Download Venezuela Economics-Assessing default risks and haircut scenarios

18 March 2016

Venezuela Economics
ECONOMICS
VENEZUELA
Assessing default risks and haircut scenarios
 A new bout of oil price weakness is raising market skepticism
on Venezuela’s chances to remain current on debt servicing
 We think the risks tilt towards a Venezuela default, though the
timing is difficult to assess; we update our forecasts
Ramiro Blazquez
North Andean Senior Economist
HSBC Bank Argentina S.A.
[email protected]
+54 11 4348 2616
 A haircut of international liabilities below the average of other
default episodes could still lead to a comfortable debt-to-GDP
ratio if there is a restructuring, in our view
Venezuela’s economic crisis deepened in 2015. Symptoms of hyperinflation
dynamics have already kicked in, in our view. The recent downturn in oil prices and
the sluggishness expected for a recovery place Venezuela between a rock and a
hard place. We believe that a continuation of current policies will eventually lead to a
credit event and that there is little the incumbent administration can do to correct this
course. The timing of a default is, however, uncertain. This is because there is no
reliable information on the quality of the international FX assets Venezuela claims to
own. We cannot rule out the possibility that between now and 2H 2017, Venezuela
(sovereign and PdVSA) defaults on its scheduled bonded debt payments.
On the back of our base case for a hard landing in Venezuela, we update our
economic forecasts, and expect an even deeper recession and sharp rises in inflation
forecasts. We look in detail at two scenarios for Venezuela: a hyperinflation scenario
(which is our base case) and an orderly adjustment scenario (a risk to our base
case). In addition, we find that in the event of a restructuring, on the back of its oil
wealth, Venezuela could apply a haircut to its international liabilities below other
credit event episodes and still reach a comfortable debt-to-GDP ratio.
1. Summary of forecast revisions
GDP growth (% y-o-y)
CPI, average (%y-o-y)
Consolidated government balance (% GDP)
Current account balance (USDbn)
Current account balance (%GDP)
International FX reserves (USDbn)
VEF/USD (eop)
VEF/USD (avg)
Total public debt (%GDP)
____ 2015e ______ _____ 2016f ______ _____ 2017f _____
New
Prev.
New
Prev.
New
Prev.
-5.7
-8.0
-8.3
-4.8
-11.3
1.5
121.7
145.9
826.8
230.6
2,023
81.3
-18.3
-22.3
-21.0
-6.1
-12.8
-4.5
-18.2
-7.0
-16.8
2.6
-1.7
6.0
-24.9
-6.2
-21.2
2.5
-2.7
5.0
16.4
20.1
7.9
14.0
10.5
19.3
206
130
2,000
343
35,000
400
124
79
878
314
23,250
371
157.6
116.6
132.2
131.6
165.1
73.0
Source: HSBC forecasts
Disclaimer & Disclosures
This report must be read with the disclosures and the analyst certifications in
the Disclosure appendix, and with the Disclaimer, which forms part of it.
Issuer of report: HSBC Bank Argentina S.A.
View HSBC Global Research at:
https://www.research.hsbc.com
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ECONOMICS  VENEZUELA
18 March 2016
Default risks dominate
 The timing of a potential credit event is unpredictable
 Nevertheless, default could be a game changer; we update our
forecasts
 Haircuts could be below 50% of outstanding liabilities in a
restructuring and still produce comfortable debt-to-GDP levels
Sinking economy, massive depreciation, but baby steps so far
President Maduro’s latest measures to address the severe economic imbalances have
kicked in too late, in our view. The authorities recently released economic data that had
remained unpublished for a full year although fiscal accounts data remain unpublished (the last
update took place in 2011). Official figures estimate GDP growth in 2015 at -5.7% with year-end
CPI inflation at 181%. Based on official data running up to 3Q 2015, we calculate the current
account deficit at an impressive USD18.2bn (c25% of GDP). The activity and inflation results
came in as a surprise as both us and other market participants (according to the consensus of
the Bloomberg survey) were anticipating that in 2015, real GDP contraction and inflation had
respectively been north of 7% and 200%. IMF authorities were quoted by press reports
1
contradicting the official release, by placing 2015 GDP and CPI at -10% and 275% . It is clear
that the economic crisis deepened in 2015, even by official standards. Last year was the second
year in a row of recession (GDP had declined 3.9% in 2014) while inflation accelerated (from
68.5% by end-2014).
On 17 February, President Maduro announced the first gasoline price increase since President
Chávez took office in 1998, from VEF0.097 to VEF6.0 per litre, a massive 6,086% hike. Higher
revenues stemming from the difference between the old and the new price will be placed in a
fund to support social programs, so the measure will do little to bring relief to a rampant 18.2%
of GDP fiscal deficit (our new 2015 forecast). Despite this unparalleled price hike, Venezuelan
petrol remains the cheapest in the world. Using our estimate of the underlying exchange rate for
the economy excluding public debt payments at VEF206 per USD by 4Q 2015 (table 3),
gasoline in Venezuela currently costs less than USD0.03 per liter and below USD0.01 if the
conversion is made using the parallel market rate at VEF1,000 per USD. The incentives to
continue smuggling gasoline out of the country (which creates losses of up to 1.3% of GDP per
year, according to former Vice-President Arreaza) remain in place, since in neighboring
Colombia, gasoline costs around USD1 per litre.
