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The Venezuelan Horror Story

November 25, 2017 / Fiona Huang

Vending machines for gold bars, exotic animals as domestic pets, traffic jams of sports cars, mind-blowing five-star hotels and shopping malls; lavish is probably the first word you think of when asked to describe the major oil-exporting countries in the Middle East. But what if I told you that the country with the world’s largest oil reserve was in South America, and anything but teeming with luxury?

For the third year in a row, Venezuela’s political and economic problems have landed the country at the top of Bloomberg’s Misery Index. It all began in 2014, when the price of oil fell to a new “norm”, $40 per barrel; it was a hard blow to Venezuela’s economy, marked by a shortage of basic living needs, such as food and medicine. Currently, despite the rising oil prices and positive outlook extending into the new year, the IMF still expects inflation to hit a whopping 2,350% in Venezuela. A country who in the past easily outperformed its South American neighbors, now appears to be standing on the edge of a dark abyss.

 

Default: A Matter of When, not If

It isn’t hard to imagine that with an astronomical level of inflation and a negative GDP growth rate, Venezuela would eventually default on its bondholders. Yet, this doesn’t appear to be a reality for Wall Street bankers, who receive fat interest payments while Venezuela’s population struggles to remain above water. On November 2nd, President Maduro was forced to call for a restructuring of its foreign debts, placing the blame on US sanctions for the worsening of Venezuela’s economic struggles. Albeit Maduro hasn’t made an explicit statement regarding the default on the country’s $63 billion debt, following the announcement, Venezuelan bond prices have tumbled by more than 50%, along with a five-year implied probability of default soaring up to 99.99%.

 

 

 The government have invited its debtholders to Caracas for renegotiations on November 13th, but with hardly any foreseeable upside to the economy, debtholders are wary that the “restructuring” is nothing more than a default. The country has kept current on its bond payments, but it has failed to pay some of its coupon on time. Hence, both Fitch and S&P have downgraded Venezuela to restricted/selective default. Maduro claimed that this decision would help pay for the country’s much-needed social aid programs and food packages for starving civilians, but creditors could eventually try to seize the country’s most valuable resource, oil, which accounts for 90% of the country’s exports.

 

What can Venezuela do now?

Ever since the country began leaning towards left-wing policies, foreign direct investment has slowed and currently accounts for only 6% of GDP, in comparison to the 32% prior to the revolution. However, while many oil companies have pulled out from the country for its political chaos and unfriendly regulations, a few Russian oil groups, such as Rosneft, has remained to invest in Venezuela’s oil sector. Russia’s interest in black gold provided Venezuela a last hope – on November 15th, Russia signed a deal with Venezuela to restructure $3.15 billions of sovereign debt that will be repaid over a 10-year period, allowing Venezuela to protect the last of its natural resources and to meet upcoming debt payments. The savior also wins – the restructuring deal is probably more politically than financially important. Instead of being a part of a creditor group managed by traditional Western economy powers, Russia now has a stronger position in representing Venezuela’s creditors in future negotiations.

Alternatively, if Venezuela were to not receive any financial support from Russia, it could also sever its relation with its beloved PDVSA. Suing a country is much more difficult than suing a company. In theory, Venezuela could renounce its control over PVDSA, the country’s oil company. If PDVSA is separated from the state and continues to pay its debt, Venezuelan bonds creditors would have no claim on PDVSA’s oil assets. Indeed, even after the rating downgrade, bonds of the oil company are still “safer” than the Venezuela bonds in the eyes of investors.

 

Bread over Bonds, a Political Play

By stopping payments on these debts, Maduro could increase the funds needed to import food and medical supplies. This relief, though very brief, could boost his vote for the upcoming elections. According to Alejandro Grisanti, an economist with the Caracas-based consultancy Ecoanalítica who was interviewed by Wall Street Journal, a default would give the leftist leader a six-to-nine-month window to try to ease the shortages that have pushed Venezuela to the edge of a humanitarian disaster. At the same time, the U.S. sanctions that prevent certain investors to hold Venezuelan bonds will allow Maduro to deflect blame for the country’s failing economy to his ideological rivals in U.S. In a televised address, cited by WSJ, he said, “It hurts me because that money (paid to Wall Street investors) could be converted into schools, or emergency rooms, or into homes.” A political play for good or for bad, the collapse of the Venezuelan economy seems to be simply a matter of time; the question is not if, but when.