The Devil's Excrement

I know, I know, I have been away for too long. I agree. Somehow this happens now every time I am in Venezuela. It is not writer’s block, it is more like information overload. Everything is a story, but in the end nothing appears to be one. The lack of information and the lack of transparency, in the presence of a thousand daily headlines, makes it impossible to understand most things. Let alone write about them.

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I spent the week trying to find good news. Not that I am a masochist, but I figure if I can find something positive to write about in Venezulea, that alone will make it a good story. Everything seems to be so negative. But good stories are hard to find, every time I think I have one, I find a wrinkle in it, some orthogonal feature that makes the good news somewhat iffy.

Take Chikungunya. Before I went looking for experts on it, I learned to spell the word, I didn’t want to be like Maduro and call it something else. I talked to a couple of people that suggested that something was up in Maracay, but.. It is the but that gets me intrigued. The but is that there is so little information that it is not clear whether it is the Ch. word or it is dengue that is to blame for what is going on. That is certainly good news, until I am told that the number of dengue cases is ballooning to levels not seen in the country’s history. To top it all off, people who either get dengue or the Ch. illness need Acetaminophen, which is in lvery ow supply in Venezuela. It seems like Chikungunya is not the good news story I am looking for, even if I learned how to spell it.

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I then turn to the release of political prisoner Simonovis, who has been been given house arrest instead of jail for health reasons. This is certainly great news, at last the Government seems to have shown some compassion for someone in the vast array of injustices that go from political prisoners, to crime, to persecutions and to human rights abuses. But then you start to see the wrinkles in the case. The measure is only temporary and he is taken to the hospital shackled and treated like a common criminal. But worst of all, you see the dark side of Chavismo in the outcries of the radical Chavistas who find this humanitarian measure incomprehensible, filled with hate, unable to have even a the slightest empathy for human beings. Unable to even consider, not only Simonovis’ role in the affairs of 2002, but to realize how Chavismo got away with murder and murders in the 1992 coup attempts. They were all forgiven. They got away with it. From Chávez to Arias Cardenas, to all of them. Many of them rule the country today.

What happened to Venezuela and Venezuelans, that hate and politics became more important than humanity and compassion? How can sending a very sick man home become a subject of protests and revolutionary symbolism? As if this was not enough, a friend explains to me why Simonovis was finally given house arrest: Don’t believe anything you read, Maduro was just worried that he may die in jail. It was a political move, nothing more. Another good story dies at this point.

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I then turn to shortages.  I go to the market and see milk, margarine and even toilet paper.  Surely this is good, no? Except that now you can’t find diapers or cleaning products. It is the rotation of priorities. The Government devoted all of its efforts to make sure there was toilet paper, but forgot about diapers, it imported milk, but forgot about margarine, and there had never been shortages of cleaning products, so the Government did not even understand they could be in short supply.

The worst part is that by now, the shortage mentality has taken over the population. There is milk in the shelves, but you don’t know how long it will last and take home as much milk as they will sell to you. The fact that there are limits, people reason, must mean that there isn’t enough for everyone. Everyone hoards whatever they give priority to. The end result is that it will be quite difficult to bring inventories up, it is sitting in people’s homes..

Take water, for example. It is raining cats an dogs in Caracas. The dams are 70% full. Reportedly, the Government is punishing middle class neighborhoods limiting their water supply. But the shortage mentality has taken over residents too. Water is rationed even when there is plenty of it. In my building, they cut it off at the usual time mid-morning, despite the fact that the tank is half full and water is coming in. This means that everyone will be ready at 12:30 to wash all the clothes, fill all the pails, pots and pans and shower again just in case. The end result is more water consumption, all clothes are clean all the time and most people (like me!) take extra showers, just in case.

Hard to break this vicious cycle. Shortages are definitely not a good story either.

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And then there is Convenio Cambiario #30, some analysts hail it as a sign of further “adjustment”. A positive. But all I see is a decree allowing Pdvsa to have total freedom as to whether it gives Bs. at three different exchange rates, to opacity-ladden-Fonden, so that Maduro may have more funds at his convenience, simultaneusly creating a new perverse mechanism for printing money: Pdvsa exchanges with the Central Bank at Bs. 50 (Sicad 2 rate) but the BCV can turn around and sell those same dollars at Bs. 6.3 per US$. All stages of this may be done with total discretion and no disclosure. Sorry, not a positive, another negative.

