The Aftermath of Venezuela’s Election: Headed for a Default?

The turmoil following the narrow victory of Venezuelan president Nicolás Maduro has raised many questions concerning whether Venezuela may renege on its debt or use its oil sources as a source of political leverage with the international community. Of course, many of the financial issues predate the election, which has merely served to exacerbate them.

Beginning with the nearly 32 percent devaluation of the Bolivar in early 2013, the government has struggled to fill the gaps between expenditures and revenues. And Venezuelans continue to face recurring food and medicine shortages, inflation over 22 percent, and chronic power outages. Polarization between supporters of Maduro and his challenger, Henrique Capriles, over the election’s result has raised the specter that these conditions will only worsen in the short-term, especially with a president lacking a clear mandate to enact any serious reform.

As a result of the president’s narrow victory and alleged voting irregularities, the Capriles campaign has called for a vote recount. After some hesitation, Venezuela’s National Electoral Council (CNE) agreed to review the remaining 46 percent of unaudited ballot boxes. However, the CNE has stated that the recount will not overturn the result of the elections and that the final decision will be left to the Supreme Court. All of these events have generated increasing uncertainty about Venezuela’s economic and political stability, which has raised important questions about the country’s credit worthiness, the risk of a default on its debt obligations, and even the possibility of restricting oil shipments.

Q1: Will a Maduro-led Venezuela embark on policies that could improve its credit worthiness?

A1: In the short term, this is unlikely. While there had been some hope that Maduro would preside over economic reforms that would help stabilize the situation, his narrow victory leaves him little wiggle room to do so. In fact, it is expected that Venezuela’s budget deficit will reach nearly 10 percent in 2013. This will make the country much more vulnerable to any potential decline in the price of commodities.

In addition, the government is likely to continue confronting double-digit inflation and may be forced to start considering a more liberalized exchange rate that would help avoid further devaluations, which may further increase the costs of imports and push inflation higher. In monetary terms, recurrent devaluations also mean that the country will have to pay higher interest rates to obtain more credit; in other words, Venezuela may find more financing increasingly expensive. Under current conditions, Maduro will likely have to cut spending from sectors such as infrastructure, health, and education, using them to pay the principle and the interest rates of the national debt. While the appointment of Nelson Merentes as finance minister has raised hopes that Venezuela’s economic policy will become more pragmatic, it is too early to tell what path he may take.

Furthermore, arbitrary legal decisions may further undermine investor confidence in Venezuelan institutions. As Capriles has pointed out, the Supreme Court is likely to rule in favor of President Maduro, despite evidence of electoral fraud. If the country’s highest court rushes to rule in favor of a controversial result without considering the evidence, it will further raise alarms about the independence of the Venezuelan judiciary. In general, one of the major concerns of investors and debt issuers is the country’s ability to guarantee their rights and contracts in case of controversies. Many concerns have been raised regarding the checks and balances of the Venezuelan rule; a hasty decision by the Supreme Court will only reinforce them.

Q2: Is Venezuela heading for a possible default?

A2: As long as Venezuela’s oil keeps flowing, default appears unlikely. However, Venezuela’s economy faces many vulnerabilities that may worsen if President Maduro proves unwilling or unable to fix them.

When looking at the main indicators of historic sovereign defaults in Latin America, the Venezuelan case may be following a similar path. First, Venezuela has kept its currency artificially strong despite the devaluations of the bolivar. In fact, in the black market the bolivar sells at roughly 12 bolivars per dollar, compared to the official rate of 6.3 bolivars per dollar. On top of this, evidence shows that the exchange rate has been artificially manipulated to serve political purposes, which has deteriorated confidence in the currency. It is no coincidence that the bolivar experienced devaluations in 2010 and 2013, but nothing happened in the run-up to the presidential election in 2012.

Second, Venezuela’s fiscal deficit is cause for alarm. Given the political, social and economic instability, and likely government spending to solidify support for the Maduro administration, it is unlikely to disappear any time soon. Third, the devaluation of the bolivar by nearly one-third of its value increased the debt to GDP ratio to 70 percent, adding up to a total debt of $180 billion dollars. Although this is peanuts compared to the Greece’s nearly 160 percent ration or even the 100 percent of the United States, it will likely undermine growth prospects. Fourth, despite a government-reported inflation rate of 20 percent by the end of 2012, lower than the nearly 28 percent rate of 2011, it appears unlikely to diminish in the near future. All of these fiscal and monetary conditions combined suggest Venezuela’s risk of default bears watching. However, it is important to wait for economic adjustments, if any, that Maduro may propose to the Congress and whether the opposition will be willing to work with any proposed measures.

It is also important to mention that this is all occurring with serious societal division and political confrontation as a backdrop. There is a chance that Maduro may see not paying his debts as a political move to demonstrate that he is anti-systemic and that he rejects the claims of the international financial system, a la Argentina with its bondholders.

Q3: What are the prospects for the Venezuelan oil exports?

A3: Venezuela recently threatened to cut energy exports to the United States after rising tensions with respect to the electoral results in Venezuela. Venezuelan Foreign Minister Elías Jaua stated that any sanctions imposed by the United States as a result of the presidential election would be met with punitive oil and trade measures. However, Roberta Jacobson, assistant secretary of state for Western Hemisphere Affairs at the State Department, denied that the United States is considering any further sanctions to Venezuela than those currently in force regarding the purchase of U.S. arms.

It’s very difficult to imagine Venezuela cutting off oil exports to any nation to force foreign governments to recognize the electoral results, given that oil is the lifeblood of the administration’s domestic and foreign policies. In addition, if Minister Jaua’s statement was intended to be a threat to the United States, it is empty at best. The U.S. market is the number one destination of oil exports for Venezuela, with roughly 40 percent of its oil going to the United States. The oil sector accounts for 25 percent of Venezuelan GDP and 80 percent of exports. Any announcements by the Maduro administration that it is considering suspending oil shipments to the United States should be met with considerable skepticism.

But there could be factors within PDVSA that could complicate matters. It is widely known that Rafael Ramirez, Venezuela’s energy minister, has political ambitions. With Venezuela’s economy spiraling, it is likely that President Maduro will raid PDVSA coffers in the coming months to fund domestic and foreign commitments. President Maduro, who is barely holding on to power, will need to strengthen his base. The promotion and expansion of the Chávez agenda will depend on these funds. Minister Ramirez may go a long to get along; on the other hand, he may see Maduro’s weakness and try to exploit it for his own gain, claiming that Maduro is leaving Venezuela’s oil industry without funds to run itself.

In sum, trends in Venezuela suggest that while the possibility of default should not be dismissed, it is not likely given Venezuela’s considerable oil resources. Venezuela’s economic situation remains precarious. More time is needed to gauge how the Maduro administration will handle the Venezuelan economy. Whether the new administration is up to the task remains to be seen.

Carl Meacham is the director of the Americas Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. César Rosales, an intern scholar with the Americas Program at CSIS, provided research assistance.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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