figure out if there is a method to the Venezuelan madness,” says Peter West of boutique advisory EM Funding. “If you are a little confused . . . don’t feel bad,” added Russ Dallen of Caracas Capital, a Venezuela debt specialist.

In part, the confusion stems from the complexity of Venezuela’s debts, which have been issued by various entities, with varied legal clauses, to multiple parties. It owes $64bn to bondholders, more than $20bn to allies China and Russia, $5bn to multilateral lenders such as the InterAmerican Development Bank, and tens of billions to the importers and service companies that keep the all-important oil industry pumping and the regime afloat.




Mostly, though, the uncertainty results from the notion that Venezuela has embarked on a classic “restructuring plan”. Caracas is not beginning a callisthenic exercise in the debt reprofiling, sustainability and other technical metrics that typically mark sovereign debt workouts. Rather it has started a grim poker game, with no betting limits.

With the exception of bondholders, for the other five players sitting around the table — the government, the opposition, the US, Russia and China — the prize goes far beyond money. At stake are the political survival of a government, the fate of 30m Venezuelan citizens and the competing geopolitical interests of three superpowers.

“It’s a complex game with many players, so it could lead to a bad outcome,” says Robert Kahn, a former International Monetary Fund staffer and veteran of sovereign debt crises. “Moreover, a lot of the players don’t know or understand the others’ incentives.”


PetroChina chairman Wang Yilin and the Venezuelan oil minister Eulogio del Pino sign an agreement while President Maduro looks on © Reuters


The government simply wants to survive. It fears that bondholders, which only want to be paid, could seize its exported oil cargos in the event of a default, cutting off Caracas from its sole source of revenue. Then there are the superpowers. Washington wants to curtail an increasingly rogue regime, implicated in global drugs trafficking, that sits on $15tn of oil reserves only a three-hour flight from the US.

Moscow, meanwhile, seeks to parlay Caracas’ distress into a stronger foothold in the Americas. China’s interests are more commercial: having loaned $60bn to Caracas over the past decade it wants continued access to Venezuela’s vast energy reserves.

Adding to the complexity are the house rules; there may not be any. All of Venezuela’s foreign bonds are governed by New York law. But the presence of Russia and China at the table further complicates a restructuring that will be least partly be conducted outside the IMF or the Paris Club of creditors.

Then there is the fact that the two Venezuelans in charge of the process, Mr El Aissami and economy minister Simon Zerpa, are sanctioned by the US for alleged drug-trafficking and human rights abuses. Their appointment is the clearest sign that Caracas imagines itself operating in a parallel legal universe — as may the ensuing poker game.



One of the few things that is clear in this bluffers’ exercise is that Venezuela can no longer afford its debts. Ten years ago, amid the commodity price boom, Venezuela enjoyed a petrodollar windfall worth an estimated $1tn. When Wall Street offered the prospect of more money still, Caracas issued over $50bn of bonds. Alongside Chinese lending and other loans, this quadrupled foreign debt in 10 years. Much of the money was wasted or stolen — as much as $300bn, according to former ministers. Now Caracas has run out of funds.

Foreign reserves hover below $10bn, near 20-year lows. Imports have been crushed by 85 per cent in five years, far worse than the most austere IMF programme. The black market exchange rate has soared to 7,000 times the official rate, and average daily oil output — the sole source of foreign exchange — has shrunk by 20 per cent from last year.

Just as decisively, Venezuela slipped into hyperinflation last month, with prices rising faster than 50 per cent. No economy can survive hyperinflation for long, and only one political regime has done so — Robert Mugabe’s Zimbabwe, at least until last week. With debt default on the cards, change may be coming to Venezuela, too.


Tareck El Aissami, vice-president of Venezuela, talks about the problem of sanctions at a news conference this week © Bloomberg


Certainly that is what the opposition hopes. Although battered and divided, it has one potentially strong card to play. Recent sanctions bar US institutions from dealing with refinanced Venezuelan debt issues, effectively making the debt restructuring that Caracas seeks impossible. The only exception is if debt is authorised by the opposition-controlled National Assembly.