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And the I notice something. The new President of PDVSA has been talking only about oil since he took over the position. First, he said that he will reactivate one thousand wells to increase oil production. He talked about modernization, met with managers and talked about increasing production by 60 to 70 thousand barrels of oil a day. He then intervened the marketing division of PDVSA, where Maduro said there were “mafias” involved in the commercialization of products. Finally, yesterday Del Pino called for making investments in the Orinoco Heavy Crude belt a reality. After years of his predecessor announcing projects and projects but little happening, Del Pino wants it to become reality saying “it is time to go beyond the presentations to financing and building the projects”. Wow!

The best part, Del Pino seldom mentions the party or politics, even if he can’t help mentioning the almighty Hugo. He apparently wants to be President of PDVSA and see if he can increase production of oil in Venezuela. What a concept! He is praising the company’s workers, trying to improve moral. For now, I will give Del Pino the benefit of the doubt. He is saying the right things and concentrating on what he should. And that, in the current Venezuela is a HUGE positive. And that, my friends, is the GOOD NEWS!

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And now that I have given you the good news, here is the bad news. One Bolívar fuerte is now worth less than a penny. That is not even bad news, it is simply depressing:

A true tribute to the success of the revolution!

As if there was not enough noise around Venezuela’s and PDVSA’s debt, credit agency S&P downgraded Venezuela to CCC+ this afternoon, citing concerns about the economy, inflation and increasing risk. This announcement will certainly add to the confusion of the last week or so, where the default opinion piece of Hausmann and Santos, has generated so much discussion and interpretations of what was said, creating such a stir that President Maduro ordered the Prosecutor to ¨take action¨ against Hausmann for seeking to destabilize the country.

One has to wonder what Maduro will say about S&P now.

But in reality, the announcement by S&P is not surprising, because the rating agency already had placed Venezuela on “negative watch“, suggesting that it was considering downgrading Venezuela’s sovereign debt. (So far, the downgrade only applies to the Republic’s debt, but a similar downgrade of PDVSA is likely to follow base on the criteria usually followed by credit rating agencies that no risk can be higher than the sovereign one)

According to the definition by S&P, this downgrade to CCC+ means that Venezuela is “vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.” S&P is not suggesting that there will be a default anytime soon, but that things are getting complicated. But we are sure that the announcement will be misinterpreted.

And I say this, because during the last week, there have been many misinterpretations of statements made by a number of people (including me) and in both Twitter and blogs, terms have been confused.

As an example, I made statements in Twitter that I did not recommend investing in Venezuela and PDVSA bonds at this time, which was taken by some as an indication that I thought Venezuela would default. As I made clear in the previous post, I do not believe that Venezuela will default in October, or that Venezuela is likely to default in 2015 or even in 2016. What I am saying is that on a risk adjusted basis, the return on Venezuelan and PDVSA bonds are just not high enough for the  lack of transparency on the country’s numbers, the political uncertainty and the volatility that these bonds exhibit.

Take, for example, the PDVSA 2022 bond, one of the people’s favorites because of its high 12.75% coupon. Today that bond was yielding about 16.1% per year if you held it until 2022 and had a “current yield” of 14.66%. The latter means that if you buy the bond today at around 86% and in one year it is still at 86%, you will make 14.6% on your money. This is what that this bond has done since the beginning of the year:

As you can see, it started the year at about 92%, dropped in six weeks to 75%, bounced back to 104% only to drop to 80% once again with all the default talk and recovered some to close today at 86%. That is a 19% drop, a 38.7% rise and a 23% drop in the space of less than nine months.

To me, this is too risky, too much volatility, given that I am paid less than the last two drops for holding the bonds. Imagine you are a fund or you have a client that buys at 100% and you have to tell him or her, that the bond is down 23% since the purchase. If it stays down there (nothing guarantees it will bounce back) the fund or your client will lose money over the first year and a half of the investment.

Now, if the price comes down below 80% again, I might be intrigued for aggressive investors (including myself). In fact, I did that when it started bouncing back in February, but sold when the yield became too low again for the risk I perceive. (Again, this is my personal perception of what the risk/return should be)

Add to this, what the Government has done (or not) in terms of giving negative signals to make the bonds even less attractive:

-It invited foreign investors to two meetings in New York with then VP for Economic affairs, both meetings were cancelled.

-It said it wanted to sell CITGO

-It has said nothing about whether or not it (or PDVSA) had significant amounts of funds in Banco Espiritu Santo or its affiliates.

-It has said a few times that all foreign currency in parallel funds will be added to international reserves, but Maduro only mentioned US$ 750 million. Analysts believe that there should be much more than that in the parallel funds

-It has done little in terms of the exchange rate and/or gas prices and moved sideways the only Minister proposing changes.

