Published On: Wed, Sep 17th, 2014

Venezuela’s long-term ratings lowered on worsening economy; outlook negative

Venezuelan socialismNEW YORK, USA -- On Tuesday, Standard & Poor's Ratings Services (S&P) lowered its long-term foreign and local currency sovereign credit ratings on Venezuela to 'CCC+' from 'B-'. The outlook on both long-term ratings is negative.

S&P also lowered its short-term foreign and local currency ratings to 'C' from 'B' and the transfer and convertibility (T&C) assessment on the sovereign to 'CCC+' from 'B-'.

According to S&P, the downgrade is based on continued economic deterioration, including rising inflation and falling external liquidity, and the declining likelihood that the government will implement timely corrective steps to staunch it.

“We assign 'CCC+' ratings in instances where we assess that issuers face at least a one-in-two likelihood of default over the next two years,” S&P said.

The rating reflects Venezuela's higher vulnerability to nonpayment and its growing dependence upon favorable oil prices to meet its financial commitments. Lowering the local currency rating reflects rising inflation and the government's growing dependence upon shares of local currency debt instruments, which now account for 65% of total government debt.

“We expect Venezuela's GDP to decrease by as much as 3.5% in 2014, and another decline might follow in 2015. Inflation could rise up to 65% by year-end, and we don't expect it to decline over the next two to three years, reflecting the inflexibility of Venezuela's monetary policy,” S&P continued.

Oil prices remain relatively high despite recent declines. Nevertheless, the government's decision to sustain a high level of public spending (including the central government and PDVSA's [Petroleos de Venezuela SA] non-oil related expenditure) without addressing growing economic imbalances is leading to a decline in its external liquidity. The economy continues to suffer from a contraction in activity, high inflation, and increasing scarcities, largely resulting from stringent import restrictions.

International reserves fell significantly throughout 2013 to now reach $20.8 billion, of which S&P estimates only $2.5 billion is liquid. Other external assets held in several government special funds (FONDEN [Fondo de Desarrollo Nacional] and BANDES [Banco de Desarrollo Económico y Social]) have also fallen. While solid oil revenue (estimated at $82 billion for 2014) will continue to provide dollar inflows, the government could come under greater strain to service its rising level of external debt maturities.

The government faces a debt payment for $1.5 billion in October 2014 and another significant maturity for $1.3 billion in March 2015. In addition, PDVSA faces a maturity for as much as $3 billion in October 2014. Venezuela's main external indicators reflect this deterioration and will remain vulnerable to a further decline in oil prices.

“We expect gross external financing needs to increase in 2014 to 96% of current account receives plus usable reserves from 91% as of year-end 2013. We anticipate this deterioration will gradually continue thereafter. Likewise, narrow net external debt also continues to increase, and we expect it to reach close to 82% of current account receipts at year-end 2014,” S&P said.

The government plans to get financing over the near term from a variety of sources, including a new loan from China for up to $4 billion. Although the loan would be earmarked for infrastructure development projects in the oil sector, part of the proceeds could be used in a situation of financial stress to repay debt. In addition, the government may seek cross-border bond funding. Finally, both the central government and PDVSA could undertake a liability management operation aimed at re-profiling external maturities due over the next three to four years.

If and when there is a proposal to exchange external debt obligations, Standard & Poor's will analyze the terms of the exchange and determine whether it should be considered a distressed debt exchange according to the rating methodology.

The Venezuelan government has not been able to introduce corrective measures to stabilize the economy despite a recent reduction in political tension and fall in political violence since the beginning of this year. President Nicolas Maduro has strengthened his leadership within the Chavista movement, winning the presidency of his party in internal elections in July.

However, successive changes in the economic team over the last two years continue to postpone adjustments in economic policies that would be needed to alleviate shortages, boost economic activity, and strengthen public finances. Such policies include steps to centralize the management of external liquid assets, reduce the divergence between the country's three exchange rates (and the unofficial exchange rate), provide more foreign exchange to liberalize imports, and increase the highly subsidized prices for gasoline and electricity.

A greater level of opaqueness in the direction of economic policy, which includes growing delays in the publication of statistical information, exacerbates the failure to implement corrective measures.

As in the past, the government could devalue the official exchange rate to improve fiscal prospects throughout the next 12 months. This will likely happen as the government shifts some foreign exchange operations from 6.3 bolivares per dollar toward the more depreciated exchange rates prevailing in Venezuela (for example, the 11 bolivares of SICAD I [Sistema Complementario de Administración de Divisas] or the about 50 bolivares of SICAD II). Such steps could provide relief to the government's fiscal accounts in the short term by increasing the local currency value of dollar-denominated oil revenues.

“We expect the general government deficit to remain between 3% and 5% of GDP over the next two years. Venezuela's net general government debt remains at a relatively low 24% of GDP estimated for 2014. High inflation will continue to erode the real value of the debt denominated in local currency over the next two years,” S&P said.

Expanding oil production over the next few years, taking advantage of Venezuela's large oil reserves, is key to addressing the country's spending needs and deep-seated economic problems. Higher oil output depends in large part on continued access to external funding. Hence, the government has a strong incentive to service external debt payments even if stress in the domestic economy increases. The government has continued to give priority to external debt servicing despite growing arrears to other creditors and recent growing shortages of foreign exchange for importers.

“We expect political polarization, erratic economic policymaking that exacerbates both the economy's oil dependence and the prevailing macroeconomic inconsistencies, and weakening external liquidity to remain the main constraints to the ratings on Venezuela,” S&P continued.

Growing restrictions on external liquidity as a result of PDVSA's marginally decreasing oil production and a more uncertain outlook for oil prices will continue to limit Venezuela's ability to deal with growing domestic political and economic challenges. The country's vast oil and gas reserves, the government's relatively low debt burden, and its low level of external debt continue to support the rating.

The negative outlook reflects the possibility that growing economic distortions, lower external assets, and sustained political polarization could increase the risks of a government debt default over the next two years.

“Our outlook also reflects the risk that, even if the government attempts to take adjustment measures (such as a devaluation or fiscal adjustment), it may not be able to implement them effectively because of the difficult political environment as a result of still-strong political opposition as well as disagreements within the government coalition. We could lower the rating by one notch under such a scenario.

“Steps to defuse the heightened political tensions in Venezuela would reduce the risks of eroding governability and greater volatility in economic policies. That, along with a growing track record of pragmatic economic policies aimed at containing economic imbalances and strengthening external liquidity, could lead us to revise the outlook to stable,” S&P concluded.

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