Sovereign Debt Restructurings

S o ve re i g n D e b t Re s t r u c t u r i n g s The Case of Venezuela

Seminar Sponsored by the LeBow College of Business and the Global Interdependence Center

23 February 2018

Newstate Partners LLP 90 Long Acre London WC2E 9RA United Kingdom +44 (0) 20 3077 4914

Situation Overview

Session 2 |

Political Landscape

Macroeconomic Overview



Opposition victory in 2015 parliamentary elections marked a watershed



Still, little progress has been made on meaningful economic policy reform



Instead, PSUV efforts focused on consolidation of power by undermining the opposition, which has sowed social discord amid international reproach



Politics will be crucial driver of the Government's approach in the event of a full default



There is no meaningful political (or financial) strategy to deal with the debt



Despite presidential elections on 22 April, the risk of a disorderly default remains high



PSUV economic policies have severely undermined resiliency to oil price volatility



Even unreliable official data evidences dire state of Venezuela’s economy



Since 2014, Venezuela’s GDP has contracted by over 40%



Deficit monetisation has led to world’s highest rate of inflation



Double-digit budgetary deficits have persisted six consecutive years



Discrepancy between official exchange rate and parallel market rate will lead to further economic deterioration and social hardships

1200%

140

Price controls and import restrictions have led to widespread shortages and a humanitarian crisis

1000%

120



800%

Key Macroeconomic Indicators Indicator

2014

2015

2016

2017F

2018F

GDP growth (%)

-3.9

-6.2

-16.5

-12

-6

Inflation (%)

38.4

111.8

254.4

652.7

2349.3

Fiscal Balance (% GDP)

-18.6

-22

-22

-17

-12

CA Balance (% GDP)

3.1

-10.9

-3.9

-3.2

-3

FX Reserves (US$bn)

21.5

22.1

11.0

9.5

N/A

Growth and Oil Prices

100 80

600%

2018

Risk of further economic US sanctions worsen the outlook

2017



2016

Creative funding sources tapped in previous years no longer available

0

2015



0%

2014

Market access non-existent

2013



20

2012

Projected external financing needs well above US$30bn for 2018

2011



40

200%

2010

Foreign exchange reserves now at a 20-year low (US$ 9.2 billion)

2009



60

400%

2008

US dollar earnings inadequate to meet both import needs and service debt

2007

External Debt



Sources: Bloomberg, IMF, Central Bank of Venezuela, IDB and CAF Annual Reports, Public Records.

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Preparing for A Sovereign Debt Workout

Session 2 |

Amid a deepening economic crisis, rising social unrest and conflicting political pressures, the risk of a full fledged default in the case of Venezuela is looking more likely. Mounting financial Venezuela Intl. Reserves, US$ bn

needs, lack of funding options and increasing social tension are likely to test and ultimately

50 45 40 35 30 25 20 15 10 5 0

override the Government of Venezuela’s outspoken political willingness to service external debts in the coming months in the absence of a consensual restructuring The outlook for an orderly work out resolution will depend on a number of factors linked to political developments over the coming months, which will in turn determine the economic reform agenda pursued by the Authorities to attempt to restore financial sustainability as well as Other reserves

Gold reserves

the external support that Venezuela may receive from both multilateral and bilateral sources It is important to continue to monitor and assess existing and emerging risks to effectively deal

Venezuela 5Y CDS 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0

with the fallout of a highly volatile and uncertain situation. Understanding domestic political dynamics, the role of the military, domestic bodies as well as evolving relations with multilateral institutions, including the IMF, the IADB, the World Bank and CAF as well as key bilateral trade partners, is critical to assess how a workout could take place In contrast to previous sovereign distress situations, political dynamics will take an even more prominent role in the timing and manner with which a default could be dealt in the case of

Sources: Bloomberg, IMF, Central Bank of Venezuela

Venezuela and how a sustainable resolution may emerge. As such, understanding political relationships and their potential impact is critical to assessing potential resolution options and understanding market reaction

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Session 2 |

Political Dynamics Will Determine Any Resolution Venezuela is not likely to have the financial resources or the funding ability to meet all external obligations going forward. However, credible policy reforms to address the growing economic imbalances remains dependent on a highly uncertain political outlook In December of 2015 legislative elections in which a highly fragmented coalition of opposition parties gained a majority, created a glimmer of hope for an economic reform agenda. However, in 2017 efforts by the PSUV to consolidate power through a variety of measures have managed to all but annulled political opposition. Such efforts to delegitimize the opposition have intensified the domestic political standoff, creating further division across the political spectrum and prolonging the policy paralysis that continues to depress economic activity. Such political dysfunction could lead to the introduction of additional policy actions to centralise power by the executive branch which will complicate any potential sovereign debt resolution. Important issues to watch in the coming months:  Incoherent economic policies that create further political and social discord  Launch of inadequate liability management operations  Discord among the ruling PSUV party  Unexpected military actions  Intensification of public discontent and social upheaval  Action to shield or assign assets from PDVSA