-There was a report that Venezuela was storing heavy crudes in Caribbean islands, while PDVSA “reviewed its pricing structure”. This was never clarified.

None of this gives you any confidence in the strategy of the Government or the bonds.

But whether you invest or not, has nothing to do with believing in default or not. That is a separate question and I don’t think that there will be default this October, even if I understand that this is a political decision in the end.

But I also think that the discussion has become somewhat circular. When I read Hausmann and Santos, I read: “If the authorities adopted common-sense policies and sought support from the International Monetary Fund and other multilateral lenders, as most troubled countries tend to do, they would rightly be told to default on the country’s debts”

This is an extremely hypothetical question, as the current authorities are not considering this even remotely. In my mind, what Hausmann and Santos said was a number of truths to warn investors not to be so complacent about the country’s debt. ( I also think that an IMF agreement and some adjustments would provide ample funds to avoid default)

In the same manner, when Francisco Rodriguez answers back that the real problem is that Venezuela is selling ten dollar bills for one dollar and it should really just change that, this is another highly hypothetical question as the last year and a half under Maduro has shown that there is no intent to sell the $10 bills for ten dollars, but at most for $2 or $3 dollars, which really solves nothing.

And now to make things even more confusing, people will certainly over interpret and confuse what S&P said today. Which, by the way, will not help the prices of the bonds tomorrow or for the next few days. Neither will it help if they announce they sold Citgo or parts of it, nor if they announce little in terms of correcting the distortions in the Venezuelan economy.

The amazing thing is that some simple steps, like talking to the market (not cancelling meetings), moving assets to international reserves and addressing issues like Espiritu Santo, would have done wonders to calm investors down. Even if you lead a “revolution”, if you want financing, issuing debt becomes cheaper the more transparent and communicative you are with investors. In the end, not doing so, becomes very costly for the country and Pdvsa to issue new debt. Ramirez seemed to have understood that, but currently, it appears as if we are back to Giordani’s days of not talking to those that provide your financing.

And in the end, all Venezuelans will have to pay for it.

If there is one thing that surprises me about people’s reaction to the Maduro Non-Adjustment, it was that people were surprised. For seventeen months then Minister of Energy and Oil and later VP for Economic Affairs had been telling us about the adjustments coming, but nothing ever happened. He proposed a system that would break the back of the parallel dollar, but all he did was recreate SITME at a much higher rate, creating a useless system once again, that did nothing but dispense, as usual, foreign currency arbitrarily. Ramirez also suggested regularly that prices of gasoline and certain products should be raised. Not much happened in this front either.

The problem was that we were hearing only one side of the debate taking place within Chavismo. Never the others who talked quietly among themselves. Ramirez tried, unsuccessfully, to gather support for some form of adjustment, fearing that not doing so would be worse than the alternative. In the end, Ramirez did not seem to convince too many people, others banded together and convinced Maduro to get rid of a man that had been a constant presence over oil and energy policy in Venezuela for almost ten years.

Yes, he did stay at another position in the Cabinet, but his lonely voice over the need of an adjustment becomes weak now. At the same time, giving him some perks and keeping him close, allows Maduro to insure that Ramirez will not play a Giordani on him, writing letters, criticizing or renewing his crusade for an adjustment outside the Government.

I have always been very skeptical as to the probability of a significant adjustment taking place. I always believed that it would be too little, too late. Not enough to mitigate the many distortions of the economy. Thus, the outcome of just nothing is not even a surprise, even if later we may see some small adjustments. Maduro has always acted like he is a man without concerns about the economy. This is likely to his ignorance or the existence of a plan B (Everyone in Venezuela has a plan B). It could be due to both too.

But by waiting so long, Maduro not only made an adjustment more difficult in terms of getting results before next year’s elections, but he also gave time to those opposed to a partial or a full adjustment to get together and create groups. Thus, those benefiting from the rackets oppose any form of adjustment, those that ideologically oppose the adjustment began accusing Maduro of betraying the revolution, those that thought the adjustment would be worse than not doing anything, also sided with the non-action.

In the end, in the absence of economists in or near the Cabinet, Ramirez was a lonely voice. The outcome is the one expected, even if it is remarkable that no measure has been announced, not even moving the Bs. 6.3 per US$ rate to the Sicad 1 rate of Bs. 11, the only measure I expected. (I also expect some very symbolic increase in gas prices).

So, what now?

Well, I am not in the camp of those that think there will be a default. But I think nobody knows if there will be a default. With Ramirez out of the Economic Cabinet, the probability of default is higher. He understood some of the consequences, particularly for PDVSA.

