The cost of protecting against a Venezuelan default has hit record highs, leading to fears that the oil-dependent country could become the first sovereign victim of plummeting oil prices.
Spreads on Venezuelan five-year credit default swaps (CDS)—derivatives that can be used to hedge against the risk of a country or corporate defaulting—are at their highest since the global financial crisis of 2007/08, indicating heightened expectations of the government failing to repay its debts.
This comes at the South American country grapples with a toxic combination of U.S sanctions, recession and hyperinflation, with economic mismanagement and a 50 percent collapse in oil prices bringing it to its knees.
Markit fixed income analyst, Neil Mehta, warned that the "first sovereign casualty of the oil price slump may be on the horizon" and told CNBC that Venezuela's CDS spread implied a 96 percent chance of a default in the next five years and a 69 percent probability in the next 12 months.
"The outlook doesn't look good," he told CNBC in a telephone interview last week. "Certainly, a default is what credit markets are implying."
Venezuela's economy hit the doldrums in 2014, shrinking 4 percent while inflation averaged a staggering 62 percent over the year.
"Lower oil prices have simply compounded dire economic conditions in Venezuela, which look set to culminate in a sovereign default," said David Rees of Capital Economics in a research note on Friday.
As its reserves dwindle, Venezuela is heading into its heaviest time for this year's debt repayments, with just over $4 billion due in October to November. These payments are split between the sovereign and state-owned oil company, Petróleos de Venezuela (PDVSA).
CDS spreads—which widen in sync with increasing risk—have broadened steadily since the middle of January and were at new high of 6,421 basis points (bp) on Monday. This is the widest on record, according to Markit, which has tracked the spread since the beginning of 2008.
Although other oil exporters are under pressure too, Venezuela's undiversified economy and unstable political situation have left it particularly vulnerable. Oil revenues account for around 95 percent of its export earnings and the oil and gas sector is worth around one-quarter of its gross domestic product (GDP), according to the Organization of the Petroleum Exporting Countries (OPEC), of which it is a member.
Nicholas Watson, senior vice-president for Latin America at Teneo Intelligence, told CNBC that Venezuela would likely service this year's debt—but that next year could prove different.
"Despite all the revolutionary rhetoric, they have always been religiously making their debt service payments because they really can't afford a default—it would be disastrous for them," he said in a telephone interview last week.
An election in at the end of 2015 will make the government particularly eager to avoid a default, as it seeks to defend its political hegemony in the face of sinking public approval ratings. However, the likely ramp up in public spending ahead of the vote could see Venezuela's financial straits worsen into next year.
"2016 is a whole other issue. Given the precarious state of the economy, it is very difficult to make any kind of long-term forecast. The government is only ever thinking in the shortest-ever time frame," Watson told CNBC.
Venezuela last defaulted back in July 1998, to the tune of $270 million, according to Moody's Investors Service. It was rated Ba2 at the time of default.
Ominously, the default (on domestic currency bonds) occurred after a significant drop in oil prices in late 1997 that knocked the value of Venezuela's exports. Russia suffered similarly and also defaulted in 1998.
This time around, Watson said that Venezuela was the most likely of any country in Latin America to default in the short-to-medium term. That was even in comparison with "serial defaulter" Ecuador, another oil-dependent economy that defaulted in both 1999 and 2008, or Argentina, which defaulted as recently as 2014 and whose premier, Cristina Kirchner, is known for her antagonism towards creditors.
On the plus side, Watson said contagion from a Venezuelan default would likely prove limited.
"It's a slow-motion car crash, so it is not going to come as a surprise if and when it happens. Everyone has been watching the deterioration on so many fronts—how high inflation has gone, the shortages of basic goods, the general breakdown in social order—so I think the markets have mostly priced this in," he told CNBC.