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Big Debts Mean Rising Default Risks for Venezuela

Blaming Washington for his woes, President Nicolás Maduro borrows more money from China while cracking down on opposition.

For Venezuelans, low gasoline prices are considered a birthright. The country sits on the world’s largest proven oil reserves, and for decades the government has set domestic fuel prices at absurdly low levels, prompting consumers to splurge on everything from gas-guzzling sport-utility vehicles to motorbikes. The last time the government attempted to hike gasoline prices, in 1989, the move provoked a riot that left hundreds of people dead.

It’s a measure of the country’s desperate economic circumstances, then, that President Nicolás Maduro has suggested raising gasoline prices. Since he raised the idea in January, ministers have said the government is considering an increase from the equivalent of 5 U.S. cents a gallon to 17 cents. A rise would be a bitter pill to swallow for consumers facing widespread shortages. Venezuelans often have to queue for hours to buy such staples as baby formula, flour, milk and shampoo — that is, when they can be obtained at all.

Years of radical left-wing policies, heavy borrowing and subsidies, and the politicization of key institutions such as the state-owned oil company, Petróleos de Venezuela (PDVSA), have left the Venezuelan economy reeling. The country’s gross domestic product shrank by 2.8 percent last year, and the International Monetary Fund forecast a further decline of 7 percent this year. Inflation stands at a whopping 64 percent, according to official data, and private analysts say the real rate could be as high as 120 percent. The minimum wage is 6,000 bolívars a month, or just $24 at the black market exchange rate, which has plunged to 250 bolívars to the dollar from 150 a year ago.

The collapse in the price of oil, meanwhile, has increased the risk that Venezuela may default on its external debts of $95.1 billion, or nearly a quarter of GDP. The government has $38.3 billion in international debt; and PDVSA, $36.2 billion. The state also owes $20.6 billion to China under a loans-for-oil arrangement. In January, Moody’s Investors Service cut its rating on Venezuela’s debt by two notches to Caa3, the third-lowest of its 21 rating levels. The price of five-year credit default swaps, a form of insurance, has soared to 4,498 basis points, meaning an investor would have to pay $4.5 million to insure $10 million of Venezuelan debt against the risk of default over five years.

In addition, PDVSA owes billions of dollars to companies such as Spanish oil and gas producer Repsol and India’s Oil and Natural Gas Corp., which helped finance oil projects. The government has run up accumulated arrears of some $3.3 billion with international airlines, prompting many carriers to cut off or reduce their services to the country. Venezuela also has an estimated $3.5 billion in unpaid bills for pharmaceuticals imports and more than $2 billion for food. Debts to foreign car manufacturers and parts makers have made smuggling of spare parts a lucrative business.

The situation could come to a head this year. The government and PDVSA have ruled out defaulting on $10 billion of principal and interest payments due this year (the flash point will come in October and November, when $5.5 billion is due). But oil accounts for 95 percent of Venezuela’s exports, and if oil prices average $60 a barrel this year, the country stands to lose up to $30 billion in export revenue. It faces an external funding gap — the difference between its dollar income and dollar outflows — of $25 billion this year, according to Alejandro Arreaza, an economist at Barclays Capital in New York.

“If it is not going to default on its debt, and with oil prices at such low levels, imports must drop by an additional 50 percent this year,” says Ricardo Hausmann, a Venezuelan-born economist who is director of the Center for International Development at Harvard University’s John F. Kennedy School of Government. “Inventories are already at record lows within the country, but the situation could become terrible for the population.”

With economic woes mounting and his popularity rate falling to just 22 percent, Maduro has clamped down on the opposition, sparking a bitter diplomatic fight with Washington. The government has arrested some opposition leaders, including the mayor of Caracas, Antonio Ledezma, accusing them of plotting a coup attempt with U.S. support. Foro Penal Venezolano, a human rights group, estimates that 102 people have been detained or are awaiting trial for political reasons.

Earlier this month the administration of President Barack Obama imposed sanctions on seven Venezuelan officials, including the heads of the country’s security agencies, over alleged human rights abuses against Maduro’s opponents. The sanctions, which freeze any U.S. assets held by the individuals and bar U.S. companies from doing business with them, cite Venezuela as “an extraordinary threat to national security.” Maduro has countered by introducing visa restrictions for Americans visiting the country and saying his government would expel 80 U.S. diplomats. Venezuela’s National Assembly has given the president emergency powers to rule without legislative approval to combat what he called threats of U.S. aggression.