On the FX front, Maduro simplified the official FX system by eliminating the middle leg of the
three-tier system. Following the elimination of Sicad (which was trading at VEF13 per dollar),
the henceforth two-tier system will be based on a priority rate for essential imports at VEF10 per
dollar (up from VEF6.30) and the SIMADI rate that will start floating within bands in some kind of
1
2
“FMI: Inflación de Venezuela en 2016 será de 500%”, El Nacional, 17 January 2016
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2. FX rates and convertibility ratios
VEF/USD
1000
VEF/USD
250
800
200
600
150
400
100
200
50
0
0
4Q11
4Q12
Parallel (LHS)
4Q13
M0/Res.
4Q14
M1/Res.
4Q15f
HSBC Weighted Avg. FX
Source: BCV,Dolartoday, HSBC
controlled market. So far, the government has not supplied the full details on the mechanics of
the new FX scheme, which is leading to speculation by representatives of private sector guilds
(notably, the federation of private companies, Fedecámaras) according to some press
2
releases.
Looking back at previous FX overhauls under the Maduro administration, these implementation
delays are not good news and could suggest internal dissent about floating the currency among
some sectors of Chavismo. In addition, how much fiscal improvement this measure will bring is
uncertain since it will depend on the amount of petrodollars PdVSA will be allowed to cash in at
the weaker rate. Considering that 74% of total imports, on average, in 2015 were conducted at
the VEF6.30 per USD rate, and that they henceforth will likely be traded at VEF10 per dollar,
the increase in fiscal revenues would be far from significant, even under official estimates of
running inflation. Further, the weaker priority rate does little to cut short the profitability margins
of smugglers and arbitrageurs, who can get hold of goods priced at the lower leg to later sell
domestically or abroad at the full international dollar price, thus making a profit of more than
VEF1,000 per dollar (one hundred times the new priority exchange rate).
3. HSBC estimated average FX rates by market
Public
Private
SITME
SICAD
SICAD II / SIMADI
Cencoex / Cadivi
Parallel
FX
Devaluation
2011 Weight (%) 2012
4.3
32%
4.3
5.7
68%
6.9
5.3
18%
5.3
4.3
9.0
5.2
26%
57%
25%
4.3
15.2
5.7
9%
Weight (%) 2013 Weight (%) 2014 Weight (%)
48%
6.3
49%
6.3
46%
52%
14.7
51%
65.1
54%
13%
11.0
9%
12.0
5%
50.0
12%
64%
6.3
76%
6.3
40%
23%
57.5
16%
131.6
43%
10.6
37.8
87%
256%
2015f Weight (%)
6.3
57%
469.7
43%
13.5
199.7
6.3
835.0
206.4
446%
3%
8%
35%
54%
Source: HSBC
We estimate that the dramatic slide in oil prices in late 2015 led to a massive FX
depreciation in Venezuela. According to our calculations, the weighted average exchange rate
of the economy (excluding public debt payments) jumped 41% q-o-q in 4Q 2015, to VEF206 per
dollar, for a total 446% y-o-y depreciation in 2015. Our estimated average FX rate is no longer
proxied by the M0-to-international reserves ratio but it is now bounded from above by the higher
M1-to-reserves coverage ratio (figure 2), the ultimate dollarization ratio if bank deposits and
money held by the public were converted into cash dollars (time deposits are almost nil due to
2
“Fedecámaras también duda de la flotación del dólar”, El Estimulo, 18 February 2016
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18 March 2016
the very negative real interest rates so there is no substantial difference between M1 and M2).
To us, this could be suggesting an increase in the velocity of circulation of money (i.e. a lower
real money demand) that could be fuelling inflation. In real terms, the VEF weakened 103% y-oy against the USD in 4Q 2015 (see figure 4).
There is no ceiling to the black market rate, in our view, due to the lack of nominal anchors
in the Venezuelan economy, the fiscal dominance, and interest rates less than one-tenth the
level of inflation. In 2015, the black market rate weakened 381%, according to website
Dolartoday, well above the most pessimistic CPI estimates (e.g. the IMF’s), but volumes in the
parallel market (USD31m per day in 2015, see figure 5) remained under the USD46.7m daily
average of 2010-12. Despite the huge depreciation, parallel market dollar supply failed to pick
up further because of (1) unanchored expectations on nominal variables (i.e. inflation and the
exchange rate) and (2) shrinking USD allocations to the private sector in the official markets
(figure 6) that collapsed 58.1% relative to 2014.
Public external purchases experienced a milder setback, with a 15.7% contraction, we
calculate. Following the release of detailed balance of payment statistics running up to 3Q 2015,
we believe that total imports contracted c22.3% in 2015 mostly on the back of the relative
resilience of public imports. This took the current account deficit to USD18.2bn, a daunting
24.9% in terms of GDP if we use HSBC’s weighted average FX to convert nominal GDP into
dollars. We highlight that if priority rate imports (public purchases to a large extent) were
to adjust further, that might curb the profits of the rent-seeking sectors that are
benefitting from the exchange rate differential. From the point of view of optimal policy
making, to us it is clear that eliminating distortions would enhance the levels of welfare of the
population and/or improve external accounts.
Politics could constrain economic developments
The opposition coalition MUD, currently controlling the National Assembly with more than
two-thirds of total seats, has said publicly that it would start considering legal options to
unseat Maduro. The menu of options would include calling for a recall referendum for an early
end of the presidential term, shortening the mandate through a constitutional reform, and
impeachment. For the Maduro administration, a meaningful fiscal and FX adjustment could entail
political costs too high to bear since it would inflict more pain on its support base (i.e. lower
income segments) while it could also be opposed by the rent-seeking sectors that have gained
influence following the death of former President Chávez on 5 March 2013.