But think about it, Venezuela has to pay US$ 6.3 billion in the last three months of the year between two maturing bonds (PDVSA 14 and Venezuela 14) and interest on all bonds. Thus, don’t you think that in a world with falling oil prices some “cabeza caliente” (There are many!) in the Maduro entourage has not suggested defaulting? This is, after all, a revolution…

Did anyone think they would fire 20,000 PDVSA workers? Did anyone think they would expropriate and not pay? Did anyone think they would allow corruption at the levels they have? Do you know when and of what of Chávez died? Scruples is not a common word among revolutionaries.

People talk about default as if it would have catastrophic consequences on Venezuela. Defaults come in many flavors, look at the latest one from Argentina. Countries default regularly and few of them have catastrophic consequences, particularly if you have an oil spigot that will provide you with cash day after day, as well as trade partners that will support your default and who happen to be the ones that are sending the most food to Venezuela.

But I digress.

By now you have all heard or read the Haussman-Santos paper on default and Venezuela. They forgot to mention one detail: Venezuela already stopped paying the Sidetur bonds and it had absolutely no effect. Of course, a wider default would. But it could be selective too. Say you are willing to pay, but can’t. Keep paying interest in all bonds. Pay maturities on only some. The creativity of investment banks is unlimited. You just need a good one.

But for now, we face the adjustment that never was or will be. A sort of: what will happen now type of scenario? They will keep pushing their survival as far as they can. People die, sick patients can’t get their medicines, and there are food shortages. But the revolution is alive and well.

And they will try to keep it that way. Subsidies to the Caribbean can be removed. Even subsidies to Cuba can be stopped, if things get bad enough. But you can bet the choice is clear: Cuba comes before Wall St.

Defaulting is a political decision. If economic policy continues this way, it is inevitable. But for now, it can likely be pushed to 2017. Maybe oil prices will rebound by then.

As I have said before, Venezuelan bonds are not paying enough, given the risk you are taking. Maybe, just maybe, they will get there soon. But you don’t want to play Russian roulette, no?

Meanwhile, I continue on vacation…

The Cadivi rackets are much harder to quantify. It has a long history of schemes and variety, but each one of them has its peculiarities and details that make it difficult to quantify. There is, of course, the statement made by both former Minister Giordani and the former President of the Venezuelan Central Bank Edmee Betancourt, that in 2012 alone, “briefcase companies” (Compañías de Maletín) had received US$ 20 billion for imports that never materialized in what is in the end the ultimate corruption scam: Get foreign currency at Bs. 6.3 to import stuff that you will not even attempt to bring into the country. Sell enough of the foreign currency at the parallel rate, which is about ten times larger to pay the Bolívars and you keep the rest in foreign currency.

Nice work if you can get it.

But let’s look a little bit at the history of rackets within Cadivi. There are many stages in them. Like so many of the rackets of the Bolivarian revolution, they started small and grew and became even more daring:

-The bring the empty container racket.

This is the earliest racket I remember hearing about. You would get some foreign currency to import something, say barrels of some expensive chemical compound use in some industrial process. Bring a few hundred barrels of the stuff with invoices and bills of lading and the like, but the containers only have water. Or bring containers of empty computer boxes. Something that has value added, so the profit is maximized.

This particular racket required little or no participation of Government authorities at CADIVI. You brought bona fide import permits; you maybe even brought a small fraction of the stuff. You just needed to pay the National Guards and the custom employees when the stuff arrived so that it would no be checked thoroughly (A couple of times mistakes were made, empty containers were discovered).

My favorite anecdote of this was overheard in a business class commercial aircraft leaving Hong Kong by a Venezuelan flying next to some pro-Government importers who had no inkling there was another Venezuelan nearby. One guy explained to the other one how he had imported 400,000 key chains made in China with a Chavez’ figurine, for which he got from Cadivi two dollars a piece. The key chain actually cost only 10 or 15 cents, giving the loudmouth a huge profit. On top of that, he boasted, he gave the key chains to the same military official that helped him get the foreign currency for the racket, to use in Chavez’ 2006 Presidential campaign.

You see, in these earlier rackets, those involved had to basically fake the imports, because the difference between the official rate of exchange and the parallel arte was not huge, thus leaving little room for charging commissions and the like.

These type of racket is very hard to quantify but at some point the Government claim to be investigating some of them in the 100-200 million dollar range. How many were there? Hard to tell. Let’s say only a few, five to six in the US$ 100 million range. Total, less than a billion. Let’s round it off at a billion.

-The pay to get your dollars racket.

