Defaults, devaluations and downgrades

May 2, 2007

It has been a rough couple of days for the Venezuelan
Government as the sloppiness of its actions and the improvisation of chief
Treasurer Chavez have cost the country quite a bit in the last two days.

On Monday, the holders of the Cerro Negro bonds, one of the
Orinoco oil belt partnerships, served notice on the Government that its actions
from the production cuts to the forced changed in ownerships constituted a
prospective default which could lead bondholders to accelerate the payment of
the bonds. This will not only be costly in terms of use of cash, but also
expensive, because there is a penalty in that case. A PDVSA Director tried
appeasing bondholders on Tuesday by saying that PDVSA is ready to buyback the
bonds of both Cerro Negro and Petrozuata. This only drove the bond prices
higher as the expectation of the buyback caught the interest of investors who
know that a forced buyback would imply much higher prices than those available
on Monday.

Then, S&P said yesterday that it had placed Venezuela on negative watch because the country
was acquiring larger stakes in the Orinoco,
which would require higher resources from PDVSA and would continue to make the
country more dependent on oil. Negative watch means that it will be more costly
for Venezuela
to issue debt in the future and the Government certainly has plans to issue
more debt in the next few months.

But things really got worse today, when a Wall Street firm
cut its recommendation
on Venezuela’s
debt based on the fact that Chief Treasurer Chavez had decided to have Venezuela
withdraw its membership from the IMF. You see, much of the country’s bonds,
including those issued by Chavez as recently as a year and half ago, include a
clause or a covenant
which says that the country leaving the IMF would
constitute a default event. Of course, Chavez knows it all, but apparently
could not remember this detail, which led to the bonds dropping today. To make
matters eve worse, the Minister of Finance, said Venezuela had no plans to default
on its debt, demonstrating his ignorance about what default means. He repeated
later in the day that Venezuela
had no plans to default, referring to no plans of stopping paying the debt, but
clearly failed to understand that a technical default would mean that
bondholders could ask for accelerated payment, lowers ratings, more cost and
even worse, the inability of the country to issue new debt while the condition

All of this would be fine and dandy for the revolution which
on the one hand talks about sovereignty, leaving the IMF, World Bank and the
like, but on the other has become highly dependent on foreign investors, who
happen to be the biggest capitalists and speculators in the planet) buying the
country’s bonds in order to finance the deficit and as a tool to lower the
parallel exchange rate. Unfortunately the runaway spending by the Government is
making this fight harder and harder and the Government is getting increasingly
frustrated after the issuing of US$ 7.5 billion in debt did not have the effect
that Minister of Finance Cabezas had promised Chief Treasurer Chavez it would

Unfortunately, the parallel rate has a strong influence on
inflation since last year estimates are 25% of imports were made at the
parallel rate. While this year it may be less, since the Government’s exchange
control office CADIVI ahs been giving large amounts of foreign currency (US$
9.8 billion in the first three months of the year). However, CADIVI’s outflow
goes according to CADIVI’s desires and Government priorities, which sometimes
are not in synch with what the local markets want, which in turn feeds the
parallel market yet again. In fact, CADIVI has even stopped authorizing
preferential dollars for ALADI, a Latin American Integration Association, which
means all products that came that way now have to be purchased at the parallel
rate of exchange.

Thus, the 1.4% inflation rate increase in April  is no fluke and it
will only go downhill from here, as the effect of the value added tax cut has
worn off, salaries were increased, the parallel rate is back up and liquidity
has yet to drop significantly. Even worse, food inflation, the most sensitive
politically was 2% in April, with the twelve month rate topping 30%.

Certainly not a pretty picture, without mentioning that
reserves continue to go down and if its is true that the concept of private
property will be removed in the secret 
and so undemocratic proposal to reform he Constitution and replaced with
that of “individual” property, you can bet that the parallel rate may have no
limit in the next few months.

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