Venezuela’s Default is Inevitable – 2/5/16

Venezuela faces continued unrest and economic uncertainty as low oil prices and a divided government make an effective response impossible.

Although many countries’ fortunes are tied to commodities, none are so closely tied as Venezuela is to oil. With roughly 96% of export earnings, 40% of government revenues, and 11% of GDP coming from oil revenue, Venezuela is facing recession and devastating budget shortfalls. The South American nation’s government used oil revenues to import many essential consumer goods such as diapers and milk, which the country lacks the capacity to produce, and to maintain social programs.

The congress opposing the president’s party of the late Hugo Chavez adds an additional complication to the corrupt, mismanaging political scene. The opposition party came into power during oil’s price decline and has since fought with the president on almost all policy issues. For his part, the president appointed a finance minister who has denied a connection between printing money and inflation during a time when the IMF has forecast an inflation rate of over 700% for the country due primarily to the government’s massive money printing spree. The opposition-dominated congress has already rejected the president’s calls that he be given “emergency powers” to deal with the economic crisis.

While a surge in oil prices could be a shot in the arm for Venezuela, the country has so far had no success in convincing OPEC and non-OPEC oil producers to restrict production. After months of calling for cuts, Venezuelan officials met with Saudi officials last week to little effect. As the de-facto leader and largest producer of OPEC, Saudi Arabia’s support is essential to reducing the oversupply that has caused oil prices to plunge more than 70% from 2014 to hover around $30 a barrel since January. Saudi Arabia has voiced concern about the oversupply but refused to reign in production on the grounds that it did not want to surrender market share to Russia or to the US producers which it has been trying to squeeze out of the market.

For short term debt payments, Venezuela may be too late to do anything. The country borrowed heavily during higher oil prices and now its bonds, which had previously delivered impressive returns, are facing high probabilities of default in spite of vows by the president to meet debt obligations. Since the country’s debt is held in most emerging-market investment funds and default is almost assured, the Feb. 26 payment  will be closely watched by investors.

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