Q1: What is happening in Venezuela?
A1: Venezuela is in the midst of severe economic and political turmoil. While many petroleum-exporting countries used the commodities boom to set money aside, President Hugo Chavez oversaw a quadrupling of foreign debt. Since President Nicolas Maduro’s succession in April 2013 following Chavez’s death and the collapse in commodity prices, the economic situation has deteriorated dramatically. Inflation had risen to an unofficial estimate of 600 percent by the end of 2015. Venezuela’s currency, the bolivar, has lost a full 98 percent of its value relative to the dollar in the last three years, the economy shrank 8 percent in 2015, and the International Monetary Fund (IMF) forecasts a 10 percent contraction in 2016. Policy errors, including currency exchange controls, price ceilings, private-sector nationalizations, and the continued printing of money have exacerbated the situation and driven the country to the verge of default.
Political tensions are high as well, especially since the opposition won a supermajority of the National Assembly last November. The judiciary, controlled by Maduro and ranked last in the world on independence, has blocked nearly every reform proposed by the new Assembly. The current political system, with a corrupt bureaucracy on one side and a leaderless opposition on the other, is unable to resolve the institutional crisis. Most basic products are scarce and inaccessible for the majority of Venezuelans, especially the poorest. Physical insecurity and electricity blackouts are also constant, plus institutions undermined by rampant corruption make Venezuela highly vulnerable to complete political and financial collapse.
The humanitarian situation is bleak. People line up outside of the supermarkets for hours or days to spend their devalued salaries. The country has gone from being the richest in Latin America in the late 1970s to one of the worst performing economies (and “ most miserable”) in the world today. Despite its enormous oil reserves, Venezuela is currently caught in one of the worst political and economic crises in modern Latin American history.
Q2: What could happen next?
A2: Given the latest political and economic measures taken by Maduro’s administration, it is difficult to foresee any sound policy changes. Maduro’s disapproval rating is now above 70 percent, and he has lost influence both within theChavista political party, the United Socialist Party of Venezuela (PSUV), and internationally. However, the executive still controls most of the institutions of the state, including the military. A resilient opposition in the National Assembly is pushing for a recall referendum by 2017, but it seems unlikely to happen due to the chavista-lead Supreme Court’s authority to block the motion.
While Venezuela is currently not insolvent, the government has focused almost exclusively on paying international debt payments on its sovereign bonds. The result is that the government has effectively halted payments to its domestic bondholders, causing an internal technical default. Many national and foreign companies have already ended much of their domestic production, but a default on the country’s external debt would cut off international credit. The ensuing collapse of the domestic financial system could then lead to a humanitarian catastrophe even more serious than the country currently faces.
Q3: Will Venezuela default on its foreign debt?
A3: With collapsing growth and a rapidly rising debt burden have come fears that Venezuela may default on its foreign debts without a change in government. Past sovereign debt crises, like those of Mexico and Argentina, have come in different ways, and few have ever combined Venezuela’s volatile economic and political conditions. In general, however, it is important to identify what external obligations need to be paid, and what the existing sources of funding are.
Venezuela currently faces about $10.5 billion in debt service costs it must meet this year to avoid a default. The country met its payments in February, but a further $700 million is due in May and $4 billion in the fourth quarter of this year. Much of that debt is denominated in U.S. dollars, meaning Venezuela requires foreign currency-earning exports to pay the debt service costs. However, Venezuela’s unprecedented reliance on oil exports means that with oil prices at historic lows, the country is projected to spend over half of its expected oil export revenue this year on debt servicing. The country could also use its central bank currency and gold reserves or take funds from Petróleos de Venezuela S.A.’s (PDVSA) foreign assets, such as its U.S. subsidiary Citgo. While Venezuela could then likely pay its bondholders, this would further squeeze imports, especially by the private sector. This then raises the question of whether the government could politically endure further shortages in basic supplies. Given the choice between default and political suicide, the Maduro government would likely choose default.
It also appears increasingly unlikely the current government could find international support to avoid default. Venezuela has had no relations with the IMF since 2007. While the Fund would ordinarily negotiate a bailout in exchange for policy changes and a review of the country’s finances, the current government has disavowed working with the Fund entirely. China has already lent Venezuela more than $50 billion payable in oil, and there is some possibility China could restructure its loans to delay oil payments, freeing up oil exports elsewhere.
Were Venezuela to default, there are fears of a lengthy litigation process similar to the aftermath of Argentina’s default in 2001. Many bonds issued by the government and PDVSA do not contain collective action clauses, meaning investors are not bound by a majority agreement and can sue for repayment, delaying any credit resolution. Unlike Argentina, Venezuela possesses many assets abroad, such as PDVSA’s subsidiary, Citgo. This would make litigation even more attractive than was the case for Argentina as Venezuelan assets could be seized abroad. Because much of the debt is held by PDVSA, particularly bonds coming due this year, there is also the possibility of inter-creditor disputes over payments in the event of a default. Given the current government’s intransigence, it would likely wage a lengthy and costly battle with its creditors.
Q4: What does this mean for the region?
A4: The possibility of a Venezuelan default poses a small but not insignificant threat to other economies in the region, according to the IMF. Through institutions such as the Bolivarian Alliance for the Peoples of our America (ALBA), Petrocaribe, and Mercosur, Venezuela has become an influential trading partner within the region. Venezuela’s default would notably have some economic implications for its neighbors Brazil, Colombia, Guyana, and Caribbean countries such as Cuba. Although Brazil has the largest economy in Latin America, bad loans and the current difficult economic environment make Brazil exceedingly susceptible to spillovers from a Venezuelan collapse. Brazil’s development bank has lent $3.2 billion to Venezuela in recent years, thus a default could affect Brazil’s trade relations with Venezuela at least in the short term.
While Cuba’s strengthening relations with the United States are expected to pay significant economic dividends in the medium term, the Cuban economy still relies on about 100,000 barrels a day in subsidized Venezuelan oil shipments. The Castro administration worries that, if Venezuela defaults, Maduro’s government will not be able to continue funding Cuban medical exchange programs—thought to be Cuba’s largest export—and health services that are currently in place in Venezuela. Less able to withstand the shock that would come from default are those that rely on Venezuelan exports through programs like Petrocaribe , a preferential oil sales program. Because of their dependency on Venezuelan energy, smaller countries, such as Jamaica, Nicaragua, and Guyana have suffered. Should Venezuela default and be unable to sustain Petrocaribe, these and other countries also risk serious economic impacts.
Colombia’s long and porous border with Venezuela makes it highly vulnerable to a Venezuelan economic shock and political collapse. Venezuela and Colombia have had strained relations under the Chavez and Maduro administrations, and while the countries’ bilateral trade has declined in recent years, Colombia is still vulnerable. A political collapse and humanitarian disaster could also potentially pose a significant security risk to Colombia.
As oil prices remain low and President Maduro continues to avoid pursuing long-term stable economic policy reforms, Venezuelan default becomes increasingly more likely. A plausible short-term option would be a bailout from international institutions that possess the know-how and the funding to reduce the political and economic costs of austerity measures. However, given Maduro’s strained relationship with the IMF, the World Bank, and the United States, this appears unlikely to happen without Maduro first being replaced in power. A more cooperative and rational post-Maduro leadership would quickly seek regional and multilateral support, and the international community would likely respond positively in an urgent effort to lessen the impact of any economic collapse.
By Michael Matera
CSIS
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