Featuring: Argentina | VENEZUELA | THE IMF

This week we analyze Argentina’s decision to freeze local law USD debt payments until year end, consider the complications Maduro’s regime might face in Venezuela due to the likely severe economic and social shock as result of COVID-19, and highlight an IMF initiative that might go a long way into reducing liquidity stress for EM issuers.

Argentina’s standstill on local law USD debt payments increases resources for external law debt service but economic and political conditions still pose risk of hard default 

Market Event: The government postponed payments on its local law USD debt through year-end via decree. The order indicated payments could resume sooner in the event of progress on broader debt sustainability.  Meanwhile, Fitch and S&P lowered the country’s foreign currency debt ratings to RD and SD, respectively.  While Fitch returned the rating back to CC shortly thereafter to reflect completion of the exchange, they noted that the rating still reflects very high probability of another default or distressed debt exchange. S&P plans to keep the rating in default until a broader debt restructuring process is complete. The next NY law coupon payment of $503mm is due on April 22nd.

Gramercy View: We saw the risk reward of local law debt as increasingly unattractive in recent months, given the decreased discount relative to external law and greater flexibility of the government to unilaterally amend Argentine law securities. While approximately $10bn in savings on local law USD payments provides greater breathing room for the government to remain current on its roughly $3.5bn of NY law debt service this year, the government has previously conveyed intentions to treat local and foreign law debt equally, potentially implying eventual cessation of payment on NY law debt. While remaining current would contribute positively to negotiations with bondholders and limit downside economic risks, social and political costs, as well as financial restraints, may limit the authorities’ ability to do so. Total remaining 2020 FX debt service of roughly $9bn (NY law & multilateral) could become increasingly challenging to meet if net FX reserves (~$12bn) continue to decline. Despite the risk of price volatility and hard default in the near-term, we continue to believe pragmatism will ultimately prevail and a consensual deal will be reached which achieves the government’s debt relief objectives  and satisfies bondholders. While the global crisis complicates the near-term situation, it should not materially alter long-term assumptions with respect to debt sustainability. We thus envisage terms to encompass some combination of principal haircut, coupon reduction, coupon capitalization and maturity extension, which will result in recovery values comfortably above current prices.

Venezuela’s increasingly untenable social situation given the Maduro Government’s severely limited capacity to respond to dual shocks of virus spread and oil price collapse 

Market Event: Venezuela’s deep economic, political and social crises are being taken to a new level by a country-wide lockdown related to the spread of COVID-19 in a society where the healthcare system has been decimated by years of underfunding and mismanagement. In addition, the price of the Venezuelan crude mix has been fluctuating recently around a level below production costs, depriving Maduro’s regime of a large chunk of its main revenue source.

Gramercy View: Venezuela is particularly vulnerable to the pandemic due to a number of factors including: the authorities’ limited capacity for effective containment and mitigation measures against COVID-19, the poor state of the national healthcare system, and the relatively higher average age of the population left behind in the wake of the massive outbound migration wave over the last several years. As such, we expect that the country will unfortunately be hit particularly hard by the health crisis. Additionally, lower oil revenues limit the resources available to fight the pandemic and create a vicious cycle that is likely to exacerbate Venezuela’s humanitarian crisis even further. In this context, the Trump administration has recently taken the opportunity to ramp up its pressure tactics on Maduro personally, as well as his inner circle, and impose additional sanctions on the economy. This has contributed to an unprecedented situation of a gasoline shortage in the country with the largest proven oil reserves in the world and bringing what remains of economic activity to almost a complete stop. We believe that the high pressure strategy by the U.S. administration increases the “cost of exit” for Maduro and other top ranking officials in the Chavista regime, incentivizing them to cling to power at any and all cost. With the opposition weak and divided and its perceived leader, Juan Guaido, unable to galvanize a popular uprising against the regime despite all the international support that has been thrown behind him, there is little political alternative to Maduro in the short-term. However, all else being equal, the likely material economic and social fallout from the ongoing dual shock is likely to gradually erode the regime’s grip on power and move Venezuela closer to the point of political transition.

Potential mechanisms by the IMF to provide USD liquidity on a short-term basis to EM economies without access to the systemic central banks’ swap lines  

Market Event: The IMF’s Managing Director, Kristalina Georgieva, has suggested that the Fund will review a proposal and will evaluate the options to provide a short-term liquidity facility targeted at economies with strong macroeconomic fundamentals that might be experiencing short-term FX liquidity pressures in the current environment, but have no access to the swap lines offered by the global systemic central banks, most notably the U.S. Federal Reserve (Fed).

Gramercy View: As part of various liquidity support measures deployed in response to the unprecedented global economic disruption caused by the COVID-19 pandemic, the systemic global central banks, especially the Fed, have introduced swap lines to facilitate the provision of hard currency liquidity into the global system. Despite these initiatives, extremely strong demand for USD amid the general risk-off market sentiment over the last weeks has made the access to U.S. dollars for many EM sovereign and corporate issuers more difficult and considerably more expensive than in the recent past. Furthermore, one of the few asset classes globally that is not a beneficiary of the systemic central banks’ purchasing/use as collateral are non-investment grade EM assets. This is the exact predicament that the IMF is signaling it will try to address by coming up with a short-term financing facility for select EM economies that is similar in nature to the Fed’s USD swap lines. We believe that, if approved and launched in due course, such a financing tool by the IMF will be a material step toward providing much needed liquidity relief across EM and gradually restoring some normalcy in EM markets. It could also make the “moral hazard” temptation for some EM governments and/or corporates less appealing, whereby they would use the current crisis situation as justification to seek material debt restructuring amid short-term liquidity constraints that are not necessarily symptoms of solvency problems.

Please contact our Co-Heads of Sovereign Research with any questions:

Kathryn Exum, Senior Vice President, Sovereign Research Analyst
[email protected]

Petar Atanasov, Senior Vice President, Sovereign Research Analyst
[email protected]

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