Thus, the executive branch is between a rock and a hard place, in our view. No matter which
policy Maduro applies (adjusting or upholding the status quo) the political situation going
forward looks highly volatile, which is not supportive for the economy.
Two scenarios
Below, we examine two scenarios for the Venezuelan economy. Based on the previous
arguments, our base case scenario is for a hard landing. Under these dynamics,
Venezuela, at best, maintains the current very gradualist approach to reforms that do little to
bridge the imbalances. This could lead to a credit event either this year or the next, and also to
hyperinflation. The timing is unclear given the uncertainty on the market value of the country’s
FX savings.
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Alternatively, the country could implement severe adjustments from 2Q 2016, which we believe
would lead to a strong recession this year but would open the door to a market-friendly
restructuring, the support of multilateral creditors, and the convergence of inflation dynamics with
fiscal dominance easing due to policy design. Several conditions would need to be met for the
soft landing scenario to materialize. At the time of this writing, we think that these conditions
(possibly including a national unity government and strong commitment to fiscal
moderation) are not present, and, therefore, we do not believe this scenario is likely.
Based on the factors discussed above, in our view, it cannot be ruled out that Venezuela
exhausts its resources and stops servicing its debt at some point between now and 2H
2017, when debt servicing peaks in the short term. We believe that the government is aware
of the hefty costs of a default given the size of Venezuela’s attachable overseas assets (e.g.
Citgo, PdVSA’s refineries abroad, and even oil shipments) and its strong dependence on
imports. The question, in our view, is whether the Chavista authorities will be able to avert
a default in case the external FX assets owned by the public sector are of very low quality. We
discuss this below.
4. Bilateral real exchange rate with the US
2009=100
500
450
400
350
300
250
200
150
100
50
0
4Q09
4Q10
4Q11
4Q12
4Q13
4Q14
4Q15f
Bilateral RER w/USA (avg.2009=100)
Source: HSBC
5. Black market volumes and FX
USDmn.
120
6. USD traded in official markets
VEF/USD
1,000
USD bn.
15
10
80
500
5
40
0
0
2008 2009 2010 2011 2012 2013 2014 2015
Est. daily traded vols. in parallel mkt.
Parallel FX rate e-o-p
Source: Dolartoday, HSBC
0
4Q11
4Q12
Cencoex
Sicad II
4Q13
Sitme
Simadi
4Q14
4Q15f
Sicad I
Total
Source: Ecoanalítica, HSBC
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7. Uses and sources of FX, 2015(e) and 2016(f)
2015
USDbn
2016 _______________________ 2016 _______________________
No ____________________ Break-even _____________________
adjustment 0% M cut 10% M cut 20% M cut 30% M cut 40% M cut
FX demand (1)
Imports
Interest
Bonds + loans
China
Principal
Bonds + loans
China
Other
o/w: Services
o/w: Current transfers
67.7
36.9
5.8
4.9
0.9
12.2
5.7
6.5
12.8
12.6
0.2
61.6
36.9
6.5
5.6
0.9
11.8
5.0
6.8
6.4
6.2
0.2
61.6
36.9
6.5
5.6
0.9
11.8
5.0
6.8
6.4
6.2
0.2
57.9
33.2
6.5
5.6
0.9
11.8
5.0
6.8
6.4
6.2
0.2
54.2
29.5
6.5
5.6
0.9
11.8
5.0
6.8
6.4
6.2
0.2
50.5
25.8
6.5
5.6
0.9
11.8
5.0
6.8
6.4
6.2
0.2
46.8
22.1
6.5
5.6
0.9
11.8
5.0
6.8
6.4
6.2
0.2
Cash exports (2)
Headline oil exports
Volumes (m bpd)
Oil price
(USD per barrel, VENZ basket)
Non-oil exports
Non-cash exports
35.8
35.1
2.1
23.8
21.8
1.9
46.7
44.7
1.9
43.0
41.0
1.9
39.3
37.3
1.9
35.6
33.6
1.9
32.0
29.9
1.9
45.1
2.2
1.6
32.1
3.2
1.2
66.0
3.2
1.2
60.5
3.2
1.2
55.1
3.2
1.2
49.6
3.2
1.2
44.2
3.2
1.2
Expected financing (3)
Off-budget funds
Savings from debt buybacks
China
Gold reserve
Others
o/w: Discounted receivable accounts
o/w: SDRs funding
o/w: CITGO dividends
o/w: Gold swap
o/w: Arrears with suppliers
27.6
0.7
0.0
10.0
0.0
16.9
3.7
1.3
2.5
1.5
7.9
14.9
2.0
0.6
5.0
2.0
5.3
1.0
0.8
1.0
2.5
0.0
14.9
2.0
0.6
5.0
2.0
5.3
1.0
0.8
1.0
2.5
0.0
14.9
2.0
0.6
5.0
2.0
5.3
1.0
0.8
1.0
2.5
0.0
14.9
2.0
0.6
5.0
2.0
5.3
1.0
0.8
1.0
2.5
0.0
14.9
2.0
0.6
5.0
2.0
5.3
1.0
0.8
1.0
2.5
0.0
14.9
2.0
0.6
5.0
2.0
5.3
1.0
0.8
1.0
2.5
0.0
4.4
22.9
0.0
0.0
0.0
0.0
0.0
13.5
61.9
0.0
10.0
20.0
30.0
40.0
FX gap after expected financing
(4 = 1 - 2 - 3)
Memo:
Int’l reserves (10 March, USDbn)
%age cut in imports for break-even
Source: HSBC, BCV, Globalsource
Hard times ahead
Most oil forecasters (figure 9) do not see the oil price bouncing back fast enough to
spare Venezuela from a sharp adjustment (either orderly or disorderly) and an erosion of
its hard currency savings.