In theory, this opens the possibility of a political bargain that could herald deeper change. The opposition could approve a debt refinancing. In return, the government would allow free, fair and internationally monitored presidential elections next year — which the opposition and its supporters like the US and the EU hope it would win.

“It is not clear that anything resembling a debt restructuring can be achieved under the current regime, at least in the absence of a rapprochement between the Maduro administration and the National Assembly,” says Lee Buchheit, a senior partner at Cleary Gottlieb and an experienced sovereign debt-restructuring lawyer.





If the government is worried, though, it so far shows little sign of strain. “We are the great hope of a people who have waited for centuries,” Mr Maduro exhorted in characteristic fashion last week. Such apparent insouciance may be due to the pervasive unreality that often grips dictatorial regimes. But there are also good reasons why Mr Maduro feels he can call the bluff of the US, the opposition and bondholders.

Advised by Cuban intelligence officials, in turn schooled by the Soviets, Mr Maduro’s domination of the country is Orwellian. Apart from the National Assembly, all institutions are under his control — including the Supreme Court, the media, the electoral authority and the military.


A long series of street protests by opponents of the Maduro regime have had little effect © AFP


Food is in short supply — and much of what is available is dispensed via a subsidised state programme that Mr Maduro can use to coerce public support. The opposition is exhausted after mass protests this year produced no change, despite more than 100 deaths. A “faithful opposition”, co-opted by the government, is even emerging.

“All this leaves President Nicolás Maduro in a comfortable position,” Risa Grais-Targow of Eurasia, the risk consultancy, wrote in a note to clients last week. It also “significantly reduces the chances of regime change.”

Indeed, this may be why Mr Maduro initiated the debt talks in the first place. Even default need not spell the end. He could use the $9bn of debt payments otherwise due in 2018 to double current import levels, thereby boosting his chances in presidential elections held next year. Legal counsel, retained by Caracas, would meanwhile work to confound investor claims in the courts.

“The government is never going to negotiate until it feels that is its best option,” says one western intelligence official close to the situation. “And that moment has not yet arrived.”



Nor, indeed, has a formal bond default. Caracas continues to pay bondholders, albeit irregularly, partly thanks to Moscow’s and Beijing’s largesse.

Last week, Russia restructured its $3.5bn bilateral debt with Venezuela, freeing resources for Caracas to pay other creditors. China, although reluctant to increase its roughly $20bn exposure to Venezuela, also seems to prefer the political status quo.

“Venezuela is a quagmire for China,” says Margaret Myers, a China expert at the Inter-American Dialogue in Washington. “But the general feeling is that it will disburse another $4bn or so to Venezuela this year via their joint venture fund — although not go far beyond that.”

It promises to be an exhausting poker game. But there will be a reckoning. Venezuelan hyperinflation and the continuing slide in oil production will see to that. Nor will Moscow and Beijing indefinitely restructure their debts while bond investors continue to be paid. When that moment comes, the other players will have to go all in, or fold.

The US may raise the stakes first. It can escalate travel bans and asset freezes on officials. It can also issue secondary sanctions on the Russian oil companies and Chinese banks that deal with Venezuela, just as it has done with companies trading with North Korea. Washington’s biggest sanction would be the “nuclear option” of banning the 600,000 barrels a day of oil imported from Venezuela. Argentina’s president Mauricio Macri suggested Latin America would support such a move.

As for the bondholders, sometime soon they will “have to decide whether to be passive or active. Passive means waiting to receive restructuring proposals from the Venezuelan government. Active would involve . . . developing their own proposals,” says Mr Buchheit.

In extremis, that means using court orders to seize oil cargos in the event of an accelerated default. If that strategy is successful, Mr Maduro, who was last week accused by his former attorney-general of crimes against humanity in The Hague, would face a dark choice.



