Venezuela’s crisis comes to a head

published 28 July 2017

855-Venezuela-634 — More than 100 people have died in protests against Maduro

"Venezuela's economy is in free fall," as Liam Denning puts it on Bloomberg. The IMF says that the economy has shrunk by around 30% since 2013. Inflation could top 700% this year. More than 100 people have been killed in battles between anti-government protestors and supporters of President Nicols Maduro, while many more have died as a result of soaring crime, and of shortages of food and medicine.

This "tragic and volatile mix of a failing, oil-dependent economy, political gridlock and simmering unrest is well known at this point", says Denning. "But things are building to a head, partly due to the relentless logic of the bond market and partly due to the more proprietary logic of US foreign policy."

On the bond side, the problem is that the country's foreign-exchange reserves are running dry, says Gideon Long in the Financial Times. Last week, these reserves stood at $9.983bn, "a 77% decrease since January 2009 when they hit a peak of $43bn". This is likely to "rekindle fears that Venezuela might default on its debt obligations".

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The government and the state oil company PDVSA must make interest payments and capital repayments of $3.7bn in the fourth quarter of this year alone. Venezuela may be able to recall some past loans made to small Caribbean and Central American countries and seize some private-sector assets, and thus find enough cash to avoid a default in the immediate future. But the outlook is bleak if oil prices remain low (oil accounts for 95% of export revenues).

Yet politics may be the tipping point in the crisis. Maduro has called an election on 30 July for an assembly that will be able to rewrite the constitution. Opposition parties, which control the national assembly, see this as "a farce designed to ensure a majority for a government with minority popular support", says Andrew Cawthorne on Reuters. The European Union and major Latin American nations oppose the plans, while the US says it is considering a ban on imports of Venezuelan oil.

This threat represents a "nuclear option", says Anthony Faiola in The Washington Post. The outcome is unpredictable, but it is clear that "slapping an embargo on Venezuelan oil could quickly exacerbate the runaway inflation and scarcities of everything from toilet paper to antibiotics". Yet some in the Trump administration favour these measures, so a decision could come this week. "Maduro and the Venezuelan people will be watching."

Euro QE: no taper just yet

"The European Central Bank is playing for time on extreme monetary policy," says Richard Barley in The Wall Street Journal. "But markets know a decision on winding down its bond-purchase programme can't be put off forever."

At his latest press conference on Thursday, Mario Draghi, the president of the European Central Bank (ECB), implied that nothing had been decided about winding down quantitative-easing (QE) policies but he "was upbeat on growth, and didn't sound too worried about the rise in yields and the euro that has occurred in the past few weeks". Currency markets saw that as bullish and the euro nosed above $1.16, its highest since January 2015.

But don't get carried away, says Swaha Pattanaik on Breakingviews. "Traders push the euro up at their own peril." A strong euro risks depressing import prices at a time when the ECB thinks that inflation is still too low: consumer prices rose by just 1.3% in June, compared with the bank's target of 2%. Low inflation will give the ECB an incentive to keep monetary policy looser for longer, which in turn would be bearish for the currency. "The more the euro strengthens, the greater the risk that the rally brings about its own reversal."

James has previously written about financial markets for MoneyWeek. He has a bacherlors degree in management and he has been awarded an investment advice diploma by The Chartered Institute for Securities & Investment (The CISI). James then worked at Moran Stanley as a U.S. Equity Sales Analyst for two years, then moved into hedge fund sales and investor relations at 36 South Capital Advisors, and then became the Global Multi-Asset Sales at Credit Suisse. Now, James is the Associate Director of US Equity Sales at Oppenheimer & Co. Inc, where he is responsible for servicing a range of clients including asset managers, hedge funds and wealth managers.