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8. Upcoming sovereign and PdVSA debt maturities
USDbn
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
1Q16
2Q16
Principal
3Q16
4Q16
Interest
1Q17
2Q17
3Q17
Buybacks savings
4Q17
Source: Finance Ministry, PdVSA, HSBC
Venezuela faces a demanding debt servicing schedule in the coming months (figure 8), with
payments spiking in 4Q 2016 (USD4.3bn for the sovereign and PdVSA combined excluding
liability management and rollover from bonds held in PdVSA’s pension fund) and in 2Q 2017
(USD7.3bn). In addition, Venezuela is paying off its debt with China with oil shipments at a pace
of USD1.8bn per quarter.
As shown in table 7, if the price for the Venezuelan mix were to average USD32 per dollar
(USD36.6 per barrel in terms of Brent crude) in 2016, in the absence of any adjustment on FX
demand, Venezuela would face an FX gap of USD22.9bn even after tapping expected funding
sources amounting to USD14.9bn. This financing would include USD5.0bn from China (we do
not expect the Asian country to increase its exposure to Venezuela as the promised increase in
oil shipments has so far failed to materialize), the recent agreement with Gold Reserve Co that
could supply USD2.0bn, and others (equivalent to scraping the bottom of the barrel), amounting
to USD5.3bn.
The flipside to examining the FX gap is to find the break-even oil price, which we have
estimated at USD66 per dollar in the absence of any further import cuts. However, this oil
price level would likely only be achieved several years from now, according to an average of oil
price forecasts from different sources (see figure 9). On 29 February 2016, central bank
3
governor Nelson Merentes said that imports would be cut by 40% . Still, to bridge the gap,
Venezuela would need an oil price that is almost USD12 higher than our current assumption
(table 7) or, alternatively, additional funding sources. Under our USD32per barrel average oil
price assumption for 2016, Venezuela would have to cut imports by c62% to bridge the
external shortfall. In any case, the magnitude of the required adjustment is such that it is highly
unlikely that it could be implemented without major social costs.
3
“Merentes ratificó que el BCV emitirá billetes de 500 y 1.000 bolívares”, El Nacional, 29 February 2016
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9. Oil price forecasts
Oil futures
Venezuela basket equivalent (USD/bbl)
140
US EIA
OPEC
IMF
WB
Average
120
100
80
60
40
20
'15 '16 '17 '18 '19 '20 '21 '22 '23 '24 '25 '26 '27 '28 '29 '30 '31 '32 '33 '34 '35 '36 '37 '38 '39 '40
Source: HSBC, US EIA, OPEC, IMF, World Bank, Bloomberg
On the other hand, if Venezuela had foreign currency savings on top of its meager
international reserves stock below USD14bn (4.5 months of imports), then it might be
able to muddle through in the short run. Central bank statistics place the amount of hard
currency securities – stocks, bonds, loans – and unidentified hard currency savings, at
USD69.1bn at 3Q 2015 (figure 10). However, authorities have been reluctant to supply more
details as to the composition and liquidity of these savings. We believe that by providing
evidence on the quality of these holdings, Venezuela might have helped to lower risk
premiums and could have issued debt at reasonable rates so as to smooth out the
transition. However, communication remains poor on this front, which has not helped to
alleviate the general view among market participants that such savings could be highly illiquid,
with very low actual market value.
10. Non-reserve FX assets
USDbn.
90
80
70
60
50
40
30
20
10
0
4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15
Stocks
Debt instruments
Commercial credit
Loans
Money and deposits
Others
Source: BCV
Hyperinflation dynamics and debt default
We present two different scenarios through 2H 2017: one, our base case scenario, featuring a
hard landing; the other an orderly adjustment. We have argued previously that a hard landing is
our base case since we do not believe that current or future political conditions will be
conducive to an orderly (and painful) adjustment of the economy.
In a hard landing (our base base), the government would be unable to rein in fiscal
dominance, so that eventually, hyperinflation dynamics would kick in. According to data
provided by economists Reinhart and Savastano (2003), the trajectory of Venezuela’s
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CPI, fiscal deficit, and black market rate premium in recent years is consistent with the
run-up of recent hyperinflation episodes (see tables 11, 12, and 13); therefore, we think it is
reasonable to expect a similar outcome if the economy deteriorates further. We estimate that
GDP will contract 8.3% and 11.3%, respectively, in 2016 and 2017, with average inflation
accelerating from c827% to c2,023%. We classify this as a hyperinflation episode following
4
economist Philip Cagan’s classic definition that was published in 1956 , with monthly inflation
exceeding 50% by late 2016. In addition, the ensuing sharp real depreciation, combined with
the economic depression we would expect, would drive the dollar GDP to cUSD62bn, down
80% from 2012 levels, reaching one of the lowest historical marks (see table 11). In real terms,
the economy would shrink an accumulated 19% by end-2017 relative to 2015. Ironically, a hard
landing could entail an even sharper adjustment compared to the alternative of a front-loaded
attack on imbalances, despite the acute pain that might immediately follow.