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Session 2 |

Key Players and Participants A Venezuelan sovereign debt work out would be extremely complex to implement given the nature and large number of participants and their often conflicting interests: 1. The Venezuelan Government (Domestic Institutions) • Central Bank; Ministry of Finance 2. The Opposition 3. Multilateral Organisations • International Monetary Fund; The World Bank; IADB 4. Key bilateral governments • United States • China • Russia 5. Regional Governments 6. Debt Holders •

External Bond holders

•

Trade suppliers

•

Others

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Session 2 |

Role of Multilateral Institutions A sovereign workout in the case of Venezuela will be extremely complex and difficult to implement without the involvement and assistance of Multilateral Institutions that would help address a number of issues.

• What is a multilateral organisation?

• What role do they play in the case of a Sovereign Debt Restructuring?

• How can the help in the case of Venezuela?

In the case of Venezuela Multilateral institutions can assist with: • The development and implementation of a credible economic reform programme • Targeted financing to support economic reform efforts and much needed investment in infrastructure particularly to upgrade oil facilities • Transparency and credibility • Validation of data and reform measures • Technical assistance

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Status of Relations with the IMF

Session 2 |

Recent Activity

Scope for Potential Programme Financing

Current relationship

Venezuela’s Quota

 Unlike neighbouring Cuba, which withdrew its membership after

 Venezuela’s quota with the IMF is SDR 2.7 billion (US$3.7 billion)

falling out with western powers in the 1960s, Venezuela remains a member country of the Fund  Venezuela, however, has not had an operational relationship with the fund for more than a decade, with the last Article IV consultation taking place in September 2004 Financial Arrangements  Venezuela’s had an SDR 3.9 billion Extended Fund Facility in place between 1989 and 1993, and an SDR 1 billion Stand-By Arrangement in 1996-1997  There are no current financial arrangements in place, and Fund officials have clarified that no official discussions have taken place for any financial assistance for the country SDR Allocation and Holdings  The country has been allocated SDR 2.5 billion (US$3.5), which constitutes liquidity held at the IMF to settle transactions with the Fund itself or other member countries  Members can choose to hold their SDRs as part of their international reserves, or to sell part or all of their allocations under voluntary arrangements with other members; that has, in fact, been a of funding for Venezuela, as it has drawn down its SDR holdings by close to SDR 2 billion (US$2.8) since start-2015, down to 0.6 billion (US$0.8) by 2017

Stand By Arrangement (SBA)  The SBA framework allows the Fund to respond quickly to countries’ external financing needs due to short-term balance of payments problems, and to support policies designed to restore sustainable growth. The length of an SBA is typically 12-24 months, and repayment is due within 3-5 years  Normal access is 200% of quota for any 12 month period and cumulative access of up to 600% (US$7.4 billion and US$22.2 billion respectively in Venezuela’s case), while exceptional access is possible under certain circumstances Extended Fund Facility (EEF)  The EFF framework is intended to address medium-and-longer-term balance of payments problems reflecting structural weakness that require fundamental economic reforms over an extended period of time (such as in the cases of Greece and Ukraine). Agreements are typically longer than under the SBA framework, with a maximum duration of up to four years. Repayment is due within 4.5-10 years  Normal access is 200% of quota for any 12 month period and cumulative access of up to 600%, while exceptional access is possible under certain circumstances

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Session 2

Lessons from Past Sovereign Workouts There are number of key lessons that can be drawn from a review of past sovereign debt workouts that should be taken into consideration in the case of Venezuela:  The uncertainty surrounding the political outlook, the existence of economic sanctions, and rising social tension together with the structure of Venezuelan external bonds may lead to a disorderly and protracted resolution process  External bond holders may employ legal options to secure judgements to protect their interests if engagement with the Authorities is not based on credible and transparent exchange of views  Lack of a consistent, robust and verifiable data makes any resolution plan difficult to implement without the involvement of an independent body that may be able to serve as an independent and impartial arbiter  Lack of market access makes multilateral institutional support imperative to finance an economic reform programme and much needed investment to rehabilitate the country's credit profile  The lack of information makes a comprehensive reconciliation of existing debts and outstanding arrears a critical undertaking  A successful sovereign debt resolution needs to rely on honest engagement and equitable treatment of all outstanding creditors as well fair burden sharing

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Phone: Fax: E-mail: Website:

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