For Venezuela, a Debt Default Trigger Is Armed
A number of recent developments, protests on Thursday notwithstanding, have raised the odds that Venezuela could default on its foreign debt repayments, triggering a cascade of events that would destabilize the country. Though the country has lived with the specter of default for years, Venezuelan officials have shown a willingness — given the existential threat that a default would pose to the current government — to cut imports and do whatever it takes to raid national coffers so funds will be available to continue making its debt payments. The country's rulers have relied primarily on its security forces to contain the unrest spawned by those tactics. But Venezuela's debt problems have now turned critical, in large part because of the pressure the U.S. government is placing on major banks to keep their distance from illicit Venezuelan financial flows.
In July, U.S.-based Citibank decided to stop processing some debt payments to Venezuela's bondholders by state oil company Petroleos de Venezuela (PDVSA), citing a periodic risk-management review. The institution told bondholders that it would end its role as PDVSA's principal pay agent and suspend its processing of at least seven debt bonds, including some due later this year and in 2017. This will force the oil company to hunt for another institution willing to process those payments. Citibank's decision brings with it considerable risk for Venezuela. If PDVSA is unable to pay bondholders because it cannot find an alternate payment processor, it would effectively be in default. Given the nature of PDVSA debt contracts, a default could trigger a lengthy court battle, which would have significant implications not only for PDVSA's financial future but also for Venezuela's social stability. At the least, a default would spell a volatile financial road ahead for Venezuela.
Citibank's decision appears to have been motivated by its notification of ongoing investigations (particularly by the U.S. departments of Justice and the Treasury) of alleged criminal activities by individuals associated with PDVSA. According to one source, concerns about money laundering involving PDVSA influenced the move. There are also reports that additional sanctions by the United States against additional Venezuelan political figures and state institutions could be forthcoming. The bank's final decision was motivated by the regulatory risk in continuing to process the payments. Several other banks, such as UBS, Santander Private Banking, Banco Safra and HSBC, are also unlikely to process PDVSA debt payments, given the growing risks. PDVSA is currently attempting to execute a bond swap to fulfill debt payments due in 2017, although it is unclear whether its interest in a swap is related to the problems with finding a pay agent or concerns about its financial ability to make upcoming payments.
The decision by Citibank and the rising perception of risk among other financial institutions places the Venezuelan government in a tenuous position. Missing a single foreign debt payment would place PDVSA in default, which would most likely lead to lawsuits by international bondholders and a disorderly legal battle. That process, which could resemble Argentina's nearly 15-year battle with creditors, would open the door for further political and economic chaos in Venezuela. An inability to pay bondholders would eventually lead to a debt restructuring process, but PDVSA, which relies on credit to pay operating costs, would likely suffer a loss of production, as lenders would be less willing to extend credit to a bankrupt company. A significant drop in oil production would exacerbate the country's instability. The flow of dollars to public finances, which are crucial to paying for imports of food and other necessary products, would be reduced, intensifying already extreme inflation and driving more social unrest.
Because PDVSA oil exports provide about 95 percent of Venezuela's export revenue, which pays for imports and public administration, its default on foreign debt would threaten the sitting government. While the core of political elites around President Nicolas Maduro has so far been able to manage the country's deepening social and economic crises and delay a recall referendum against the president, a default would take Venezuela into uncharted territory. It would trigger a steady decline for the country's oil exports, with no real relief in sight until energy prices rise. Even with oil price recovery, PDVSA would still face a limited ability to borrow abroad as long as it remained in default.
There is still a possibility that PDVSA can find a replacement for Citibank as a payment processor and make the $5 billion in debt payments due in October and November. But if it cannot, the sharp decline in living standards accompanying a default would be extremely dangerous for stability in Venezuela. This is where U.S. influence through the International Monetary Fund could play a significant role in providing a softer landing post-default. Certainly, in a default situation, Venezuela would seek a financial assistance package from the IMF or other international lenders.
For PDVSA and the administration, the next few months will be crucial. How the military and civilian institutions surrounding the president react to a looming default — or even to the ongoing deterioration of Venezuela's economy and public finances — will be key to the nation's immediate future. A default would be a socially traumatic event that would likely widen the already visible cracks in the ruling party's alliances and could shift the outlook by pro-government institutions on their continued support of the president as he attempts to resist the recall referendum. It is also important to keep an eye on powerful individuals within the government, such as Defense Minister Gen. Vladimir Padrino Lopez, to see if they begin to publicly support a political transition away from Maduro. Public demonstrations of support for a referendum, currently ongoing in Caracas and elsewhere in the country, are only a piece of the picture. Less visible are the developments that could trigger a default and thus a political transition on very shaky economic ground.
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