11. Average annual inflation rates (%) in recent hyperinflation events
Argentina (1989-90)
Bolivia (1984-85)
Brazil (1989-90)
Peru (1990)
Ukraine (1991-94)
Average
Venezuela (2017)
(Default scenario)
t-3
90.1
32.1
147.1
86.3
n.a.
88.9
62.2
t-2
131.3
123.5
228.3
667.3
2.1
230.5
121.7
t-1
343.0
275.6
629.1
3,398.5
4.2
930.1
826.8
t (hyper)
2,697.0
6,515.5
2,189.2
7,485.8
1,613.7
4100.2
2,022.6
t+1
171.7
276.3
477.4
409.5
376.4
342.3
t+2
24.9
14.6
1022.5
73.5
80.2
243.1
t+3
10.6
16.0
1927.4
48.6
15.9
403.7
t+1
1.7
2.5
27.2
1.4
8.7
8.3
t+2
-0.4
7.4
44.2
2.6
4.9
11.7
t+3
0.2
5.7
58.1
2.7
3.2
14.0
Source: Reinhart and Savastano (2003), HSBC
12. Fiscal deficit (% of GDP) in recent hyperinflation events
Argentina (1989-90)
Bolivia (1984-85)
Brazil (1989-90)
Peru (1990)
Ukraine (1991-94)
Average
Venezuela (2017)
(default scenario)
t-3
4.2
7.8
11.3
9.0
n.a
8.1
21.2
t-2
6.7
14.7
32.3
6.4
n.a
15.0
18.3
t-1
8.6
19.1
53.0
7.2
n.a
22.0
21.0
t (hyper)
4.9
16.7
56.3
7.4
14.1
19.9
12.8
Source: Reinhart and Savastano (2003), HSBC
13. Average parallel market premium (%) in recent hyperinflation events
Argentina (1989-90)
Bolivia (1984-85)
Brazil (1989-90)
Peru (1990)
Ukraine (1991-94)
Average
Venezuela (2017) (default scenario)
t-3
66.7
54
111.5
278.8
n.a.
127.8
1,339.9
t (hyper)
67.7
119.1
102.3
32.7
n.a.
80.5
t+3
10.9
7.3
18.1
6.4
11.1
10.8
Source: Reinhart and Savastano (2003), HSBC
4
Following Cagan, a hyperinflation episode would begin in the month when the rise in prices exceeds 50% and would end
the month before the monthly rise in prices drops below that rate and stays below it for at least a year. For more on this,
please see Cagan, Philip, 1956, “The Monetary Dynamics of Hyperinflation,” in Studies in the Quantity Theory of Money,
ed. by Milton Friedman (Chicago: University of Chicago Press), pgs 25–117.
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ECONOMICS  VENEZUELA
18 March 2016
14. Hard and soft landing scenarios for 2016 and 2017
2009
2010
2011
2012
2013
2014
2015f
2016 no default
2016 default
2017 no default
2017 default
Real GDP Nom GDP
% y-o-y
USDbn
-3.2
195.3
-1.5
256.0
4.2
271.7
5.6
316.8
1.3
247.3
-3.9
185.1
-5.7
72.8
-11.6
70.3
-8.3
79.5
0.5
85.5
-11.3
62.3
Fiscal def
% of GDP
-8.7
-10.4
-11.6
-17.5
-16.9
-21.2
-18.3
-8.0
-21.0
-4.3
-12.8
___ Inflation _____ _____FX rate _____
Avg.
eop
Avg.
eop
25%
27%
3.8
3.6
27%
28%
4.1
4.0
28%
26%
5.2
5.0
20%
21%
5.7
5.2
56%
41%
10.6
10.2
69%
62%
37.8
22.0
181%
122%
206.4
124.2
259%
341%
600
460.0
1,785%
827%
2,000
877.5
49%
66%
580
632.5
930%
2,023%
35,000
23,250
Curr acct deficit _
USDbn % of GDP
0.4
0.2
5.6
2.2
16.3
6.0
2.6
0.8
4.6
1.9
3.6
1.9
-18.2
-24.9
-10.3
-14.6
-16.8
-21.2
-5.2
-6.1
-1.7
-2.7
Reserves Total pub debt
USDbn
% of GDP
35.8
38.8
30.3
36.7
29.9
48.1
29.9
49.0
21.5
59.5
22.1
70.8
16.4
157.6
13.2
148.6
7.9
132.2
17.1
71.4
10.5
165.1
Bilateral RER
Avg % chg
100.0
13.6
86.9 -13.1
89.8
3.3
77.8 -13.4
111.4
43.1
146.1
31.2
364.2 149.3
321.7 -11.7
294.7 -19.1
277.2 -13.8
352.3
19.5
Source: HSBC
An orderly adjustment (soft landing) would command an unprecedented fiscal adjustment
since we consider this would be a necessary condition for Venezuela to implement a marketfriendly restructuring and start normalizing its economy. The manoeuvring room for Venezuela
to implement shock policies would be very low right now, due to the extraordinary magnitude of
its imbalances and the lack of collaboration between the different branches of government.
Even if the concerns on the liquidity of FX savings are overstated, credibility would only come
after the country has given proof of its commitment towards healthier policies. Hence, we
estimate that in this scenario, real GDP would fall 11.6% in 2016. The fiscal deficit would decline
by 10ppt of GDP to 8%, similar to the current account deficit, which we estimate would sink to
14.6% from 24.9% of GDP in 2015.
