Navigation Search
Close

Select your location and role to view strategy and fund content

United Kingdom
  • Global homepage
  • Australia
  • Belgique
  • Botswana
  • Denmark
  • Deutschland
  • España
  • Finland (Suomi)
  • France
  • Hong Kong (香港)
  • Ireland
  • Italia
  • Luxembourg
  • Namibia
  • Nederland
  • Norway
  • Österreich
  • Portugal
  • Singapore
  • South Africa
  • Sweden (Sverige)
  • Switzerland
  • United Kingdom
  • United States
  • International
Professional Investor
  • Professional Investor
  • Individual Investor

Tailored for investment professionals this site provides information on our products, strategies and services. Please remember capital is at risk and past performance is not a guide to the future. We use cookies to ensure that we give you the best experience on our website. This includes cookies from third parties. Such third party cookies may track your use of our website. By continuing you are confirming that you are happy to receive all cookies on our website. Please refer to our Cookie Policy for further information, including steps to take to disable cookies.

By entering you agree to our Terms & Conditions
Emerging Perspectives

Venezuela: lessons from history

15 February 2019
Author: Mike HugmanPortfolio Manager

Recent developments in Venezuela have raised hopes for a desperately needed change in political regime. With some investors weighing the potential gains from a debt restructure, Portfolio Manager Mike Hugman examines the crisis unfolding in the context of similar historical events across emerging markets and urges caution.

Venezuela is in the midst of a political, economic and humanitarian crisis. With the incumbent president facing mounting pressure and hyperinflation crippling the economy, a change in regime and restructure of the country’s US dollar debt seem increasingly inevitable.

In this piece we discuss our understanding of the facts relating to the current situation and draw comparisons with other major episodes of the last 15 years, where countries have faced major economic and humanitarian crises forcing a debt restructuring. We examine the case of Iraq, a country which – like Venezuela – has enormous oil and gas potential and which saw a protracted regime change after years of economic decline. The Iraqi experience illustrates some of the practical difficulties in realising the potential of oil and gas reserves after an economic crisis.

We also consider some of the varied political and economic factors that will play a role in solving Venezuela’s debt and broader economic problems in a constructive way.

An economy in freefall

It is very difficult to say anything with certainty, as Venezuela stopped releasing macroeconomic data years ago. But here are some provisional metrics based on the latest estimates from the IMF:

GDP (in USD) GDP is down by 75% from its peak levels in 2011, according to the IMF. It is now approximately US$90 billion.1
Debt to GDP Whilst Venezuela has around US$60 billion of tradable bonds outstanding, US legal experts estimate total liabilities of the government may be more like US$196 billion, putting current debt/GDP some way above 200%.2
Energy production Years of neglect and sanctions on the public oil company PDVSA have seen total oil output (including gas) fall from a peak of 2.5 million bbls/day to around 1 million currently.
FX and inflation Years of economic mismanagement have led to a collapse in the currency and inflation running at millions of percent per year. A new currency or dollarisation is likely required.

How bad is it?

In Table 1 below, we list some key restructuring events that have taken place around major economic crises over the last 15 years and provide key economic and debt metrics for the two years leading up to the restructuring event. On the whole, Venezuela is in a weaker position than seen in most recent cases. For example:

  • Debt/GDP rarely reaches materially above 100% before emerging markets are forced to seek a restructuring of their debt. The two prior exceptions to this were Iraq, which had been in default for many years, and Greece which has exceptional support from the European Union and European Central Bank. The exact level of Venezuela’s total legitimate liabilities is unknown, and we have adopted a conservative estimate from the afore-mentioned legal experts.
  • Other commonly-used ratios to capture a country’s debt load are debt/revenue and debt/exports, since these help to determine the repayment capacity of the government and country. Using IMF estimates for revenue and exports, our analysis suggests Venezuela’s current capacity to repay its debt is lower than in other cases, although both revenue and exports after a regime change may be quite different.
  • Most other countries in this sample had also seen the start of an economic recovery before their restructuring took place, as measured by the five-year change in US dollar-denominated GDP. Even assuming a very optimistic 40% recovery in US dollar GDP for Venezuela in the wake of an initial regime change, the growth situation has been more challenging than in other cases.
  • Finally, as shown by inflation and the change in the nominal US dollar exchange rate, Venezuela faces a situation of hyperinflation and currency collapse which has not been seen in recent restructuring episodes but was common in the 1970s and 1980s, with Peru being one example.

