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ISDA decision unlikely to rattle Venezuelan bondholders

ISDA decision unlikely to rattle Venezuelan bondholders

Venezuelan bondholders have way more financial incentive to hold out for payment than to agitate about a default process that could take decades to resolve.

As such, while this week’s default calls by Standard & Poor’s (S&P) and the International Swaps and Derivatives Association (ISDA) caused an international media storm, bondholders remain relatively calm. Though the Maduro government’s debt restructuring meeting in Caracas was no more than a stunt; the message from Caracas is that the government remains willing to pay, in some form, on its headline bond debt.

Russian deal creates breathing space for all parties

Of more import for bondholders than the S&P/ISDA announcement is Russia’s USD3 billion bilateral debt restructuring deal. The Russian finance ministry said the deal would allow Maduro to "allocate funds for the development of the economy, improve the debtor’s solvency, and increase the chances of all creditors to return loans previously granted".

Notably, however, though the deal postponed debt servicing, Russia did not provide any additional cash. Rosneft separately said it planned no new lending for Pdvsa.

Similarly, China’s foreign ministry issued a second statement expressing confidence in Venezuela’s ability to handle its debt issue, noting that bilateral financial relations were "proceeding normally". But again, while China last year restructured some Venezuelan loans, it has not recently provided new lending.

The strategy in Caracas

The Maduro government seems to be angling for a restructuring deal on the sovereign debt, while remaining current on Pdvsa obligations. Ringfencing Pdvsa - the county’s sole income source –will always be the prime ambition. But this is a strategy fraught with risk, for several reasons.

First, the US government would have to relax its current sanctions to allow for a sovereign restructuring. The Trump administration would only do this in return for very concrete moves towards a negotiated political transition in Venezuela. But getting the Venezuelan opposition and the Maduro government to that point has defeated even the Vatican. Maduro, emboldened by the material and vocal Russian and Chinese support, is still taking a hard line on the domestic front, as the brand new "anti-hate law" amply illustrates.

Secondly, a sovereign restructuring must be accompanied by an economic recovery plan, possibly with IMF backing. It’s very unclear that Maduro, would be able to countenance orthodox policy recipes imposed from Washington.

Thirdly, there is no guarantee that at some point certain sovereign creditors would not seek an ‘alter ego’ ruling in US courts, thereby risking seizure of Pdvsa assets. This legal route already is being pursued by Canada’s Crystallex, for example.

And finally, the vultures are circling. Almost certainly, distressed debt funds are waiting to swoop on sovereign and Pdvsa bond debt once prices hit a certain level (typically less than 20 cents on the dollar), with a view to future litigation in demand of full repayment. In that scenario, a potentially decades-long and extremely tortuous wrangle hoves into view. This could be the worst of all scenarios for the country.

Running against the clock

For now, Maduro’s immediate tactic is to continue to pay lip service to dialogue - with bondholders, with the Venezuelan opposition, and with his military backers - in order to buy time. With the bond repayments schedule relatively light to April 2018, there is now a short window of opportunity for negotiations on all three fronts. Arguably though, bondholders with payments falling due in coming months will anticipate that Maduro will prioritise payment in a presidential election year. Therefore, they will have little incentive to go into restructuring talks now.

The bigger question is for how long Maduro can continue to play this very risky game. Ultimately, it’s a fairly straightforward answer. Unless Maduro can improve conditions on the ground, and stave off an external debt debacle, the possibility that the military will remove him, on constitutional grounds, will increase. This could pave the way for a pacted transition agreement, and fresh elections.

By Eileen Gavin Politics Senior Analyst, Americas

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