Facing tough Congressional elections in December, Maduro is likely to turn up the heat on the opposition even more. In response to mounting protests, in January he issued orders that the national guard could use live bullets against demonstrators. The following month a 14-year-old protester was shot dead by police.

The economy, meanwhile, is tanking so badly that foreign companies are being forced to take huge write-downs on their businesses in Venezuela. In February, Spain’s Telefónica took a €2.84 billion ($3.18 billion) write-down on the value of its telecommunications operations there. In January three U.S. companies announced similar write-downs: Ford Motor Co. wrote off its entire $800 million investment in the country, PepsiCo took a $105 million charge to revalue its assets there, and Kimberly-Clark Corp. took a $462 million hit.

Earlier this month China reportedly agreed to extend a fresh $10 billion in loans to Venezuela, but that could end up costing Caracas a further chunk of its diminishing oil revenue. Opposition leaders have criticized the opacity of the government’s borrowings from China. Barclays’s Arreaza estimates that the country currently sends China about 450,000 barrels of oil a day, or just over 15 percent of its production, to service its debts.

“Previous Chinese credit seems to have entered black hole funds and essentially disappeared,” says David Rees, a Latin America economist at Capital Economics, the London-based consultancy. “The Chinese are now more wary of lending to Venezuela, and any further loans are likely to have tight strings attached. For example, they must be for specific infrastructure projects by PDVSA.”

Venezuela produces 2.9 million barrels of oil a day. In addition to domestic consumption and debt-service shipments to China, the country sends 80,000 b/d to Petrocaribe, an arrangement that allows Caribbean states to buy Venezuelan oil on preferential terms. That leaves some 1.8 million barrels a day that Venezuela can export for cash. At a price of $50 a barrel, that would bring in less than $32.9 billion this year, down from $61.6 billion in 2014 and $73.2 billion in 2013.

The situation is so dire that some analysts believe the government and PDVSA will have no option but to default on their debts. It would take “an act of God” to avert a default this year, contends Siobhan Morden, the New York–based head of Latin America strategy at Jefferies Group.

Armando Armenta, New York–based Latin America economist at Deutsche Bank, puts the risk of default by the government or PDVSA at 50 percent within the next 18 months. Such a move would cripple the country’s oil industry by cutting off access to trade credit. Trade credits account for more than 80 percent of Venezuela’s short-term debt, compared with less than 20 percent for Russia, according to analysts at BNP Paribas.

“I cannot see the state or PDVSA ever defaulting because the cost to the Venezuelan people would be so great,” says Michael Ganske, London-based head of emerging markets at Rogge Global Partners, a fixed-income investor that holds Venezuelan debt. “Cutting imports to bridge the external financing gap would have a high price this year, but a default would be catastrophic for an economy that imports so much.”

Venezuela should be able to service its debt this year by running down its external assets. According to analysts at Barclays, the government has already secured around $9.4 billion since the fourth quarter of 2014. It raised $1.9 billion through the sale of Dominican Republic debt under Petrocaribe, and $2.5 billion through a debt issue by Citgo Petroleum Corp., the U.S. refiner that is a subsidiary of PDVSA.

The government is also working on options to obtain additional funding, including the sale or prepayment of Jamaican debt under Petrocaribe (which could provide $1.6 billion to $1.8 billion), and a rollover of some of the bilateral debt coming due ($2 billion), which is owed mainly to Russian and Brazilian banks.

According to the Central Bank of Venezuela, public sector assets totaled $48 billion in September, but only $15 billion to $17 billion of that total is believed to be liquid. Some $14 billion of reserves is in gold, which would take some time to sell for cash.

Jan Dehn, the London-based head of research at Ashmore Investment Management, an emerging-markets investment manager that holds Venezuelan bonds, says the country could raise up to $20 billion if it were to securitize the receivables of other Caribbean countries that take part in Petrocaribe. “The country is not insolvent and can securitize its oil reserves,” he says: “In my view, it will not default.”

Analysts say that the government should consider a bailout from the IMF. But Venezuela has a poor relationship with the Fund, having refused to let its staff review the Venezuelan economy for the past decade. Instead, the Maduro administration tries to muddle through and looks at novel ways to attain essential goods. In February, Trinidad and Tobago offered to swap tissue paper for oil, for example.

All of this is bad news for Venezuelan consumers, but there is a silver lining to the crisis for the country’s motorists: The value of used cars is climbing. With inflation soaring, people have few means to retain the value of their money. One of the few assets they trust is cars.

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