On the left hand side of the table we provide estimates of what a restructuring of Venezuela’s debt may look like, based on a 2015 paper by Cruces & Trebesch.3

Table 1 – Two years before a restructuring

    Argentina Ecuador Iraq Congo, Rep. Ukraine4 Greece Venezuela5
Date of restructure   Jun 2005 Jun 2009 Jan 2006 Dec 2007 Oct 2015 Mar 2012
Amount restructured US$m   60,572 3,190 17,710 2,100 18,000 261,410 57,700
NPV haircut, %   76.8 67.7 89.4 90.8 28.0 64.6
Assumed discount rate, %   10.4 13.0 12.3 11.8 10.0 15.3
Market haircut, %   78.8 68.6 89.4 90.8 76.9
Face Value reduction, %   29.4 68.6 81.5 76.2 20.0 53.5
Debt/GDP 2-year avg before restructure 98.2 21.3 185.3 104.7 74.8 170.1 225.3
GDP/cap, US$ 4,739 4,255 2,075 2,264 2,615 24,034 3,049
Inflation, % 11.1 6.6 48.2 7.1 34.1 1.2 100,000,000
Debt/revenue 362.5 268.1 288.8 236.0 182.1 377.9 1,960
Debt/exports 468.5 126.9 381.9 179.5 559.9 677.6
Change US$ FX, % 5-year avg before restructure -35.2 -0.5 -26.6 -116,323
Change US$ GDP, % -0.2 11.5 36.4 20.6 -5.5 6.4 -5.6

For illustrative purposes only. Econometric modelling is inherently imperfect and not a reliable indicator of future results. Information on calculations or methodology are available on request.

Source: Investec Asset Management estimates. National sources. IMF World Economic Outlook, October 2018. Sovereign defaults: The price of haircuts. Cruces, Juan J.; Trebesch, Christoph.  CESifo Working Paper 3604. http://hdl.handle.net/10419/52478.

What could come next?

In Table 2 we show how our sample of seven sovereign debt restructuring countries were positioned after their restructuring. We provide the same economic and debt variables in the 5 years after the restructuring, with debt/GDP in general brought down to levels of around 50-70% of GDP, whilst in the emerging market cases debt/revenues and debt/exports were brought closer to 200%.

For purely illustrative purposes we have shown our own estimates of the same metrics that could prevail if Venezuela reduced its total debt stock (our prior assumption of US$196 billion total) by 80%. In reality, all projections of growth, revenues and exports in the 5 years following a regime change would be subject to a very wide range of uncertainties.

Table 2 – Five years after a restructuring

    Argentina Ecuador Iraq Congo, Rep. Ukraine6 Greece Venezuela7
Date of restructure   Jun 2005 Jun 2009 Jan 2006 Dec 2007 Oct 2015 Mar 2012
Amount restructured US$m   60,572 3,190 17,710 2,100 18,000 261,410 57,700
NPV haircut, %   76.8 67.7 89.4 90.8 28.0 64.6 80.0
Assumed discount rate, %   10.4 13.0 12.3 11.8 10.0 15.3
Market haircut, %   78.8 68.6 89.4 90.8 76.9
Face Value reduction, %   29.4 68.6 81.5 76.2 20.0 53.5 80.0
Debt/GDP 5-year avg after restructure 49.4 19.8 58.1 61.5 67.0 180.4 49.8
GDP/cap, US$ 9,600 5,574 4,317 3,104 2,863 19,613 7,419
Inflation, % 8.8 3.9 3.3 3.0 9.4 -0.5
Debt/revenue 157.8 52.3 119.5 135.5 167.1 373.5 182.0
Debt/exports 277.4 76.7 128.0 204.9 605.4 273.1
Change US$ FX, % 5-year avg after restructure -6.2 4.3 -7.8
Change US$ GDP, % 17.1 18.6 25.5 14.6 9.5 -6.6 14.6

For illustrative purposes only. Econometric modelling is inherently imperfect and not a reliable indicator of future results. Information on calculations or methodology are available on request.

