By Manuel Orozco,
Lisa M Schineller, PhD,
and Joydeep Mukherji
S&P Global Ratings
NEW YORK -- On July 11, 2017, S&P Global Ratings lowered its long-term foreign and local currency sovereign credit ratings on the Bolivarian Republic of Venezuela to 'CCC-' from 'CCC'. The outlook on the long-term ratings is negative. We affirmed our 'C' short-term foreign and local currency sovereign ratings. In addition, we lowered our transfer and convertibility assessment on the sovereign to 'CCC-' from 'CCC'.RATIONALE
The downgrade reflects continued deterioration in economic conditions, rising political tensions, including within the Chavista government base, and the government's worsening liquidity position.
Economic policy continues to be erratic, in a context of very high inflation; severe fiscal, monetary, and exchange-rate rigidities; and draconian controls on imports.
Recent developments have raised the risk of default, including through a debt exchange that we would view as a distressed exchange, within the next six months, absent unanticipated significant improvement in Venezuela's economic and political conditions.
In March 2017, Venezuela's Supreme Tribunal of Justice (TSJ, Spanish acronym) passed a ruling to transfer the legislative powers of the opposition-led National Assembly to the TSJ and to President Nicolás Maduro. This ruling, which was later revoked, contributed to further political polarization and increased public demonstrations against the government. Amid this turmoil there have been nearly 100 deaths. Moreover, the country continues to suffer from severe shortages of basic goods given the controls on imports and higher levels of violence, exacerbating political tensions.
Amid the increased social unrest, President Maduro and his supporters are seeking to rewrite the country's constitution. This political strategy is perceived by many as an effort to concentrate more power in the presidency.
The government has scheduled elections for a National Constitutional Assembly (ANC, Spanish acronym) on July 30. Several prominent members of the government and the dominant Chavista political movement have spoken out against the TSJ ruling and the proposed ANC.
We expect internal divisions within the Chavista movement could sharpen. Ongoing social unrest could also deepen divisions within the country's military, which has supported the government thus far.
After three years of economic contraction, S&P Global Ratings expects Venezuela's economy to contract again by at least 6% in 2017 and real GDP per capita by 7.2%.
Based on our oil price deck forecast, we would expect Venezuelan oil exports to enjoy higher prices on average in 2017, but output is likely to decline toward an average of 2 million barrels per day from 2.4 million barrels per day in 2016. In our opinion, the level of GDP per capita in dollar terms is currently a misleading indicator given severe distortion on exchange rates. Shrinking oil output, which represents 95% of Venezuela's exports, will result in a current account deficit of around 4% of GDP this year, contributing to deteriorating external liquidity (in the absence of new external funding).
Therefore, we expect the government to maintain import controls to try and preserve the level of international reserves. According to Venezuela's central bank, the country's foreign exchange reserves stood at US$10 billion as of June 2017, but we estimate non-gold reserves between US$3 billion and US$4 billion. There is no updated information about other government funds denominated in foreign currency; we believe other significant noncash assets may already have been used as collateral for existing debt.Absent significant new external funding, we expect the government to have difficulty paying debt service of around US$2.8 billion in the second half of 2017 and around US$7 billion in 2018.
Moreover, the state-owned energy company, Petróleos de Venezuela S.A. (PDVSA), faces US$4 billion of external debt maturities during the remainder of 2017.
PDVSA's debt is not guaranteed by the government, and the government's debt does not have cross-default clauses connected with the debt of the national oil company. However, we expect PDVSA's debt service needs will put pressure on Venezuela's international reserves and external liquidity.
The combination of poor monetary, fiscal, and other policies has resulted in rising inflation. The latest published information shows a 180% inflation rate in 2015. Doubts about the accuracy of reported economic data (whose disclosure has decreased, and delays in reporting have mounted since early 2016) have weakened market confidence and made it more difficult to make inflation forecasts. We estimate inflation was 500% in 2016, and we expect it to be 950% in 2017.
With around 50% of the government's revenues coming from the oil sector, low oil prices have undermined fiscal policy, resulting in large budget deficits and increased recourse to inflationary financing from the central bank.
Official data on fiscal balances have not been published since 2014, but estimates from private sources and the International Monetary Fund suggest that the general government deficit was around 20%-25% of GDP in 2016. We expect it to be at a similar level in 2017.
General government debt was 2% of GDP as of year-end 2016. However, Venezuela's reported low debt stocks and interest burden are misleading as the government uses the preferential foreign exchange rate of 10 bolivares (VEF) per $US1 to account for external debt.
Venezuela's fiscal deficits will be mostly financed by domestic sources, but if the preferential exchange rate were to depreciate at the same pace as our inflation forecast, as our base-case scenario suggests, the increase in Venezuela's net general government debt could be as much as 40% of GDP in 2017. Under our base-case scenario, net general government debt would rise toward 45% of GDP and interest payments toward 25% of general government revenue in 2017.
The government has not published balance of payments and international investment position data since September 2015. We estimate the country's gross external financing needs in 2017 at around 200% of current account receipts (CAR) plus usable reserves, a similar level to our estimate for 2016 but twice the level in 2013. We expect Venezuela to finance this need by the public sector running arrears with most of its suppliers and noncommercial creditors, and liquidating external assets. We expect Venezuela's external debt net of reported public- and financial-sector assets will remain around 250% of CAR during 2017-2019. OUTLOOK
The negative outlook reflects the heightened risk of the Venezuelan government defaulting, including through undertaking a distressed debt exchange, in the next six months. Failure to introduce substantial corrective measures to stabilize the economy, alleviate shortages, and reverse the recent growth in political polarization could lead to worsening external liquidity and debt default.
Steps to defuse the heightened political tensions in Venezuela would reduce the risks of eroding governability and high volatility in economic policies.
That, along with prompt, corrective reforms that begin to address the country's economic imbalances and to strengthen its external liquidity, could lead us to affirm the ratings at their current level.