By Allison Fedirka
Venezuela’s ability to make its debt payments – thereby avoiding default – has once again come into question. A similar issue arose at the start of 2015, which ultimately ended with Caracas managing to meet its debt commitment. However, a year later Venezuela and the rest of the world find themselves in a markedly different reality. Caracas is starting 2016 with $6.3 billion less in reserves compared to this time last year, while previously reliable foreign lenders – China, Iran and Russia – face financial challenges of their own. Oil prices have not recovered and now appear to be comfortably hovering around $30 per barrel. Therefore, commodity exporters are finding themselves in crisis. Although Venezuela managed to avoid default last year, it faces more constraints this year and has limited options. Speculation around a default this year continues to mount as avoiding a major credit incident will become increasingly difficult for the government.
The Extent of the Debt Problem
Venezuela owes about $10 billion in debt payments this year, with major payments due in February, October and November. Financial analysts generally believe that Caracas will make good on the $1.5 billion principal and interest payment on global bonds at the end of February, putting the chance of default at a mere 10 percent. However, this risk of default rises to about 78 percent by the fourth quarter of this year, when state-run oil company Petróleos de Venezuela S.A. (PDVSA) faces $5.2 billion worth of debt payments.
The country’s current international reserves stand at $15.3 billion. About two-thirds of this amount is held in gold, although these gold reserves lost approximately $3.5 billion in value in 2015 due to the metal’s price fluctuation and previous gold swaps. In December 2015, the Central Bank of Venezuela and Deutsche Bank agreed to execute a gold swap in 2016 for an unspecified value. While the government has made moves to free up these gold reserves for future debt payments, concerns remain over other financial constraints. Export revenue is expected to be less than $18 billion this year, with oil contributing 90 percent of the total sum. Meanwhile, 2015 imports totaled approximately $37 billion, even after a 20 percent cut compared to the previous year. Even without the major debt payments, the government would need to reduce 2016 import expenditures by about 40 percent just to break even. Given that food imports significantly contribute to Venezuela’s overall food supply and scarcity is already a problem, cutting imports by this amount is nearly impossible, especially considering no significant decline in consumption is expected.
The country has limited options when it comes to ensuring its debt obligations are met. Several of the tools Caracas used to avoid default in 2015 – drastically cutting imports, cashing in PetroCaribe loans and selling off assets and high-yield bonds through Citgo – are no longer available. The option of gold swaps still remains, but the amount of gold held in reserves is finite. Oil revenue serves almost exclusively as Venezuela’s source of U.S. dollars, which are used to pay off bonds and other debt. The country’s 2016 budget assumes oil will be priced at $37 per barrel. While low, this price assumption is still several dollars higher than the current price, leaving the government with a potential budget shortfall. A sharp rise in oil prices would dramatically improve the country’s U.S. dollar revenue inflow, but such an event appears very unlikely at this time.
Another remaining option for Caracas is to negotiate a refinanced payment plan with debt holders. PDVSA floated this idea in November 2015 but it has failed to gain traction for a couple of reasons. First, any type of exchange or postponement of payments with bondholders would need to be done on a voluntary basis. This means the new conditions essentially would need to be more attractive to bondholders than the current ones, in order to persuade them to accept a new agreement. This would end up being a very expensive alternative that Caracas can’t afford at this time. Also, these bonds do not have collective action clauses, meaning any potential agreement with the majority of bondholders could still make Venezuela subject to lengthy and costly court battles with those not opting to participate in the new deal. This is particularly worrisome given the recent precedent U.S. bondholders have set in U.S. courts regarding their debt settlement rights following Argentina’s default.
The one possible exception to Venezuela’s struggle to restructure payments is its oil-linked debt owed to China this year. This debt derives from agreements Venezuela made to exchange oil for Chinese loans. With the drop in oil prices, the number of barrels per day that Venezuela must ship to China to meet repayment obligations has dramatically increased. When oil was at $100 per barrel, Venezuela owed China 228,000 barrels a day. According to a Barclay’s report released on Feb. 2, at current prices Venezuela needs to be exporting 800,000 barrels a day to China to meet loan requirements. Oil shipments at these volumes are simply not taking place. China also seems unlikely to provide additional loans to Venezuela at this time. However, restructuring the Chinese debt – something largely dependent on political negotiations between the two nations – could help buy Venezuela some time. In 2015, China renewed one tranche of loans, increasing the amount from $4 billion to $5 billion and extending the length of the loan from three to five years. A second tranche of Chinese loans is due for repayment this year and there is hope that a similar arrangement on maturities would help Venezuela pay off at least $1 billion in short-term debt due in the first quarter.
Finally, Venezuela may look to the International Monetary Fund (IMF) or other financial institutions for assistance. As its debt problems deepen, there will be more talk about the possibility of getting funding from the IMF. However, it is very unlikely for the current Venezuelan government to view the IMF as a viable recourse. The IMF would insist on massive restructuring of the economy and constraints on consumption. That may eventually be the only solution but is not a course of action that the government of President Nicolas Maduro, which was founded on strong populist policies, could follow without complete political chaos. As other options dwindle, the IMF solution may turn out to be the only one left. However, it is an alternative that would cause even more upheaval than the current situation. The benefits of this approach for the government and the Venezuelan economy would be uncertain and a long way off at best.
A Venezuela default this year, though not a certainty, would have an impact both on international markets and Venezuela’s domestic political trajectory. Over the past couple of decades, markets have traditionally viewed Venezuela as a rather unpredictable and risky location for doing business. For this reason, it is unlikely that savvy investors would heavily weigh portfolios with Venezuelan papers or that a default in Venezuela, where the economy has become infamous for its instability, would shake investors’ confidence in all emerging markets. While a default would certainly attract headlines, the impact on international markets as a whole would be minimal, as only those who invested – and most likely were aware of the risks – would feel the effects.
On a domestic level, however, a default would be nothing short of a disaster. A default would make it nearly impossible to enforce any type of regulated exchange rate systems. The already weak bolivar would become essentially worthless and looting would be rampant. Without strong access to U.S. dollars or credit, the government would struggle to acquire food imports. This could devastate a population that already experiences food shortages but has managed to survive thanks to imports and informal markets, where prices are still not out of reach for consumers. If a default were to happen, economic activity would move at a snail’s pace at best and it would be nearly impossible for the government to maintain key programs like gasoline subsidies. Rising fuel costs would make transportation of workers and goods unaffordable for many.
For now, the Venezuelan government’s move to continue with gold swaps suggests it still desires to find a way to honor its debt obligations. If 2015 is any indicator, we can also expect to see the government prioritize debt payments over non-threatening domestic issues, such as shaving off non-essential imports. In the past, Venezuela has been able to take advantage of regional political ties to help ensure food supplies by coming up with alternative payment programs such as oil-for-food schemes or tolerance delayed payments. Unfortunately for Venezuela, this no longer works. Brazil must attend to its own economic problems, the new government in Argentina is strongly anti-Maduro and Uruguay has shown signs of waning patience. No country in the region wants to see the chaos that would ensue from a Venezuelan default, as such an event would lead some to call for extra-regional intervention to help restore order. However, no regional partners are in a position to help Venezuela. At best, they can offer political support and encourage the fighting factions within Venezuela to work together to avoid default and ensuing disaster.