This being said, we estimate that by 2H 2017, activity could improve and that the negative
statistical carryover from 2016 could be overcome, as the economy regains access to external
funding and Venezuelans repatriate some of the overseas savings, which the central bank
estimated at USD160.2bn at 3Q 2015. Thus, we would expect GDP to interrupt its freefall and
post positive growth of 0.5% in 2017. It is worth mentioning that notwithstanding a deeper
contraction in 2016, the orderly adjustment would lead to a shallower activity cost
compared to the hard landing case, according to our calculations. Also, Venezuela would
be able to maintain a higher current account deficit, although the flipside to this would be much
more severe fiscal discipline (see a comparison of both scenarios in table 14). By end-2017, we
would expect dollar GDP to also be significantly higher in a soft landing.
Noteworthy are the differences in the behavior of the inflation and real exchange rates in both
scenarios. We factor in hyperinflation dynamics only in the case of a hard landing: year-on-year
inflation would peak at almost 3,600% by mid-2017, we estimate. We believe that conditions
for a regime change could emerge after an outbreak of hyperinflation and that by end2017, annual inflation could decline to below the 1,000% threshold. Despite this, we
acknowledge there are material upside risks to this inflation projection, depending on how fast
money demand can recover.
Conversely, in an orderly adjustment scenario, we believe that once expectations become
anchored and fiscal dominance is reined in, inflation could drop below 50% by end-2017,
although the speed of disinflation could ultimately depend on the type of stabilization plan put
into place (see Venezuela Economics – Growing strains: a gloomier macro outlook with default
more likely in 2016, 2 June 2015). Importantly, hyperinflation (according to Cagan’s definition)
would not kick in, in this orderly adjustment scenario, assuming of course that market
participants find policies credible enough.
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ECONOMICS  VENEZUELA
18 March 2016
Regarding the real bilateral exchange rate with the US, after peaking in 4Q 2015, in a default
trajectory, it is likely that the government attempts to anchor the nominal exchange rate to
control inflation in the short term. In this scenario, capital controls remain in place, as well as the
segmentation of the official FX markets and the existence of a subsidized exchange rate.
Importantly, we are not modeling the exchange rate framework as there are multiple shapes
that this could take. In this regard, we have to consider that as table 3 shows, in the last few
years, the average level of the currency has weakened by diverting more dollar demand to the
parallel market, instead of allowing for a more expensive dollar in the official markets.
Eventually, we believe that the attempt to anchor the FX rate would be followed by a new and
abrupt real devaluation triggered by a credit event and the exhaustion of dollar savings. An
orderly adjustment could feature a RER appreciation once the government ends the
restructuring efforts and uncertainty on debt servicing eases (figure 16). We think that for the
orderly adjustment to take place, capital controls would have to be eventually removed and that
it would also be necessary to eliminate the multiple exchange rates that foster distortions and
arbitrage opportunities.
15. Inflation scenarios
% y-o-y
3500
3000
2500
2000
1500
1000
500
0
4Q11
2Q12
4Q12
2Q13
4Q13
2Q14
Inflation EOP (% y-o-y)
4Q14
2Q15f
4Q15f
2Q16f
Default Scenario
4Q16f
2Q17f
4Q17f
No Default Scenario
Source: BCV, HSBC
16. Bilateral RER with US in both scenarios
450
400
350
300
250
200
150
100
50
4Q11
2Q12
4Q12
2Q13
4Q13
Bilateral RER w/USA (avg.2009=100)
2Q14
4Q14
2Q15f
4Q15f
Default Scenario
2Q16f
4Q16f
2Q17f
4Q17f
No Default Scenario
Source: HSBC
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ECONOMICS  VENEZUELA
18 March 2016
Haircut scenarios
To set out these different scenarios, we rely on a simple concept often used to evaluate
“haircuts” by financial market participants, namely, to compare the market value of the new debt
and cash received to the sum of the outstanding face value of the old debt and past due
interest. We note that economists Sturzenegger and Zettelmeyer (2005) also discuss an
alternative definition, but we prefer to stick with their traditional one. Sturzenegger and
Zettelmeyer provide hard evidence on local and international debt restructurings and ensuing
haircuts in recent times. Under the traditional definition above, the average haircut for external
debt restructurings has been 48.3% of outstanding face value, with a median of 51% (see table
17). The case of Uruguay (2003) stands out as a possible outlier due to its very low haircut
compared to other renegotiation experiences.
17. Historical evidence of haircuts in sovereign debt (%, traditional definition)
Haircut
Russia (1999-2000)
GKO/OFZ non-residents
MinFin3
PRINs/IANs
Average
Ukraine (1998-2000)
OVDPs non-residents
Chase loan
ING loan
International bonds
Average
Pakistan (1999)
Eurobonds
Ecuador (2000)
International bonds
Argentina (2005)
2005 international
Uruguay (2003)
External
Average
Median
Std deviation
Minimum
Maximum
61.5
61.0
69.2
63.9
59.2
30.7
38.0
40.1
42
30.4
60.0
67.0
26.2
48.3
51.0
17.8
26.2
67.0
Source: Sturzenegger and Zettelmeyer (2005), HSBC
In table 18, we present different haircut scenarios and how these would impact the debt-to-GDP
ratio of Venezuela, a standard metric in terms of assessing the burden of a country’s liabilities
relative to its income (although not of its wealth). During financial distress episodes, the real
exchange rate typically overshoots, which could lead to an artificially low dollar GDP compared
to the country’s underlying potential dollar output. Hence, we acknowledge this by depicting the
different values that debt to GDP could assume with different dollar income levels: (1) our 2017
nominal dollar GDP forecast, (2) 2017 GDP using the level of the real exchange rate in 2009
when the Venezuelan basket averaged USD56 per barrel and there was a much lower
perception of political risk, and (3) the level of 2004 dollar GDP (when the oil price stood at
USD33.9 per barrel) in terms of 2017 dollars.
