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AmericasMarch 19 2019

What next for Venezuela?

The scene is set for a leadership change in Venezuela as its population continues to suffer hardship, and international sanctions bite. How to handle such a delicate situation is proving tricky for bond holders and foreign investors, as Silvia Pavoni reports.
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Nicolás Maduro

US sanctions have pulled the plug on Venezuelan oil sales and bond trading; foreign creditors to the Latin American country, sitting on the world’s largest proven oil reserves, have largely been resting idle on their credit notes since 2017. Other types of investors would also be excused for becoming increasingly disgruntled, because even favourable outcomes of lawsuits may not lead to payment under the current leadership of socialist president Nicolás Maduro. International pressure for regime change and negotiation, rather than litigation, may represent their best hope.

There have been a flurry of lawsuits against Venezuela since the expropriation of foreign assets more than a decade ago, with six new lawsuits filed since December 2018, as reported by the Financial Times. But even the largest, most successful claimants are struggling to recover what they are owed. In March 2019, ConocoPhilips won an award of $8.7bn as compensation for the expropriation of its Venezuelan investments in 2017, granted by the World Bank’s International Centre for Settlement of Investment Disputes. But out of the $2bn settlement that followed a favourable arbitration, under the different rules of the International Chamber of Commerce in April 2018, ConocoPhilips managed to recover only $430m by seizing some of Venezuela’s oil assets in the Caribbean sea.

Repayment unlikely

Bond holders’ legal pursuits of repayments might be even less lucky. But is it likely that, under a different regime, repayments will be made?

Venezuela is a treasure trove of natural resources. Besides oil, these include bauxite, iron ore, gold, diamonds and strategic minerals such as cobalt, which is used in hi-tech industries. “Venezuela has a liquidity crisis, not a solvency crisis,” says Russ Dallen, head of boutique investment bank Caracas Capital. “You have all this phenomenal stuff in the ground – [and the current regime is] just incredibly incompetent in getting it out without stealing it.” 

The opposition-led legislative power, the National Assembly, would need to approve the terms for any extraction of natural resources. Furthermore, while some bonds do not have collective action clauses (CACs), which bind all holders to the debt restructuring terms approved by a certain majority, leaving the door open to ‘Argentina-style’ holdouts, most of the notes do, according to Mr Dallen. This should speed any such process along.

It would be hard to find anyone who believes Venezuela will be solvent in the short term, however. Its external debt has spiralled over the past decade. According to estimates by Haver Analytics and the Institute of International Finance (IIF), the government’s external debt – including that of state oil company PDVSA – is about $140bn; by the end of 2007 it hadn’t topped $50bn. Of this figure, $36bn is in bonds, and about $17bn between bonds and other credit is due in 2019. As a sign of desperation, some point to Venezuela’s attempts to repatriate the $1.2bn-worth of gold it holds at the Bank of England, which the UK central bank is reluctant to allow because of pressure from the US, which has recently warned banks against supporting the current Venezuelan regime, according to Bloomberg. 

US sanctions have made a dire economic situation worse, but the reason for Venezuela’s collapse is because of years of mismanagement, according to Ruth Krivoy, a former governor of Venezuela’s central bank and an adviser at management consultant GlobalSource Partners. “What the sanctions have done is restrict the foreign exchange cashflow for the government. But the rest of the policy framework [of the current administration] has been in place for years and continues to be as bad as it was.”

Power struggle

While Mr Maduro holds on to power, the US and 50 other countries, including major European countries and neighbours in Latin America, recognise opposition leader Juan Guaidó as Venezuela’s interim president. Mr Guaidó swore himself in the role in January 2019. Cuba, Bolivia, Russia, China and Turkey continue to officially support the current regime, which has overseen an economic decline comparable to the collapse of the Soviet Union, notes the IIF in a recent report. The inflation rate is set to reach 10,000,000% by the end of 2019, according to the International Monetary Fund (IMF).

Mr Maduro came to office in 2013, having been appointed by the late Hugo Chávez as his successor before his death. It is estimated that the Venezuelan economy has lost half of its value since then – not helped by lower oil prices. In July 2017, Mr Maduro dismantled the opposition-controlled National Assembly, which continues to meet and is now led by Mr Guaidó, and replaced it with a Constituent Assembly. The move sparked US sanctions that barred investors from purchasing or trading new Venezuelan bonds. This move accompanied other sanctions imposed by Canada and the EU. The results of elections held in May 2018, which Mr Maduro says confirmed his leadership, are widely considered invalid. 

At the end of January 2019, the US ramped up the pressure by imposing additional sanctions on Venezuelan oil. Stronger action may well follow as the tone of US officials, led by secretary of state Mike Pompeo, is increasingly menacing and all US diplomatic personnel have been repatriated from Caracas. 

The government’s finances are collapsing just as Venezuela’s infrastructure, from oil to electricity, is failing. A major blackout in early March dealt a further, cruel blow not only to economic activity in the country but to essential provisions such as healthcare, with reports of chaos, looting and hospitals struggling with essential equipment. It took a week to restore power across most of the country. A fire destroyed a vital part of the power grid, according to the faculty of engineering of the Central University of Venezuela and as reported by The Guardian.

Mr Maduro blamed the breakdown on a cyberattack supposedly carried out by the US. China, a large investor, publicly offered to help restore power. Meanwhile, the US has generally blamed the dire state of Venezuela on Russia and Cuba.

