On Tuesday January 13th Moody’s downgraded Venezuela to Caas3, a rating one step away from default and equivalent to that of war-torn Ukraine. Venezuelan inflation is more than 65% at tapered government figures, extreme currency controls value the US$ at a 28th of the free market price and a widening balance of payments issue is being catalysed by the crash in oil price. The country with the greatest oil reserves on the planet now finds itself on the brink of economic and social collapse; one that their current leadership is entirely unable, unwilling and unprepared to deal with.
The Venezuelan Economy is Deteriorating Alongside the Oil Price
Much like Russia, Venezuela is heavily dependant on oil exports and has so far exclusively relied on these windfall profits to avert full economic meltdown. The oil price hit its six-year low of $45.6 per barrel (p/b) this week, a 48% collapse in price over the past six months, and is estimated to level off at $40p/b. As 96% of Venezuela’s export earnings originate from oil, each $1 drop in the oil price costs the country more than $700 million in lost revenue a year. Every $10 drop in Venezuela’s oil basket, which has dropped $30 in the last three months, will result in a $5.7 billion loss in revenue. Government profligacy, such as petroleum subsidies at home pricing a litre of petrol at a fraction of a cent and oil patronage to the Caribbean, has cost the country $77 billion in two years alone. According to Bank of America Meryl Lynch estimates, Venezuela will face a funding shortfall of $25 billion in 2016, and has a 96% chance of defaulting this year if the oil price stays in the $50 region.
The Near-Certainty of Venezuelan Default
Of the many financial crises plaguing Venezuela, one in particular has many investors concerned. Their government owes $21 billion on overseas bonds by the end of 2016, which is an amount equalling the entirety of the country’s Foreign Currency Reserves. Until recently, bond investors relied on Venezuela’s $85bn annual oil exports. That confidence is now shaken with bonds currently trading at yields of 50%. Investors must now pay $5.9 million in advance to insure against the default of $10 million in Venezuela’s five-year bonds. Fortunately for investors, there is very little fear of contagion outside of Argentina due to Venezuela’s near-total reliance on oil revenue and heavy-handed government.
Now the fiscal deficit has reached 11.5% of GDP, and public debt is at 34.2% of GDP, according to the latest government figures released in 2012. Former bus-driver and current President Nicolás Maduro has resorted to slashing imports and seeking foreign funding to balance payments. As Venezuela imports 75% of all goods and services, the country now has more domestic shortages than those experienced in Syria. Rationing has started across the nation, and the National Guard have been deployed to control queues. The President has also returned empty-handed from his emergency global tour this month, with China offering little financial assistance and OPEC refusing to cut production. In his absence, opposition favourite Henrique Capriles took the opportunity to announce a “state of emergency” in the country, calling for the people to “mobilize in the streets.”
The decline in oil price requires a huge policy response; otherwise the end will be imminent for the Bolivarian Republic. Data transparency, higher gasoline prices and currency devaluation would be the obvious first steps, but Maduro remains reluctant. Fears of further alienating supporters, despite his approval rating halving to 24.5% since his arrival in office, is the only reason for maintaining his economic policy. The patience of the Venezuelan people, once attracted by false-promises of equality and prosperity, will run dry.
What will happen next? Forced intervention of the non-democratic kind is by no means out of the question.