He could fold and escape to exile in Cuba — an exit already suggested by Latin American diplomats to Havana. Or, as export revenues crater, he could stand ground and repress the growing social unrest. The role of the military would then be key: it remains loyal to Mr Maduro but may not always be — as Zimbabwe has showed.

The green baize table is set, the antes are due. The play will be rough, but the returns potentially huge. That is especially so for investors prepared to wage the kind of battle that produced outsized profits for several vulture funds that snapped up debt in Argentina’s $100bn bond restructuring and then suedfor full repayment at par. Someone is going to take a bet.

“Ultimately, there is going to be more money made in Venezuela than even in Argentina,” says Hans Humes, head of Greylock Capital, which is forming an investor committee. The geopolitical and humanitarian consequences are likely to be larger still.


Additional reporting by Jonathan Wheatley


The Russia connection: Moscow’s Latin America push balances US influence


Many western and even Chinese creditors have been scratching their heads over why Russia was building a massive exposure to Venezuelan debt.

Moscow’s generosity and patience with Caracas come amid a broader push into Latin America. Since Vladimir Putin’s first presidential term in 2000, Russia has pursued a return to countries in the region with which the Soviet Union had close ties. First and foremost, this happened through arms deals: Russia has sold more than $15bn in weapons to Latin American customers since 2000, with exports accelerating over the past five years with Venezuela one of the top customers.

The armed forces and security services have followed suit: the Kremlin has rebuilt ties with Cuba and Nicaragua, and is pursuing the restoration of listening posts aimed at the US in both countries.

At the same time, Russia has pursued closer ties with the continent’s largest economies and political heavyweights: “It is inaccurate to claim we are just restoring the Soviet Union’s footprint. We have built a stable relationship with Brazil through our joint work in Brics [also with India, China and South Africa], we are rapidly expanding co-operation with Argentina,” says a former Russian ambassador to the region. Indeed state-owned Gazprom is looking at shale projects in Argentina, and Rosneft is prospecting for oil in Brazil.

Moscow also sees “a lot of new potential” with Mexico, the ambassador says. “There are open doors there against the background of their difficulties with [Donald] Trump.”

Such opportunism is typical of Moscow’s foreign policy. Russia often seeks to move in where Washington is in retreat and increase its weight globally versus the US.

Kathrin Hille


The Fed Versus Tax Cuts

The central bank has pushed back against tax cuts in recent years by raising rates

By Justin Lahart

Federal Reserve Chair nominee Jerome Powell testifies before the Senate Banking Committee last month.
Federal Reserve Chair nominee Jerome Powell testifies before the Senate Banking Committee last month. Photo: Ron Sachs/Zuma Press


The Republican tax plan has been driving the market. The Federal Reserve could be next behind the Wheel.

The tax plan’s final details are still in flux, but whatever form it takes, two things are clear.

First, the expected corporate tax cut will boost corporate earnings. Second, it should give some sort of boost to the economy next year. Both those things seem pretty sweet to investors, which is the big reason why stocks have performed so well as the tax plan moved from “maybe” to “almost certainly.”

The Fed also has grown more certain about the future. It is on track to raise interest rates for a third time this year on Wednesday, and it expects to keep raising rates next year. Experience with tax cuts suggests that investors should be watching the Fed as carefully as they watch the markets.

According to a recent Fed working paper, tax cuts have tended to act as a drag on stock-market returns since the 1980s. Starting then, the authors say, the Fed got a lot more vigilant about responding to inflationary pressures. So before the economic effects of a tax cut had a real chance to show up in corporate cash flows, rates already were getting wrenched higher. Before the 1980s, the Fed was slower to respond to tax cuts, in part because it showed less political independence, so tax cuts were better for stocks.

THE FED HAS BEEN ITS FRIEND
The S&P 500



Today, the Fed values its independence far more than it did in the 1970s, and that appears to be true for incoming Fed chair Jerome Powell. Still, persistently low inflation might keep the Fed from aggressively raising rates. Yet with unemployment low, it wouldn’t take much of a pickup in either inflation or wages for the Fed to try to offset the stimulus of tax cuts by raising rates.