Applying a 67% haircut on Venezuelan debt à la Argentina would produce a debt-to-GDP
ratio of 74.6%. While this is a high level, it is necessary to take into account that an undervalued
currency would be producing an artificially low dollar GDP. In the case of the updated 2004
nominal GDP level, the debt-to-GDP ratio would be only 31.1% with an Argentina-type
restructuring.
Instead, a 48.3% haircut, in line with the average of past experiences, would yield a 100.4%
debt-to-GDP ratio under our 2017 forecast and a very manageable 41.4% under the 2004
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ECONOMICS  VENEZUELA
18 March 2016
nominal USD GDP. Therefore, judging by table 18 and figure 19, we conclude that a haircut
of outstanding external liabilities of the sovereign and PdVSA combined that would be
consistent with a debt-to-GDP ratio in the vicinity of 50% once the exchange rate reaches
a fair value, could be below 50%. If the real exchange rate were to converge to 2009 levels (a
nominal USD GDP equivalent to USD237bn in 2017 dollars), then a haircut similar to the
Uruguayan episode would lead to a debt burden of only 36% of GDP.
18. Haircut scenarios
Min H (Uruguay)
26.2
130.8
36.1
53.6
2017 nominal USD GDP (f)
2017 GDP (using 2009 RER)
2004 GDP (2017 dollars)
Avg H
48.3
100.4
28.1
41.4
Max H (Argentina)
67.0
74.6
21.4
31.1
Source: Sturzenegger and Zettelmeyer (2005), HSBC
19. Debt-to-GDP ratio in different haircut scenarios
% of GDP
200
175
150
125
100
75
50
25
0
0
10
20
30
2017 GDP (forecast)
40
50
% of Haircut
60
2017 GDP (using 2009 RER)
70
80
90
100
2004 GDP (2017 dollars)
Source: HSBC
20. Old vs new estimates
Previous
VEF/USD average
VEF/USD end-year
Nominal GDP (USDbn)
Current account balance (% GDP)
Total public debt (%GDP)
Int’l FX reserves (USDbn)
Current
VEF/USD average
VEF/USD end-year
Nominal GDP (USDbn)
Current account bal (% GDP)
Total public debt (%GDP)
Int’l FX reserves (USDbn)
2012
5.2
5.8
316.4
3.5
49.0
29.9
2012
5.2
5.7
316.8
0.8
49.0
29.9
2013
10.3
11.1
244.9
2.2
61.5
21.5
2013
10.2
10.6
247.3
1.9
59.5
21.5
2014
23.1
40.0
178.4
2.9
83.0
22.1
2014
22.0
37.8
185.1
1.9
70.8
22.1
2015f
79.5
130.5
113.8
-6.2
116.6
20.1
2015f
124.2
206.4
72.8
-24.9
157.6
16.4
2016f
314.4
342.5
103.4
2.5
131.6
14.0
2016f
878
2,000
79.5
-21.2
132.2
7.9
2017f
371.3
400.0
120.0
5.0
73.0
19.3
2017f
23,250
35,000
62.3
-2.7
165.1
10.5
Source: HSBC, BCV, Finance Ministry
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ECONOMICS  VENEZUELA
18 March 2016
Conclusion
Despite the hefty costs associated with a credit event, and given that the government would
have internalized these, a default in the near term cannot be ruled out because of: (1)
uncertainty on the market value of FX holdings, (2) unpredictable political events in a highly
polarized society, with the opposition seeking to unseat the incumbent president, (3) the
government’s inability to implement an aggressive reform agenda, which might dry up FX
savings, even if fears about these savings’ true market value have been overstated.
Venezuela will have to choose between the lesser of two evils: (1) a painful and socially costly
adjustment, or (2) to maintain current policies, which we believe will eventually lead to a
collapse.
Given the country’s vast oil wealth (owning the largest proven recoverable oil reservoirs in the
world), Venezuela might be able to withstand a lower-than-average haircut of its liabilities
compared to previous international episodes. The immense oil resources of Venezuela
support our view that dollar GDP could undershoot under distress conditions, but once
expectations improve, a significant rebound could be expected, thus enhancing the country’s
debt servicing ability.
21. Main economic forecasts for Venezuela
GDP growth (% y-o-y)
CPI (% y-o-y)
Current account balance (% GDP)
Consol gov’t balance (% GDP)
Int’l FX reserves (USDbn)
VEF/USD end-year
2008
5.3
31.9
11.5
-3.5
43.1
2.7
2009
-3.2
25.1
0.2
-8.7
35.8
3.8
2010
-1.5
27.2
2.2
-10.4
30.3
4.1
2011
4.2
27.6
6.0
-11.6
29.9
5.2
2012
5.6
20.1
0.8
-17.5
29.9
5.7
2013
1.3
56.2
1.9
-16.9
21.5
10.6
2014
-3.9
68.5
1.9
-21.2
22.1
37.8
2015f
-5.7
180.9
-24.9
-18.3
16.4
206.4
2016f
-8.3
1784.9
-21.2
-21.0
7.9
2000.0
2017f
-11.3
929.7
-2.7
-12.8
10.5
35000.0
Source: HSBC, BCV, INE
On the other hand, the destruction of physical and human capital over the past few years will be
a formidable challenge for authorities going forward, particularly if oil prices surprise to the
upside, and the real exchange rate once again becomes undervalued. Venezuela’s oil bonanza
critically damaged non-oil industries to the point that non-oil exports sunk to an all-time low,
while enhancing the country’s dependence on imported manufactures and foodstuffs.