Source: Investec Asset Management estimates. National sources. IMF World Economic Outlook, October 2018. Sovereign defaults: The price of haircuts. Cruces, Juan J.; Trebesch, Christoph.  CESifo Working Paper 3604. http://hdl.handle.net/10419/52478.

Compare and contrast: the case of Iraq

Iraq provides an interesting, if imperfect, case study of an approach taken to help country with large oil potential but facing humanitarian crisis to recover post a regime change. Clearly many factors, such as the security situation in Iraq post regime change, may not apply to Venezuela.

A UN Security Council resolution supported a regime change in Iraq in 2003 after years of sanctions and major economic decline. This protected Iraqi assets worldwide from creditor actions. US President Obama further extended this protection, allowing a haircut of around 90% to be applied to some US$18 billion of commercial debts.4 Together with Paris Club debt relief and an IMF programme, this eventually put Iraq back on its fiscal feet.

Attractive new fiscal terms for the oil sector initially attracted a lot of bidding for proposed investments. However, security concerns and other factors meant this ultimately took 10-15 years to come to fruition, as shown in the charts below.

Other factors at play

A wide range of factors will be vital in determining the next chapter for Venezuela.

First, the US government’s stance will be key. To what extent will it attempt to directly force a regime change? How much aid might it provide for reconstruction (effectively bailing out creditors)? And will it use the legal instruments it has at its disposal to assist the new government in starting with a clean slate?

China and Russia will also pay major roles. Venezuela owes billions of dollars to both countries, including from forward oil sales (arguably of questionable legality). Both countries will have to decide whether to play a constructive role in a restructuring, which could help or hinder other creditors.

The picture is made even more blurry by the complicated structure of debt and creditors. In addition to the countries mentioned above, Venezuela’s large debt stock is held by a wide variety of other nations and a large and varied group of bondholders. History suggests the more complicated the set of the creditors, the more complex the restructuring.

And then to domestic politics. Venezuela would likely need a new president to validate a debt deal. While the opposition leader Juan Guaidó has staked his constitutional legitimacy on organising free and fair elections, it is unclear who would win those and what their approach would be to economic policy.

Finally, there is the challenge of bringing investment into the oil and gas sector whilst also rebuilding the real economy. Venezuela has traditionally had some of the most punitive fiscal terms for oil companies in the world, experts suggest these would have to be loosened to attract new investment, boosting output but reducing the amount of actual government revenue. We saw this same pattern in Iraq.

Conclusion

History tells us that debt restructurings in the wake of such extreme humanitarian and economic crises are rife with complexity and can take years to materialise. With so many factors at play, we remain cautious until it is clear that a sustainable economic future for Venezuela can be secured.

 

The value of investments, and any income generated from them, can fall as well as rise.

Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.




1Source: IMF, World Economic Outlook Database, October 2018.

2Walker, Mark and Cooper, Richard, Venezuela's Restructuring: A Realistic Framework (September 19, 2017). Available at SSRN: https://ssrn.com/abstract=3039678 or http://dx.doi.org/10.2139/ssrn.3039678

3Sovereign defaults: The price of haircuts. Cruces, Juan J.; Trebesch, Christoph. CESifo Working Paper 3604. http://hdl.handle.net/10419/52478

4Source: IMF, second programme review, September 2016. 

5Historic macro variables from IMF World Economic Outlook, excluding debt/GDP using Cooper & Walker estimates of total liabilities. Assumes +40% rebound of US$ GDP in 2020.

6Source: IMF, second programme review, September 2016. 

7Historic macro variables from IMF World Economic Outlook, excluding debt/GDP using Cooper & Walker estimates of total liabilities. NB debt/exports on oil exports only, so over-statement. 

 

Additional Information:

This material is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual results may differ materially from those stated herein.

All rights reserved. Issued by Investec Asset Management, issued February 2019.

Mike Hugman
Mike Hugman Portfolio Manager

The content of this page is intended for investment professionals only and should not be relied upon by anyone else

Please confirm you fall under this category

By entering you agree to our Terms & Conditions