Success and failure in Latin America: The good, the bad and the ugly

It´s time for a quick update on Latin America. We have a potential default just around the corner in Venezuela. The country is a prime example of a string of failed economic experiments in Latin America. Then - on the other hand - you have Argentina on its way out of their long lasting default.
There are a lot of moving parts at the moment.

The good, the bad and the ugly ... let´s start with the ugly:
Brazil is going through an extensive corruption scandal that involves almost everybody in power, both in politics and in business. The scandal (aka operation car wash) is centered around the national oil company Petrobras, where the current president Dilma Rousseff was recently the director of the board. A lot of the wrongdoings in Petrobras were done on her watch. So, the question is if she will be able to continue as president. Recently, Lula the former president was picked up by the Police for his role in the scandal. That made Dilma nervous and she quickly made him a minister, simply to keep him out of prison. Cabinet ministers enjoy a special judicial standing in Brazil and can only be tried by the supreme court.

The logic is the following: If they get Lula, they will eventually get Dilma and the government will fall. Dilma wants none of it and saved Lula to save herself.

When it was announced that Lula was picked up by the police in mid March, the price of Brazil government bonds rose because the market was a bit more optimistic about a change in government. That remains to be seen though. No doubt that a new start with a new government can almost only be a positive one.

Argentina:  ... almost out of the woods this time

The good, the bad and the ugly ... this is the good one! Argentina has been in a position where they have been unable to issue new debt. This is because of a dispute between two investor groups and the government of Argentina. The brief story is: The economy of Argentina was in a poor state back in the beginning of the 2000s and defaulted on their debt. Back in 2005 and again in 2010 Argentina made an "offer" to holders of Argentina debt. Holders of debt were given bonds with terms that were worse than the original bonds. But, some investors did not accept the deal and a lenghty and volatile conflict was born. You can read much more in a previous blog entry of mine.

Above, you can see the price of one of the "new" bonds that were issued in 2005. Now, Argentina has been in a technical default since 2014 and is not allowed to pay coupons to creditors - why? Please read my previous blog for more details.

So, why are the bonds rallying? Why is the price of a bond that does not pay coupons rising, as you can clearly see for yourself above. Because markets expect Argentina to solve the conflict with creditors soon. So, the rally is driven only by the expectation of a resolution.  And it seems that the market is right. This Thursday, the senate finally approved a negotiated solution with the creditors:

"Early Thursday, the Senate voted 54 to 16 to let Mr. Macri issue $12 billion in bonds and use part of that to pay $4.65 billion to the hedge funds, which had sued Argentina for not paying out on bonds they bought after the country defaulted on its debt 15 years ago."

If you are subscribing to Wall Street Journal, you can read more about it here.

Venezuela ... it's really just a matter of time, or is it ? 

The good, the bad and the ugly ... let´s end this blog entry with the bad: Argentina is on its way out of default, but another country that is very close to default is Venezuela. The economy is relying on oil almost entirely. That is great when the oil price is high. When the oil price is low, they are in trouble.

The economy is importing everything it needs - from toilet paper to cars - with dollars they receive from exporting oil. So, when the price of oil drops (and it has) dollars become a scarce commodity. When you have fewer dollars you have to import less than you did in the past. All of a sudden, with less toilet paper, fewer cars and fewer goods in general, inflation will rise. And it has - according to a recent IMF estimate, inflation for 2016 is estimated to 720% up from around 250% in 2015. The highest recorded inflation in the world today.

So, what do you do when you need dollars - can you issue debt? No you can´t since the outstanding debt in Venezuela already is at an unsustainable high level. In addition, every time there is a debt repayment, the air is filled with rumours and tension ... "are they gonna pay this time?"

The current president Maduro has pledged that all debt will be honored (as did Chavez before him). But, it's very hard to believe in that pledge when there are no dollars to back it up. It is in my opinion just a matter of time when Venezuela defaults. The question is when and on what terms. This could become a new Argentina mess in a couple of months.

On and around February 26 a large debt redemption was due. It was the bond issued by the government - called VENZ 5.75 02/26/16 - that was up for redemption. Venezuela payed up and that induced a rally of the bond that was next in line - a bond issued by the national oil company PDVSA. The PDVSA bond with a maturity in November 2016 rose from around 55 to around 80, only because of hope that this bond might stand a chance of getting payed also.

I will most definitely write a blog entry when a dafault happens in Venezuela. It´s just a matter of time.