Last May, our co-head of the Emerging Markets Debt Team, Rob Drijkoningen, wrote a commentary for the IOC's Weekly Outlook where he highlighted the positive momentum for emerging markets fundamentals and the reforms being implemented in Brazil, Argentina, India, Indonesia and Mexico. At the top of the list of identified risks, however, was Venezuela, where the funds to pay off the debts were rapidly running out.
Just in time for the 20th anniversary of the Asian crises, as well as the 35th anniversary of the Mexican default that triggered the crisis in Latin America, Venezuela is once again grabbing the headlines. Will we be writing about it again in 20 years, reflecting on the events leading up to another summer slump in the emerging universe?
ECHO OF THE 80'S
In Venezuela there are clear echoes of the crisis of the 80s. At the time, surging crude had forced commodity importers into debt to meet costs, while encouraging exporters to capitalize on good fortune for their own development, believing that oil at those prices would last forever. . When crude oil prices collapsed, the debt levels reached became unsustainable.
Venezuela has relied on high oil prices to prop up disastrous populist economic policies that have increased debt while doing little good to citizens and productivity. GDP is now shrinking by 10% a year and the population suffers from triple-digit inflation and food and medicine shortages. President Nicolás Maduro's regime attempts to consolidate power as anti-government protests sweep across the country leaving a trail of victims.
The government has done all it can, digging deep into its dwindling foreign exchange reserves, driving imports into collapse, and resorting to off-budget deals to raise funds by pawning future crude production and related assets for good. market, all in a desperate rush to hard currency to meet debt obligations. His determination to stick to power not only exponentially worsens the conditions for recovery under a new regime, but also raises the threat of a vicious circle. Condemnation from abroad includes rumors of US sanctions that would result in a ban on crude oil imports, while civil strife puts exports at risk – both prospects would strain the country's ability to pay the rest of its debts in 2017 .
MARKETS ALREADY PRIZE INSOLVENCY
The Venezuelan debt market appears to have concluded that a default is virtually inevitable. Sovereign bonds are trading at 35-45 cents on the dollar, with prices falling steeply due to US sanctions already in the air. Rather than the probability of default, price volatility is now associated with estimates of the timing of a bankruptcy, subsequent recovery values and background political circumstances.
FOR MANY INVESTORS, THE REAL ISSUE IS THE POTENTIAL IMPACT
This crisis has unfolded all too predictably. Given that the default will not be a shock, contagion is likely to remain contained. An impact on the energy sector is expected, given Venezuela's importance as an exporter of crude oil. Crude oil prices have been fairly stable lately, but other factors have come into play, such as promises of production cuts in Saudi Arabia and shrinking US inventories. However, this trend in crude oil has not been disproportionately reflected in energy stocks and bonds, suggesting that the market sees it as a short-term circumstance rather than something lasting.
Venezuela accounts for 1,7% of the JP Morgan EMBI GD index, at the moment. Given the significant investment in passive strategies, it is important to remember that in the event of default, exclusion from the index would not be triggered automatically, if the other inclusion criteria were still met.
TRAGIC, USELESS, BUT NOT REPRESENTATIVE
The long winning streak of emerging stocks, however, confirms a generally positive sentiment since the early months of 2016. This rests mainly on the recovery of fundamentals: better growth rates in the world, a mix of progressive and pro-growth policies in most countries, benign inflation, reasonable public debt levels and stronger current account dynamics. Circumstances in Venezuela do not change the larger reality.
Perhaps this is the most important lesson that investors can draw from the current crisis. Venezuela looks like a Latin American country from the 80s, when major economies like Brazil and Mexico could collapse with a contagious effect on the weak banking systems of an overleveraged and inflation-ridden emerging universe. But it's small and represents a flashback. Today, most emerging markets look quite different.
What is happening in Venezuela is tragic and totally unnecessary. At the same time, however, it reminds us of the great progress made by emerging economies over the past 35 years.
