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The present scenario
The prognosis is grim. Sometime later this year, the Bolivarian Republic of Venezuela is likely to default on its debt obligations. This in a country which reputedly has bigger oil reserves than even mighty Saudi Arabia.
Venezuela's economy is forecast to decline 8% in 2016, on top of the 10% plunge in the previous year. Venezuela joins other Latin American countries like Brazil, Ecuador and Argentina in witnessing economic contraction. Local surveys have shown that the poverty rate has ballooned to 76% today, from 55% in 1999.This despite a commodity boom in the intervening years.
Compounding problems is the regime's misplaced priorities. For example, gasoline retails at one cent (US) per gallon. Even a small increase would net substantial revenues for the government. At this rate the outgo on fuel subsidy alone is humongous. In the last couple of years, the price of oil, Venezuela's chief export, has nosedived from $100 plus level to around $30 per barrel. As things stand today, the oil glut and hence low prices seem set to continue for a while longer. This means that the fiscal elbow room for Venezuela is limited.
Hyperinflation
Inflation is expected to hit 720% this year, according to the IMF. Inflation had reached a high of 141.2% annually at the end September. Inflation rate above 50% per month is termed as hyperinflation. The government is printing and/or importing plane loads of currency notes to keep up with the demand for currency notes, ironically further boosting inflation. Little wonder then that the currency is losing value rapidly. The bolivar sank to 1000 per USD on the black market. It has lost 81% of its value in last twelve months, says dolartoday.com. This plunge is greater than that of the Azerbaijani mannat, the world's worst performing currency. The amount of cash in circulation has doubled in the last one year. (Bloomberg, February 4, 2016)
Shortage of consumer goods
A stark reality stares the government in the face. Widely consumed common goods are becoming scarce and most of these, including food items, are imported. The head of the country's pharmaceutical association recently appealed for external aid from the World Health Organisation, stating that nearly seventy percent of the drugs distribution system was disrupted. The government is unable to pay for basic items like flour, eggs and milk. Many shops, including large departmental stores sport depressingly empty shelves. Recently, even McDonald's ran out of french fries, even if only temporarily. Food shortages and growing lines to buy essential items are testing the people's patience. Unrest has already started and could blow up any time. "There are no eggs, there's no milk," says Dallen, who frequently travels to Venezuela. "It's getting worse." (Money.CNN.com January, 20, 2016)
Food lines are getting longer and longer....
And for those who can afford, there's very little in the supermarkets anyway
The economics of probable default
Venezuela faces a hard choice between cutting imports to save foreign currency while at the same time finding enough money to keep items of mass consumption in supply, or default on obligations.
Francisco Rodrigues, analyst at Bank of America Merrill Lynch, "absent major corrections to relative prices, scarcity could rise to levels that would make 2015 seem like a time of abundance. At a price of $25.4 per barrel of Venezuelan oil - the average so far for the year - Venezuela's total export revenue in a whole year would fall to $22bn, barely enough to cover debt service on bonds ($10.1bn), oil sector imports ($4.3bn) and repayment of Chinese loans ($6.2bn).
Everyone - including authorities - is fully aware that in such a scenario, capacity to pay would be significantly strained. Nevertheless, we continue to see key decision makers in the oil company, finance ministry and central bank maintaining a strong commitment to honour international obligations for as long as possible even under conditions of stress.
The government's primary strategy of adjustment continues to be a combination of attempts to further rationalize imports, seeking new sources of financing and continuing to dissave from its stock of external assets." (Financial Times)
In the current full year, Venezuela is projected to earn $18 billion at current oil price levels. The country has to pay $10 billion on its existing debt of $120 billion. That would leave just $8 billion for imports. Last year imports declined 20% to $37 billion. The first pressure point could come as early as May, when $700 million in interest payments falls due. Even if the government manages this, it would have to be ready with $4 billion by the last quarter of the year.
The main worry for investors is that the country needs to service about $20 billion in debts and interest. A third of this is owned by PDVSA, another third is payable to China, while the balance is owed by the central bank. Given these numbers, Venezuela will not be able to meet its requirements even it defaults on its debt obligations.
In this scenario, markets are increasingly factoring in a sovereign default. For instance, Venezuela's bonds are trading at between 32 and 37 cents to the dollar. According to the Financial Times this is a distressed level. Another indicator of investor wariness is that the cost of insurance for government bonds and debt issued by the state owned Oil Company PDVSA is climbing.
The options
As days go by, the government is rapidly running out of options. Venezuela has already used its foreign currency reserves freely. Further, is has issued oil debt and sold off assets to raise money to pay foreign bond holders, It has thus far avoided default.
At the height of former President Chavez's socialistic dream, Venezuela broke ties with the IMF, secure in the surge of revenues, when oil sold in triple figures. Today it will have to muster the political will to re-engage with the IMF to head off a catastrophe. The only other hope is if the government manages to renegotiate the terms of Chinese debt which stands at $50 billion. (Washington Post, February, 11, 2016)
Leaders across Latin America, even around the world, are watching nervously as the government of President Maduro continues its antagonistic approach against an opposition that won a legislative victory in the recent elections. At any time political instability is bad news for the economy. More so in the present circumstances in Venezuela, which is now on the brink of disaster. Venezuela has dug a debilitating fiscal hole for itself, through years of financial profligacy. One only hopes that sobriety prevails and both the government of the day and the opposition summon the political will to take the stern measures to head off a calamitous default.
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