Venezuela flirts with default, could be worse than Argentina

Students take part in a rally against President Nicolas Maduro's government in Caracas on Nov. 21, 2015.
Carlos Garcia Rawlins | Reuters
Students take part in a rally against President Nicolas Maduro's government in Caracas on Nov. 21, 2015.

Venezuela, a country that has endured nearly three continuous years of economic and social crises, is all but certain to touch off a new round of instability — one that is not altogether unfamiliar territory for emerging markets.

With inflation logging near triple-digit gains and crude oil — the lifeblood of the Bolivarian Republic's economy — deeply entrenched in a bear market, market observers are bracing themselves for the prospect of a calamitous debt default sometime this year. Last month, Venezuelan president Nicolas Maduro used his national address on Jan. 15 to declare an "economic emergency," augmented by a political stalemate with the country's congress. The International Monetary Fund estimated Venezuela's economy contracted by at least 7 percent in 2015.

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More than a decade ago, Argentina's messy collapse triggered the largest sovereign debt default in history. Venezuela's external debt, estimated to be $185 billion, according to central bank data, is considerably more than Argentina's 2001 default on more than $100 billion of its obligations.

Though Venezuelan debt is not widely held by private institutions, it could yet ricochet across the region. Writing in the Financial Times last week, Harvard Economist Ricardo Hausmann said that Venezuela's political instability, a fact of life since the death of former president Hugo Chavez, could make its potential default eclipse Argentina's 2001 debacle.

"Venezuela is in a death spiral," Steve Hanke, professor of applied economics at Johns Hopkins University and director of the Troubled Currencies Project told CNBC. For the second consecutive year, the Andean nation topped Hanke's list of "most miserable" countries.

"Without a change of government or ideology," both debt prices and Venezuela's currency — the bolivar — "will continue to sink."

Much of Venezuela's debt is denominated in bolivars, which in theory means the government can print whatever it needs to pay those obligations. Its foreign currency denominated debt, however, is a whole other story — and is what could make a default so messy.

Not Brazil or Argentina

On rare occasions, a financial crisis can trigger a dramatic reversal of fortune. Both Brazil and Mexico experienced wrenching currency crises in the 1990s that resulted in painful adjustments, but both rebounded relatively quickly.

In the aftermath of Argentina's 2001 credit event, the country endured a messy devaluation, was shut out of the financial markets and endured a stretch of political uncertainty. Yet by early 2003, Argentina's economy roared back, galloping ahead at a torrid 9 percent pace for 5 years.

Few, however, expect Venezuela to see the same sort of beneficial outcome. The country's heavy reliance on oil — which has plunged from above $100 last year and now hovers near $30 per barrel — as well as the government's profligate social spending has dug it into a deep hole from which virtually no one expects it to escape.


The country's foreign exchange reserves have dwindled to around $15 billion, leaving it almost no cushion with which to blunt a collapse. Meanwhile, unrestrained money printing has sent inflation on a tear, and rendered its currency almost worthless.

According to Paul Christopher, head global market strategist with Wells Fargo Investment Institute, Venezuela relies on oil exports for "96 percent of its hard currency and 40-45 percent of the federal budget." The drop in crude has blown a hole in government spending and curtailed its ability to use oil revenues to placate the population.

"As long as the government refuses to ease its spending policies and as long as oil prices stay low and with a downward bias, the government is depleting foreign assets," Christopher told CNBC recently.

The road to avoid a collapse, though narrow, could involve Petroleos de Venezuela, or PdVSA, Christopher said. The country's state-owned oil and gas company could "delay default by having PdVSA exercise a voluntary bond swap, or sell increasingly limited assets," he added.

Johns Hopkins' Hanke also said that an economic liberalization may help spark an eventual revival, yet most observers say that is unlikely given Maduro's ideological bent. Some also think a renegotiation of a loan agreement with China might also give it some breathing room.

All that being said, reasons for optimism remain scarce.

"The decline in oil prices is bringing Venezuela's 2016 financing gap to levels that are difficult to fund," Alejandro Arreaza, Latin America Economist with Barclays investment bank, said in a recent note to clients. "Absent a fast recovery in oil prices in the next few months, a further contraction of imports or the use of available assets would be insufficient to avoid a default, in our view," Arreaza said.