Venezuela's House of Cards

One measure that the credit research firm Moody’s publishes is Expected Default Frequency, which seeks to reflect the credit risk of a given sovereign. If you had to guess, which country would you think had the highest EDF at the end of trading on Friday? Argentina, which effectively defaulted for second time in less than twenty years over the summer? Ukraine, which is dealing with an active Russian-sponsored insurgency in its east? Puerto Rico, which is in the middle of a debilitating debt crisis? In fact, the answer is Venezuela, which with an EDF of 11.61%, was seen as a significantly riskier proposition than any of the other sovereigns mentioned above. For comparison, Argentina, the country with the second highest CDF, was 7.75%.

Why is a country with no threat of imminent invasion and no long history of default seen as such a risky proposition for investors? The answer lies in Venezuela’s disastrous economic policies.

In April 2013, a little more than a month after the death of strongman Hugo Chavez, the still-grieving country took to the polls to narrowly elect former bus driver and devout socialist Nicholas Maduro, who campaigned as a spiritual successor to Chavez. While foreign election monitors from the Carter Center and the Union of South American Nations declared the election technically fair (in the sense that ballots weren’t stuffed), they raised concerns that state resources unfairly were used to bolster the Maduro campaign. There were reports, for instance, that the national oil company, PDVSA, had bussed workers to pro-Maduro rallies. In the end, Maduro won election with 51% of the vote and the Supreme Court denied opposition candidate Henrique Capriles’ appeal for a recount.

Maduro’s policies have without a doubt been a disaster. In March, Maduro proposed “Sicad II,” a continuation of Chavez’s elaborate foreign-exchange regime. Instead of simply floating the Venezuelan currency, the government assigned an exchange-rate to different consumers. For example, the government gets a rate of 6.3 bolívares to the dollar, while for most others its 50 bolívares to the dollar – high, but still well short of a black market rate that is quickly approaching 70 bolívares to the dollar. Unsurprisingly, this inefficient policy has contributed to the current economic crisis. Inflation has spiked over 60%, which especially painful since the country is heavily reliant on imports because its economy has never diversified away from petroleum exports.

Another contributor to Venezuela’s economic woes has been the precipitous decline in oil prices, now down more than 30% since its June high. Venezuela earns 96% of its foreign currency from oil exports. According to the New Yorker, every $1 drop in international oil prices is $700 million less in revenue for the Venezuelan government. It is thus unsurprising that the government hasn’t published GDP figures since the beginning of the year (although internal leaks suggest that the economy may have contracted as much as 5% in the first half of 2014) and that there is a persistent shortage of everything from basic necessities such as food to even airplane tickets.

In response to growing pressure from the public to do something about the crisis, Maduro fired Rafael Ramírez, the chairman of the state oil corporation. Ramírez had been the strongest voice in Maduro’s cabinet for true fiscal reform; he had called for a unified exchange rate, tight monetary policy, and reducing domestic fuel subsidies.

Without any true dissent in his cabinet, Maduro seems set to keep pushing Chavez’s economic agenda. Although this endeared him to the electorate in 2013, it remains to be seen whether his policies will be sustainable in the long-term.

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