Paradoxically, oil has been, at the same time, Venezuela’s closet friend and enemy.
References
Calvo, Guillermo A., Alejandro Izquierdo and Ernesto Talvi, Phoenix Miracles in Emerging
Markets: Recovering without Credit from Systemic Financial Crises, NBER Working Paper
No12101
Fischer, Stanley, Ratna Sahay and Carlos A. Vegh, 2002. “Modern Hyper and high inflations”
Journal of Economic Literature, volume 40 (September), pgs837-880
Sturzenegger, Federico, and Jeromin Zettelmeyer, 2005. “Haircuts: Estimating investors’ losses
in sovereign debt restructurings 1998-2005,” IMF Working Papers n5/137
Reinhart, Carmen and Savastano, Miguel, 2003 “The realities of modern hyperinflation”,
Finance and Development, June 2003, pgs20-23
Sargent, Thomas J., 1982, “The end of four big inflations” in Inflation: Causes and
consequences, ed by Robert E. Hall (Chicago: University of Chicago Press), pgs41-97
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ECONOMICS  VENEZUELA
18 March 2016
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Disclosure appendix
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recommendation(s) or views contained in this research report: Ramiro Blazquez
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Osmar Camilo
LatAm Equity Strategy
Oil & Gas, Petrochemicals
LatAm
Luiz F Carvalho
Filipe M Gouveia
Ivan Enriquez
Andre C Carvalho
Equity Product Management
Metals & Mining
55 11 3371 8190
Brazil
Andre C Carvalho
Marina F Valle
55 11 3371 8190
55 11 3371 8191
Mexico
Jaime Aguilera
52 55 5721 2379
Southern Cone & Andean
Francisco J Schumacher, CFA 1 212 525 4430
Kevin R Gonzalez
1 212 525 4394
1 212 525 5150
55 11 8747 5433
55 11 3847 9502
55 11 3371 8178
55 11 3847 5451
52 55 5721 2397
Pulp & Paper
Jonathan Brandt, CFA
Botir Sharipov, CFA
1 212 525 4499
1 212 525 5150
Real Estate
Jonathan Brandt, CFA
Ivan Enriquez
Fred Mendes, CFA
Victor Tapia
1 212 525 4499
52 55 5721 2397
55 11 3847 5436
55 11 3847 5317
Currency Strategy
David Bloom
44 20 7991 5969
Emerging Markets Multi Asset Strategy
Murat Ulgen
Bertrand J. Delgado
44 20 7991 6782
1 212 525 0745
Retailing
LatAm Equity
Head of LatAm Equity Research
Francisco Navarrete
55 11 2169 4612
Agribusiness
Alexandre Falcao
Ravi Jain
Gustavo H Gregor
Economics
1 212 525 4449
1 212 525 3442
55 11 3847 5635
North America
Kevin Logan
Ryan Wang
David Watt (Canada)
1 212 525 3195
1 212 525 3181
1 416 868 8130
Brazil
Constantin Jancso
Marcio A Gregory
55 11 3371 8183
55 11 3847 5190
1 212 525 4449
1 212 525 3442
55 11 3847 5635
52 55 5721 2397
South America (ex-Brazil)
Javier Finkman
Ramiro Blazquez
Jorge Morgenstern
54 11 4344 8144
54 11 4348 2616
54 11 4130 9229
Foreign Exchange
US
Daragh Maher
1 212 525 4499
1 212 525 5150
Luciano T Campos
55 11 3371 8192
1 212 525 4114
Financials
1 212 525 3345
Carlos Gomez-Lopez, CFA
Neha Agarwala, CFA
Henry Nasser
1 212 525 3117
Food & Beverages
Precious Metals - Global
James Steel
Jonathan Brandt, CFA
Botir Sharipov, CFA
Education
LatAm/Emerging Markets
Clyde Wardle
Cement & Construction
1 212 525 5253
1 212 525 5418
55 11 2169 4424
Carlos Laboy
(Global Beverage Sector Head) 1 212 525 6972
Andrew Muench
1 212 525 4866
Fixed Income Strategy
North America Credit Strategy
Edward Marrinan
1 212 525 4436
LatAm
Alejandro Martinez-Cruz
Aaron T Gifford
52 55 5271 2380
1 212 525 3277
US Rates
Larry Dyer
Jacob Kim
1 212 525 0924
1 212 525 5126
Healthcare
Luciano T Campos
55 11 3371 8192
55 11 2169 4429
52 55 5721 2745
55 11 3847 6066
Telecoms, Media & Technology
Christopher A Recouso
1 212 525 2279
Sunil Rajgopal
1 212 525 0267
Transportation
Alexandre Falcao
Ravi Jain
Gustavo H Gregori
Capital Goods
Alexandre Falcao
Ravi Jain
Gustavo H Gregori
Ivan Enriquez (Mexico)
Richard Cathcart
Ana C Hernandez
Mariana Vergueiro
1 212 525 4449
1 212 525 3442
55 11 3847 5635
Utilities
Francisco Navarrete
Arthur Pereira
55 11 2169 4612
55 11 2169 4415