By Richard Francis
& Erich Arispe
NEW YORK -- Venezuela's downgrade reflects Fitch's view that a default is probable given the further reduction in financing options for the Government of Venezuela following the imposition of additional sanctions on Venezuela by the U.S. government on Aug. 25, 2017.
The sanctions prohibit U.S. persons or entities based in the U.S. from a series of financial transactions with the government and PDVSA, including any dealings in new debt as well as dealings in certain existing bonds owned by the Venezuelan public sector and dividend payments to the government of Venezuela.
Venezuela's external liquidity was weak before the sanctions with a liquidity ratio estimated at just 33% (the stock of central bank international reserves plus the banking system's liquid foreign assets relative to external debt with a residual maturity of less than one year).
Gross international reserves have declined further in 2017, falling by nearly USD1.2 billion in the year through August to USD9.8 billion. Venezuela has additional FX liquidity in government-managed funds, but these have likely declined and remain opaque in their administration and execution. The U.S. sanctions will exacerbate the country's already weak external liquidity.
The authorities' payment record through severe economic and political stresses has demonstrated the sovereign's strong willingness to service debt. However, the expected reduction in the international reserve position in the context of sanctions will severely test the government's capacity and willingness to continue with timely debt service.
The sovereign faces nearly USD3.7 billion in external amortizations in 2018 (USD2 billion in bond amortizations). External financing needs for 2018 are expected to remain high in the context of a current account deficit and amortization needs.
The political environment in Venezuela and relations with a number of countries deteriorated sharply after the government called a Constituent Assembly to rewrite the constitution. The elections for the Assembly were held on July 30. The outcome of this process combined with the U.S. sanctions will likely deepen the political and policy uncertainties, aggravate the economic crisis, heighten political polarization and increase social unrest.
Venezuela's economy is expected to contract for a fourth consecutive year in 2017 with a 5.5% downturn after a deep contraction of an estimated 18.6% in 2016.
Venezuela's economic recovery is likely to be further constrained by the prospect of continued tight FX financing/liquidity conditions aggravated by the sanctions, declines in oil production and political uncertainty.
Inflation rose to an estimated average of 360% in 2016 (Caracas Inflation Index), and Fitch expects it to end 2017 at over 600% due to FX rationing, distortions in the FX market, monetary financing of the fiscal deficit and price adjustments to counter scarcity. Official data for inflation, the national accounts, and balance of payments has not been published since end-2015.RATING SENSITIVITIES
The main risk factors that, individually or collectively, could trigger a rating action are:
--A debt restructuring exercise or payment default by the sovereign.
--Easing of economic sanctions that improves prospects for FX flows to the economy
--A significant recovery in oil prices that eases financing constraints for the economy or greater than expected bilateral funding to the government and/or PDVSA;
--A reorientation of economic policies that reduces external and macroeconomic vulnerabilities;KEY ASSUMPTIONS
--Fitch expects Brent oil prices to average USD52.5/b in 2017, USD55/b in 2018 and USD60/b in 2019.
Fitch Ratings has taken the following rating actions on Venezuela's sovereign ratings:
--Long-term foreign and local currency IDRs downgraded to 'CC' from 'CCC';
--Senior unsecured debt downgraded to 'CC' from 'CCC';
--Short-term foreign and local currency IDRs affirmed at 'C';
--Country ceiling downgraded to 'CC' from 'CCC'.