Cuban ties

Understanding Venezuela is no easy task. “You have to look at it through the lens of Cuba,” says Mr Dallen. The two countries have long had strong ties, with Cuba providing medical personnel to Venezuela, while the latter reciprocates with oil. It is widely believed that Havana also provides intelligence services. Even while struggling financially, Venezuela continued its shipments to the Caribbean island, complementing them with purchases of Russian oil when necessary, according to Mr Dallen. Cuba has endured US sanctions for nearly six decades but, says Mr Dallen, while Cubans have a “cause people believe in... at this point, nobody in Caracas thinks this stuff is going to work. [Venezuela] lacks the revolutionary discipline of people willing to endure [extraordinary] deprivations.”

In March, the National Assembly banned any further oil shipments to Cuba. Soon after, US national security adviser John Bolton put shipping companies and insurers facilitating those movements ‘on notice’ through a Twitter message. 

Russia has long been another ideological ally, providing Venezuela with funds and arms. Over the years, Russian state oil company Rosneft has lent Venezuela $6bn, which the Maduro administration has been careful to repay, according to Mr Dallen. Russia is also by far the largest arms supplier to Venezuela, according to data from Stockholm-based Sipri. But overall, Russia’s economic strength is limited and its budget burned by conflicts in Syria and Ukraine. While Russia might enjoy a proxy conflict with the US through Venezuela, its international reach is constrained by financial considerations.

On a much smaller scale, China is also providing arms to the Maduro regime. But Beijing’s true interests remain economic, according to Margaret Myers, director of the Asia and Latin America programme at the Inter-American Dialogue. “Chinese military equipment sales achieve a number of aims but are still largely economically motivated,” says Ms Myers – that is, they are part of a broader effort to upgrade overall exports and help strengthen diplomatic ties with existing governments.

Much of China’s international non-economic activity falls under the auspices of its Belt and Road Initiative. Crucially, however, Beijing is committed to not interfering with another country’s domestic affairs, though it will want its debt to be honoured. Its policy banks have lent Venezuela a total of $67.2bn since 2007 according to the Dialogue, part of which is to be repaid in oil. 

Although it continues to recognise Mr Maduro’s leadership, some believe that China might prefer an administration that can produces enough oil to service its debt. “[China] would probably prefer a new and more capable leadership but at this point it is very carefully balancing its support and trying not to lean too heavily towards one side or the other,” says Ms Myers.

As self-appointed interim president, Mr Guaidó has said that he will honour commitments to China as long as these were reached within the limits of the law.

Military influence

Another key player is Venezuela’s military, which until now has remained loyal to Mr Maduro. Its highest officials have been enjoying privileges and often impunity, according to Ms Krivoy. “There are some who are strongly leaning towards the illicit side of business and those have little to gain from Mr Maduro’s departure,” she says. Mr Dallen adds: “There are warrants for their arrests in the US. In a sense, they have everything to lose – and nowhere else to go.”

But the picture changes further down the military hierarchy, with the rank and file deserting or leaving by the thousands over the past few years, according to Ms Krivoy. Mr Dallen adds: “Most of those [low-ranking] soldiers don’t really believe [in Mr Maduro], and they’re starving, their families are starving, they’re living on $5 a month. Even if they were getting $20 a month, that’s barely lunch for a week.” 

But there are signs that the top military’s commitment to the current regime may be wearing thin. Ms Krivoy notes that during the attempted delivery of humanitarian aid in late February from the Colombian border, which the Venezuelan government opposed, “no higher ranking officer was seen or heard; they all avoided appearing [to support] Mr Maduro”. The repression of that attempt was left to the Venezuelan National Guard, part of the armed forces, and, more effectively, to the colectivos, the motorcycle-riding gangs Mr Maduro has publicly called on for “active resistance in the community”, as reported by the international press.

The colectivos and other gangs roaming the country would still likely be defeated by Venezuela’s armed forces. Offering the military’s top echelon a strong enough deal could swing the country’s fate.

What comes next?

“[It has been a] slow-motion burn; a continued deterioration. Until it gets so bad that someone tries to take it into their own hands to change it, I don’t see any alternatives,” says Eric Farnsworth, vice-president of the Council of the Americas and Americas Society.

“What has to happen is that the National Assembly, controlled by the opposition, needs to come up with a better offer to the Venezuelan military beyond what it has done so far. And it’s tricky,” says Ted Piccone, senior fellow at the Brookings Institute. He adds: “The opposition is exhausted; I’m more worried about real hunger and disease spreading, and more and more of a migration flow and crisis, than of a civil war.”

Foreign investors should also be hoping for better prospects for the Venezuelan people. Although some may continue down the legal route, which could establish a pecking order for a new administration, a more sympathetic approach towards the country might prove to be a better choice. Talking to the Financial Times, an investor described hedge funds suing Venezuela now, during a humanitarian crisis and with the possibility of a leadership change, as “amateurs” who risk looking “like assholes”.

As Mr Dallen says, when it comes to honouring its debt, Venezuela’s problem is liquidity, not solvency, thanks to its wealth of natural resources. “That’s one of the exciting things about Venezuela: the IMF can come in with a big programme and have a reasonable degree of security that it is going to be paid back,” he adds. 

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Read more about:  Americas , Americas , Venezuela
Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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