Wednesday, November 7, 2007

Hugo Chavez and Cristina Kirchner: Hot or Not Hot?

Venezuela and Argentina are different countries (duh!); but for the credit-markets and emerging markets portfolios, they are reasonably close and different! Sort of like the Cain and Abel of the Latin-American fixed income portfolios. Who's who, who knows. They are all (grand) children of God (or at least, Simon Bolivar). And in recent times, one has been more volatile than the other -- depending on what time-frame you investigate.

As per credit market data, the 5-year CDS for Argentina and Venezuela are trading at the same premium rates (around the band of 240bps). Over the past year and half, in order for you buy protection against the possibility of Venezuelan credit event on its loans as opposed to Argentina credit event – the spreads between the two have converged. This convergence in CDS spreads was caused by a greater confidence in Argentina and declining macroeconomic sentiments in Venezuela.

In fact, up until December 2006, Argentina’s spread seems to mimic the directionality of Venezuela’s spread movements. This tango, of sorts, meets an abrupt end in late December when Venezuela begins its nationalization of oil companies. Subsequently, the possibility of Venezuela pulling out of the IMF led to an increased spike in its premiums as well. The credit market fears in late summer led to a serious liquidity crunch (overnight rates climbed to 90%!!). Add to this political tomfoolery by Hugo Chavez (opposition arrests, indiscreet pressuring of central bank officials, closing of television stations etc.,). From a spread in July 2006, of 140bps on notional; today the spread is around 260bps – an approximate increase of 85%. All of this has occurred when oil prices were rampaging from around 55USD per barrel to the approximately 95USD per barrel. i.e., despite the filling of coffers in Venezuela, the credit markets were increasingly apprehensive of the possibility of “some” credit event, or even worsening of credit quality.

In contrast, Argentina has made gingerly adjustments to “normalcy”. This has come in the form of political stability, some swallowing of the bitter financial pill (staying out of the financial markets for a year after paying around 35 cents on the dollar for bonds – for 140bn., bonds!) thanks in part to Nestor Kirchners’ hard nosed bargaining, helped with generic boom in internal aggregate demand as opposed to aggregate global demand (13% of growth) etc., All this said, there is still uncertainty – most keenly evidenced by Argentines emigrating out to Spain, Canada and even Mexico. Unemployment rate has fallen to around 8.4%, inflation hovers around 8-9%. The real story is that year or year surplus has declined by around 60% compared to last year. (i.e., Spending increased. Is it me or do I see a relationship between government spending the election of Cristina Kirchner!)

In essence, the question is – who will the credit markets bet against! A loopy and statist petrocracy run by a junta or preternaturally prone to crises democracy. What has seemed obvious in the past few months is that – (a) every time Venezuela does something silly (claim to nationalize even more industries in the name of the people), the spreads have increased by 10bps or more, only for the rates to stay up there (b) the markets are willing to let Argentina have a pass, (Is it the democracy factor?) and has increasingly found itself comfortable with the non-Washington consensus based policies of the Kirchners. A subtle, but difficult to reason-out-completely-point, is that increasingly the largest holder of on-the-run Argentine bonds are the Venezuelans. So, in some sense, Argentine government spending is financed by the petrocrats in Caracas.

So, now what?

The primary bet are on the following events, and the subjective probabilities:

  • Chavez goes to nationalize some more: About 40-60%
  • Kirchner can’t control spending: About 60%
  • Oil prices rally to 120USD in next six months About 45%
  • Political turmoil in Venezuela About 10%

Over the next six months, I would bet on Venezuela’s spreads rising in the market – and the Argentine spreads trailing behind. So, sell Argentine protection and buy Venezuelan protection. It is imperative to note that in Argentina, one is dealing with credit risk that works its way through government finances. In contrast, in Venezuela one is dealing with “event” risk. So, in the strictest sense – it is not the same underlying propagating mechanism.

This is imperfect knowledge; and hence precisely more fun!

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