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Inside, confidential and off the record


Venezuela: No clear way out

Annual inflation should remain above 500% for the majority of 2017


We expect Venezuela’s economic, political and humanitarian crises to persist in 2017, unfortunately. Prospects for regime change and an improvement in economic policy in the near-term are bleak, in our view.

Thus, the country will likely continue to suffer through one of the world’s largest economic contractions, triple-digit inflation and massive goods shortages. The probability of a credit event within the next twelve months has declined, though, mainly owing to higher oil price projections and apparent continued financial support from China.

■ Social and political pressures will likely remain intense next year. President Nicolas Maduro’s popularity reached a new low in October when fewer than 20% of participants in a Datanalisis poll evaluated him positively. Public opinion surveys consistently identify scarcity of food, medicine and other basic goods, the cost of living, long lines and violent crime as being among the country’s biggest problems. We do not expect much improvement on these fronts in 2017 as the slight pickup we project in imports is driven by higher costs for the oil sector rather than more goods entering Venezuela. Maduro’s recent decision to abruptly remove the most widely held banknote from circulation also risks adverse economic and social fallout in the near term, in our view.

■ Still, our base case is that President Maduro will stay in office until his term ends in early 2019. Chavismo has effectively suppressed the institutional channels for bringing about political change any sooner. Furthermore, we are not optimistic that talks between the Maduro administration and the opposition will bear fruit, because we would not expect the former to fulfill any commitments that could weaken its control of domestic institutions. Organizing massive street protests seems to be the
opposition’s most viable remaining strategy for curtailing Maduro’s tenure at this point. However, its leadership appears to be weaker and more divided since the Vatican-led talks began, and could struggle to regain lost momentum unless there is another highly disruptive political or economic event. Opposition leaders may also shift their focus to gubernatorial and mayoral elections, which the electoral authority has said will be held by June 2017 and December 2017, respectively.

■ We now project a 6.1% contraction in real GDP in 2017, compared to - 5.0% previously. This would follow an estimated 10.0% retrenchment in 2016, and Venezuela would remain the worst performing economy in our Emerging Markets coverage universe.1 Real wage losses and political and economic uncertainly will probably continue constraining private
consumption and investment, while falling oil production and foreign exchange restrictions further reduce economic activity on the production side. Our initial 2018 forecast calls for the pace of GDP decline to decelerate to 2.8% in real terms as public spending rises ahead of the next presidential election, which the constitution stipulates should take place at some point that year.

Annual inflation should remain above 500% for the majority of 2017, according to our projections. Venezuela fares far worse than any other country we cover on this metric as well. We estimate that 12-month inflation reached 395% in October.2 Monthly prints will probably spike in the near term due to a significant increase in domestic liquidity during the second half of 2016 and a massive depreciation of the unofficial exchange rate in the fourth quarter. Monetary financing of the overall public sector deficit, which we project will remain substantial at 12.4% of GDP in 2017, continues to be the primary underlying culprit, and recent decisions to raise the minimum wage and
reduce banks’ reserve requirements have exacerbated associated pressures. Goods scarcity and administered price increases will also likely remain inflation drivers.

■ We do not foresee meaningful improvements to Venezuela’s exchange rate policy framework during 2017. The majority of hard currency supplied to the domestic market will likely continue to be allocated at the official Dipro exchange rate (10 bolivares per dollar currently). We would not be surprised to see this rate devalued, and the official Dicom rate (672 bolivares per dollar) allowed to weaken more rapidly, but not sufficiently to contain depreciation pressure on the parallel rate (3,570 bolivares per dollar) in a sustainable manner. The central bank’s plan to introduce higher denomination bills and coins into circulation, the largest of which will be worth about $5 in the unofficial market, will likely prove to be little more than a tacit acknowledgement of the high inflation rate unless accompanied by fiscal and monetary tightening.

■ In terms of the external environment, the benefits of the recent OPEC accord likely outshine other potential downside risks for Venezuela in the near term. A $5 change in the average price of the Venezuelan oil basket would be worth about
$3.1bn in crude revenues in 2017, according to our estimates. Meanwhile, we think that any negative impact on Venezuela stemming from changes in US trade policy or energy sector regulations is more likely to materialize over the medium- to long-term. Venezuela is quite dependent on the US market, though, as it shipped the equivalent of 13.1% of GDP of goods and 35.4% of its total exports there in 2015. This was almost entirely barrels of oil, which could be difficult to divert if the US were to impose restrictions down the road given Asia’s lack of refining capacity for extra heavy crude.

■ We expect average total crude oil production to decline by another 5%, or roughly 125,000 bpd in 2017, but the cash-generating level could remain stable.3 The headline reduction we foresee is beyond the 950,000 bpd agreed with OPEC and
would follow an estimated 10% drop in 2016. The decrease is due to factors including a lack of investment and maintenance, drilling inefficiencies, shortages of the diluent needed to move extra heavy crude oil as well as some oil service providers’ decisions to scale back or cease operations due to payment delays. PDVSA and its minority partners should be able to keep cash generating crude production steady in 2017, though, thanks to a temporary reduction in deliveries to China for debt service. We project that revenues from those exports will rise to $30.4bn from $21.5bn in 2016.

■ The Venezuelan authorities continue demonstrating willingness to pay dollardenominated bond debt, although not without some recent hiccups. Data from Venezuela’s main trading partners shows that imports contracted about 45% yoy over the first three quarters of 2016, following a roughly 25% decline in 2015. Additionally, PDVSA offered equity in Citgo, its US subsidiary, as collateral in an effort to reduce near-term maturities (and we would not rule out another liability management operation in 2017). Around 40% of eligible bondholders participated in PDVSA’s debt swap despite multiple deadline extensions. Technical issues were blamed for late payments on bond coupons and international arbitration settlements due in November. These sorts of delays lately seem to last longer and occur more frequently, which is particularly worrisome in the context of limited external liquidity.

■ The foreign exchange financing deficit has narrowed and suggests reduced risk of default owing to inability to pay in 2017. We currently foresee a more manageable $1.2bn shortfall next year. The improvement since we last updated this projection is mainly driven by a higher oil price forecast. We are also factoring in an additional $3.0bn of financing from China on the assumption that Tranche C of the China-Venezuela Fund has been renewed, a larger drawdown of public sector foreign
assets and only $1.5bn growth in imports despite $6.8bn higher revenues. Additionally, bond debt service is $0.9bn lower due to PDVSA’s exchange. Still we remain concerned by the limited transparency regarding many of these details as well as the
chance that the aforementioned payment delays belie liquidity management issues.

1. The central bank has not published national accounts data since the third quarter of 2015.

2. The last official inflation figure published was 181% as of December 2015.

3. Our cash-generating crude oil production estimate accounts for domestic market sales, deliveries to China for debt service and shipments provided under petro-diplomacy programs.

Casey Reckman/Research Analysts/Credit Suisse/ Dic. 16, 2016

ISSUES.... 12/ 19/ 2016 - Send Us Your Issues

ISSUES.... Inside, confidential and off the record

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