Venezuela: Edging Towards the Precipice

new venezuela

Venezuela held a controversial vote for a new Constituent Assembly over the weekend.  As Venezuela moves further toward autocracy, the chances of an external debt default are rising. 

POLITICAL OUTLOOK

President Maduro wants to rewrite the constitution.  The new 545-member Constituent Assembly, stacked with his supporters that include his wife and son, will allow Maduro to do so.  Note that the duly-elected (and opposition-controlled) National Assembly was basically rendered toothless this year by a Supreme Court ruling.

Official say 8.1 mln people voted, or a 41.5% turnout.  Opponents put the turnout much lower at 12.4%.  Note that earlier this month, more than 7.5 mln voted in an unofficial opposition referendum that rejected the notion of rewriting the constitution.  The country remains deeply divided, and we expect violent protests to continue.

The US has already enacted a round of narrowly targeted sanctions on 13 current and former Venezuelan officials.  However, more may be on the way.  Today, President Maduro himself was sanctioned, but there remains speculation that the US may put some sort of sanctions on the oil sector.  Moody’s said current sanctions are unlikely to have much impact, but warned that broader economic sanctions could “hasten a default event.”

The next presidential election will be held in 2018.  Ahead of that, Maduro will continue efforts to consolidate power and marginalize the opposition.  Polls suggest Maduro has only about a 20% approval rating.

The business environment is deteriorating.  Note Delta and Avianca last week suspended service to Venezuela, citing security concerns.  Venezuela scores poorly in the World Bank’s Ease of Doing Business rankings (187 out of 190), as well as in Transparency International’s Corruption Perceptions Index (166 out of 176).

ECONOMIC OUTLOOK

Official economic data are no longer being released.  As such, the country’s outlook is based on nothing more than educated guesswork.  Note that the current economic crisis has its roots in the oil price collapse.  However, it has now taken on a life of its own.

The economy remains in deep recession.  The IMF forecasts GDP will contract -7.4% in 2017 and -4.1% in 2018, after an estimated -18% in 2016.  This latest leg up in oil would normally point to upside risks to the growth forecasts, but the broader economic performance has decoupled from oil prices.

Hyperinflation is in place, though no one knows exactly how bad it really is.  Most of this is caused by the central bank printing money to finance the budget deficit.  The IMF forecasts inflation of 720.5% in 2017, picking up to 2068.5% in 2018 from “only” 255% in 2016.  Widespread price controls have done nothing but create shortages of those goods.

Fiscal policy has remained expansive to maintain popular support.  The drop in oil prices should have necessitated fiscal tightening, but Maduro is in no mood for austerity.  The budget deficit came in at an estimated -14.6% of GDP in 2016, down from -17.6% 2015.  It is expected at around -14.2% of GDP in 2017 and -15.7% in 2018.

The external accounts should improve.  Low oil prices have hurt exports, but the ongoing recession and foreign exchange shortages have reduced imports.  The current account deficit was about -2.4% of GDP in 2016, and is expected to widen to -3.25% in 2017 before narrowing to -2.1% in 2018.

According to Bloomberg data, Venezuela produced 1.97 mln bbl/day of crude oil in June.  Capacity is estimated at 2.5 mln bbl/day.  At current prices, this should bring in nearly $100 mln/day in oil revenues.  The US is its largest export market, as many US refineries are geared to work with Venezuela’s “sour” (high sulfur) grade.

Yet foreign reserves continue to fall.  At $10.1 bln in July, they barely cover 1 month of import and are only a third of its stock of short-term external debt.  There are large payments due on PDVSA debt in October and November.  According to Bloomberg data, the nation has $6.3 bln of debt servicing (principal and interest) still coming due this year, followed by $12.1 bln in 2018 and peaking at $13.7 bln in 2019.

INVESTMENT OUTLOOK

There are several different exchange rates that are meant for various types of uses.  Back in February 2016, the official rate (used for imports of food and medicine) was devalued from 6.3 to 10.  The three-tier system was later simplified but the fact of the matter is that there are still chronic shortages of foreign currency.  The black market exchange rate is being quoted at an all-time high of nearly 11,200 today, which underscores the need for a painful devaluation of the official rates.

Venezuelan bonds appear to be pricing in a default event.  The yield on 5-year USD-denominated government bonds is currently around 33%.  Furthermore, 5-year CDS protection is currently around 42%.

Our own sovereign ratings model shows Venezuela’s implied rating at D.  Can Venezuela continue servicing its external debt when reserves are dwindling and its own citizens are facing chronic shortages of food and medicine?