Emerging Markets

Back To The 80s With Venezuela Crisis; Debt Default Won't Be A Shock - Neuberger Berman

Editorial Staff, August 22, 2017


The US firm ponders the high chances of a debt default by the country.

Investment chiefs at Neuberger Berman, the asset management house, see echoes of the emerging markets debt-crisis period in the 1980s in what is unfolding today in Venezuela, but say a default will be expected and unlikely to cause market shockwaves.

The Latin American country has hit the headlines, amid fears of a lurch towards dictatorship under President Nicolás Maduro, on the 35th anniversary of the Mexico debt default that triggered a crisis across the continent.

"There are distinct echoes of the 1980s crisis in Venezuela. Back then, rising oil prices forced commodity importers to borrow to meet their costs, while encouraging exporters to leverage their good fortune for development, in the belief that expensive oil was forever. When oil prices collapsed, the resultant debt levels became unsustainable," Brad Tank, chief investment officer of fixed income at the firm, said in a note. Debt markets are pricing in an inevitable default by the country, he continued.

The country has relied on high oil prices to sustain "ruinous populist economic policies that have pushed up its debt, while doing little to benefit its citizens or its productivity," Tank said. Gross domestic product is shrinking by 10 per cent a year and the public suffer from triple-digit inflation and shortages of food and medicine.

"The government has done everything it can, including eating deep into its dwindling foreign-exchange reserves, forcing a collapse of imports, and resorting to off-balance sheet deals to raise cash by pledging future oil production and related assets on the cheap – all in a desperate scramble for hard currency to meet its debt obligations. But its determination to cling to power is not only exponentially worsening the conditions for recovery under a new regime, it is also threatening a vicious circle," Tank said.

Venezuelan bonds trade at 35-45 cents on the dollar, with prices dipping further around rumours of US sanctions. Price volatility is now associated less with the probability of default than with estimates of the timing of a bankruptcy, subsequent recovery values and the political circumstances surrounding all of this, Tank continued.

Contagion risk is not high because a Venezuelan default is expected, Tank said.

"An impact in energy markets is to be expected, given that Venezuela is such an important oil exporter. Oil prices have been firmer of late, but other factors have played a role here: pledges of production cuts by Saudi Arabia and falling US stockpiles. Moreover, this move in oil prices has not translated into a commensurate move in energy stocks and bonds, suggesting that the market sees this as a short-term spike rather than anything more sustained.

Venezuela represents 1.7 per cent of the JP Morgan EMBI GD Index at present.

"Venezuela looks like a Latin American country from the 1980s, when big economies such as Brazil and Mexico could collapse, spreading contagion through the weak banking systems of an over-indebted, inflation-plagued emerging world. But it is both small and a throwback. Most other emerging markets look very different today," he added

Rob Drijkoningen, co-head of the EMD team at Neuberger Berman, added: "We have been maintaining an underweight view across our hard currency portfolios – as well as our blend portfolios – for more than a year now based on the deteriorating fundamental outlook."

"Our Country Credit Score for Venezuela has been worsening steadily, driven by both the macro and the ESG components, and is the lowest in our universe of 84 emerging market countries. We also considered valuations to be at the high end of the range, especially after the rally last year and in light of the lack of ability to pay," he said.

The economist says he thinks Venezuela is running out of ways to service its debt, with falling oil output caused by lack of maintenance, decrepit infrastructure and payment arreas ro oil service providers. The country also does not provide much besides oil.

"While we maintain an underweight bias to the country, we believe maintaining some exposure is warranted. There is still meaningful recovery value and a decent chance the opposition will take over within a reasonable timeframe, improving the chances for meaningful reforms. In terms of exposure, we favour lower priced bonds from PDVSA, as this debt may fare better than other index bonds in a restructuring scenario," he added.


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