This was the second stage racket, when Government officials got involved. It started small time, when differences between the Cadivi rate and the parallel arte were small, but then it grew and grew. By the time that the exchange rate was increased to Bs. 4.3 per US$ and the parallel rate was Bs. 6+, Cadivi officials were asking for Bs. 1 to “ease” your way. Once the swap market disappeared in 2010, Bs.1 or 2 was the norm. Once companies fell in for it and started paying, it was the only way to get their Cadivi dollars.

During the last two years, as the parallel rate soared from around Bs. 10 per US$ to Bs. 80 and counting, the number of Bs. Charged for Cadivi dollars by officials or intermediaries “gestores” simply grew.

It is tough to quantify how big this racket has been. The commissions charged were only a fraction of the parallel dollar, but the dollars affected were in the billions. My guess is that at least US$ 10 billion of the US$ 40 to 60 billion a year in imports from 2009 to 2013 was flowing only if it was grease appropriately. Assume a 10% commission (of the parallel dollar, which set the pace of the size of the commissions) and you are talking at least US$ 1 billion per year from about 2007 to 2013. US$ 6 billion more.

And there were 7 billion…

-The Briefcase companies rip-off (Empresas de maletin)

Note that as CADIVI grew, more and more military officials were sent there. At all levels. Soon, they got more and more involved with it.

As El Nacional has reported in its investigative reporting on Cadivi, soon retired military “friends” with active military starting founding companies to import stuff. Flight by night operations began springing up all over the place. There were two types: a) Those that were created to import stuff for real b) Those that were created to apply for the foreign currency and never bring anything to the country.

In between these two, there were other side business, such as the purchase and sale of companies already registered in RUSAD, a prerequisite for obtaining Cadivi, Sitme and now Sicad 1 dollars. The same with the sale of certificates of no local production, another prerequisite to receiving Cadivi dollars. Just trading these generated a lot of wealth for those involved.

But it was not until Giordani suggested that the fake imports were about US$ 20 billion in 2013 that we got an inkling of the magnitude of the rip-off. (Can´t call it racket, it is so huge). In fact, the only reason one could have thought that something like that was going on at the time, was the fact that despite close to US$ 60 billion in imports, there were shortages of many products. If traditional importers were not getting dollars for say, toilet paper, then someone was getting the foreign currency and not bringing the stuff.

In order to quantify it, is tough to know exactly when it started or the magnitude. Let’s first estimate how long it went on for. My assumption is that this rip-off started when or around the time when Chávez got sick. It built up and had its crowning glory the year Giordani referred to as having US$ 20 billion in fake imports. Thus, this appears to have built up over a year and half. I will assume then that whatever estimate I reach for the year Giordani said was US$ 20 billion, there was about half as much the year before. Half, because Chávez got sick in May 2011 and I imagine they got bolder as time went on.

Well, pro-Government economist Manuel Sutherland has looked at the import numbers and his conclusion is as follows: Up to the beginning of exchange controls, the average price per kilo imported was roughly one dollar, year after year. It never deviated from this empirically. Never mind that the mixture of cars, paper products, automobiles or whatever was, this never changed.

Well, he argues, it started changing in 2005 and by 2013, 17 billion kilos of “stuff” were imported, but instead of costing the canonical US$ 17 billion of the ten years prior to 2004, the cost went up by almost a factor of three to US$ 47 billion. Sutherland (or someone else during his talk) says that there is no justification for the change. The mix of imports has changed little and the prices tend to scale anyway. At most, only 50% of the increase can be attributed to a possible change in the mix, or in the type of things being imported.

Thus, if 50% of the price increase can be attribute to over prices, inflation and the change in the mix, then each kilo would cost at most US$ 1.5. But each kilo cost US$ 2.76. This means that of the US$ 47 billion, around US$ 23 billion could not be justified. (Curiously, Edmee Betancourt’s number was US$ 22 billion). A large fraction of this went “empresas de maletin”.

Thus, if you are generous, want to be conservative in the estimates, if this is all empresas de maletin, we are talking about some US$ 33 billion in the rip-off in 2011 and 2012.

In the interest of underestimating things, I will only add a couple of billion before that, from 2004 to 2011 to fake imports.

Which means that very quickly, we are up to US$ 42 billion.

There are many other rackets around imports that I cannot quantify. Overprices is one. Government imports is another, just from 2003 to 2013, the Government went from importing US$ 3.5 billion to importing US$ 34 billion. This is a factor of ten. Nobody knows in what. There are rackets in there, we do not even understand or imagine. But if I can not assign a number to it, I will just ignore it for our purpose.

US$ 42 billion…US$ 23 billion in 2012 alone, do you think those controlling that want to give up that type of racket?

Think again…