High stock valuations have been a concern for some Fed officials for a while now, and the market rally in anticipation of tax cuts is probably adding to their unease. Tax cuts have driven the market higher, the Fed may determine their next move.


Getting Technical

Markets Point to Lower Interest Rates

By Michael Kahn

Markets Point to Lower Interest Rates
Markets Point to Lower Interest Rates Photo: Getty Images 


With abundant good economic news and the Federal Reserve on track for another short-term interest rate hike this month, it makes sense that inflationary forces might wake up. Yet one look at the bond market shows a very different story.

The benchmark 10-year Treasury yield is now at 2.37%—exactly where it was Thanksgiving week of last year (see Chart 1). Even with heated discussions over tax reform, the market’s daily range since late September is quite narrow, with historical volatility at the bottom of its range since the financial crisis.

Markets Point to Lower Interest Rates


Logically, interest rates, which are really the cost of money, should move higher as an improving economy demands more capital. Of course, logic is rarely a component of market analysis, and right now there are far too many indicators suggesting one outcome: Interest rates seem more likely to decline than move higher over the foreseeable future.

John Kosar, chief market strategist at Asbury Research, says the futures market shows just that. The Commitments of Traders reports show that small speculators—the group that usually gets caught up in the news of the day—are betting on higher rates, while commercials—the so-called smart money—are leaning toward lower rates.

In addition, an analysis of activity in inflation-adjusted bonds shows no inflationary leanings. In fact, the ratio between the iShares TIPS Bond exchange-traded fund (ticker: TIP) and the unadjusted iShares 20+ Year Treasury Bond ETF (TLT) has been on the decline most of this year. In other words, inflation-adjusted bonds are underperforming “regular” bonds.

Finally, there is the yield curve, or the difference between long- and short-term interest rates.

Last week, I wrote that the yield curve is as narrow as it was in late 2007. Again, that is not the usual marker of a strengthening economy, with its higher demand for money.

We can debate whether than means the bond market really does think the economy is on the wrong track. The point here, though, is that inflation is still not an issue—and investment strategies should take that into account.

For example, last week, gold broke down below its one-year rising trendline (see Chart 2), and it remains in the middle of its trading range in effect since prices collapsed in 2013. Silver shows even weaker conditions, with a general decline in place since the middle of last year.

Markets Point to Lower Interest Rates

The trend goes beyond precious metals. Crude oil showed strength over the past few months, and last month even moved above the top of the $42-$55 per-barrel range I outlined here in several columns.

Overall, though, this market has been stuck in place since its 2014 collapse. So has the broader commodities arena, with the Bloomberg Commodity Index also in a multiyear flat range.

If interest rates remain low, clearly savers will be the losers. Rates on money-market funds hover near 1.25%. And there will be no incentive to hedge using gold and silver.

Still, low rates help companies that have high capital-funding requirements or have high levels of debt on their balance sheets, such as telecommunications. Low interest rates also translate into low mortgage rates, and that gives home builders a boost.

Low rates also favor riskier assets in general, including stocks, because the rate of return far outstrips those of bonds or commodities. That means stocks still have more bull market ahead, despite the current “melt-up” feeling in the market and a greater chance a correction is getting close.


Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.


Preparing for the Trump Trade Wars

BILL EMMOTT

Trump Trade speech

LONDON – Is US President Donald Trump what Maoists used to call a paper tiger, or should his noisy threats be taken seriously? That question has loomed particularly large over the North Korean nuclear issue. But after Trump’s fairly emollient 12-day tour of Asia, fears of a conflict on the Korean Peninsula have ebbed somewhat.

And yet that same tour raised another threat, which the world has every reason to take seriously. In the second year of his presidency, Trump’s administration will likely set its sights on trade, suggesting that the prospect of more trade wars will increase substantially.

In his first year in office, Trump has often huffed and puffed about other countries’ unfair trade practices, just as he did during the 2016 election campaign; but he has done little to turn words into deeds. This inaction is understandable. Trump is relying on China – one of America’s largest trade partners – to apply pressure on the North Korean regime, while US businesses have lobbied vigorously against any measures that might inhibit trade.

Still, Trump’s apparent restraint cannot be expected to last. Trade is one of the few policy areas where he can be said to have an ideology. The “logic” of that ideology holds that trade deficits are proof of unfair practices by other countries, and should thus be met with tough and decisive action.

Moreover, Trump has a compelling political interest in maintaining the support of his core supporters. After Twitter, Trump’s trade rhetoric is his most powerful weapon. It is never too early to start building a case for re-election in 2020.

Until now, Trump has been willing to hold back on the trade issue until the Republican Party’s planned tax overhaul makes its way through Congress. He does not want to risk disrupting his and his party’s last chance to secure a real legislative victory this year. Once tax legislation is off the table – and especially if it fails ignominiously in the same manner as the Republicans’ health-care-reform effort earlier this year – Trump will want to show that he means what he has said on trade.

Trade is at the center of Trump’s “America First” approach, which he claims will protect and even restore lost American jobs. While some in Trump’s cabinet might reject efforts to apply the slogan to the issues they oversee, Secretary of Commerce Wilbur Ross, US Trade Representative Robert Lighthizer, and National Trade Council Director Peter Navarro all share Trump’s views on trade.

Each agrees that America’s big bilateral trade deficits with countries such as China, Japan, Germany, and Mexico are proof that America is being taken for a ride by its competitors. Trump and his trade advisers believe that by reducing or even eliminating those deficits, they can create well-paid jobs for American workers.

Trump made his views clear in a speech at the Asia-Pacific Economic Cooperation (APEC) summit in Da Nang, Vietnam, on November 10. “We are not going to let the United States be taken advantage of anymore,” he said. “I wish previous administrations in my country saw what was happening and did something about it. They did not, but I will.”

But what concrete actions will Trump actually take? So far, he has abandoned the 12-country Trans-Pacific Partnership – which his election opponent, Hillary Clinton, had also promised to do – and opened negotiations with Mexico and Canada to update the North American Free-Trade Agreement, which President Bill Clinton signed into law in 1994. This is minor stuff.

But next year, Trump can be expected to turn rhetoric into action on two main fronts. The first is China, which Trump has singled out as the greatest trade exploiter of the US. Unless the North Korea standoff escalates critically, he will likely initiate anti-dumping actions against Chinese industries – notably in steel – deemed to be selling their goods below cost; and he will probably launch a broad assault on intellectual-property violations in China.

These measures will almost certainly provoke retaliation from China. China feels stronger than ever in the Trump era, and in the eyes of Chinese cadres, not responding forcefully would be a sign of weakness.

The other main front for Trump is the World Trade Organization, which America helped establish in the early 1990s as a successor to the post-war General Agreement on Tariffs and Trade. Lighthizer has gone on record to describe the WTO’s dispute-settlement system as harmful to America. And already, the Trump administration is blocking the appointment of new judges to WTO arbitration panels. If it maintains that policy, the WTO’s entire dispute-settlement system will be crippled within months.

With the WTO essentially out of the picture, the US will launch a new initiative to strike bilateral deals on trade rules – an approach that Trump advocated in his APEC speech. Given that the US remains a vital market for most exporters, such an initiative will have clout.

Asian and European countries, in particular, should be preparing for the worst by negotiating their own trade agreements with one another to preempt American mercantilism. After all, taking the initiative to boost trade and other commercial contacts is the best way to resist a trade war.

By reviving the TPP without US involvement, Japan and other Asia-Pacific countries are already on the right track. But if a Trump trade war is in the offing, they – and other countries – will need to double down on that approach.


Bill Emmott is a former editor-in-chief of The Economist.


China’s One Belt, One Road Faces Pushback

By Kamran Bokhari


China’s One Belt, One Road, a much-touted initiative to connect the country with Europe, the Middle East, Africa and other parts of Asia, is facing resistance from states whose cooperation Beijing needs to build its highly ambitious infrastructure projects. Last week, Pakistan and Nepal both pulled out of deals to build dams with China because of disagreements over the terms of the deals. Countries that have partnered with China on projects such as these need Chinese finance and expertise to help develop their economies and infrastructure. But these two cases show that some countries are unwilling to just accept China’s terms in exchange for access to its cash. There are limits to China’s economic clout, and Beijing can expect similar pushback from other countries.
On Nov. 15, Pakistan announced that it had withdrawn from the $14 billion Diamer-Bhasha Dam, part of the China-Pakistan Economic Corridor project, over its objections to certain terms and conditions set by Beijing. According to the head of Islamabad’s Water and Power Development Authority, China demanded ownership of the project and its operations and wanted its own forces to provide security. Pakistan will use its own financing to go ahead with the dam, which is expected to provide 4,500 megawatts of power – roughly equivalent to the country’s energy shortfall.
Before the dam was included in the $62 billion CPEC project, the Pakistanis had sought financing from the World Bank and the Asian Development Bank. Both institutions refused to fund the project because of its location in the Pakistani-controlled part of the disputed Kashmir region. The project, which has been in the works for 15 years, has already faced numerous delays and could face even more if Pakistan is unable to supply the money needed to complete the dam.
The CPEC will continue to fund other projects, including roadways, energy facilities, transportation systems and the port of Gwadar. At a time when relations with the United States have deteriorated, Pakistan is all the more reliant on China for development assistance, making the decision to reject Chinese funding for the dam even more significant. Pakistan didn’t make this decision lightly, but it couldn’t accept the terms China was seeking; Chinese ownership of a major infrastructure facility guarded by Chinese security forces was just a step too far.
China One Belt One Road forum
Leaders attend a roundtable meeting during the Belt and Road Forum at the International Conference Center in Yanqi Lake, north of Beijing, on May 15, 2017. LINTAO ZHANG/AFP/Getty Images
Also last week, Nepal announced that it would scrap a $2.5 billion deal with Chinese state firm China Gezhouba Group to develop the Budhi Gandaki hydroelectric project. The hydroelectric plant would have generated 1,200 megawatts of electricity. The deal was signed last June – less than a month after Nepal agreed to participate in OBOR – by the pro-Beijing Maoist-dominated government in charge at the time.

That government has since been replaced by an interim government, which has said that a key part of its decision to pull out of the deal was that the agreement was reached without a competitive bidding process. There is much speculation that factions that support India within the interim government were behind the decision. Nepal has long been part of a struggle for influence between the world’s two most populous nations. With elections due on Nov. 26, the future balance between pro-China and pro-India factions in Nepal remains unclear, but the struggle between these two camps is just one part of why Nepal pulled out of the deal and why China has had trouble ensuring the cooperation of its partners.

In an article published this week, the Hong Kong-based South China Morning Post highlighted the larger implications of the cancellation of these two deals. That a Chinese paper has been openly critical of how China has handled this issue is noteworthy. Chinese publications don’t often acknowledge problems associated with a signature project of President Xi Jinping. But people are beginning to take notice of the many problems with OBOR. The failure of these deals is related to the fact that OBOR is an overly ambitious initiative that lacks a coherent strategy.

The most developed of OBOR’s six overland economic corridors runs from Xinjiang province in western China through the entire length of Pakistan to the port of Gwadar on the Arabian Sea. Pakistan views the project as a major part of its close relationship with China and its efforts to address its chronically weak infrastructure. But Pakistan understands that China’s main interest in the project is to ensure that Chinese firms can profit from it, to find new markets for its goods and to establish a new trade route that isn’t dependent on maritime shipping lanes.

It is unlikely that Pakistan and Nepal will be the only countries critical of China’s approach to these infrastructure projects. Countries in Central Asia, where the Chinese are aiming to develop another critical corridor as part of OBOR, could also raise objections to Chinese demands, which are proving to be unduly onerous on China’s partners. These countries want China’s funding, but not at any cost.