Yes, Venezuela Is On The Brink Of Default. No, That Doesn't Mean Regime Change.

Nov 21, 2017

Two things happened last week that gave hope to opponents of Venezuela’s socialist regime – especially to Venezuelan exiles in South Florida.

Opposition leader Antonio Ledezma, the former mayor of Caracas, escaped from house arrest in Caracas and made it into neighboring Colombia – with the help, he claims, of Venezuelan military officers. From there he vowed to keep fighting to topple Venezuelan President Nicolás Maduro, who critics say has wrecked the economy and created a dictatorship.

But Maduro probably felt more threatened by something else last week.

"They're trying to make the world think Venezuela's in default," Maduro complained. "Never!"

Maduro was railing at news that credit ratings agencies finally said the d-word – default – in relation to Venezuela’s massive foreign debt.

READ MORE: Dear Chileans: Don't Just Give Venezuela's Opposition Leaders Refuge. Teach Them.

For a country, default is like bankruptcy or foreclosure on a home. It can no longer pay its creditors –international bondholders, banks, investment firms and countries like China.

"When the ratings agencies say you're in default, that's a bad thing," says Venezuelan debt expert Russ Dalle, who heads the Miami investment firm Caracas Capital Markets.

Everything gets more aggressive if default happens. International creditors start trying to seize Venezuelan oil shipments on the high seas, because their job is to collect their debt. –Russ Dallen

But Dallen also points out the agencies didn’t say Venezuela was in full-blown default. They used the term “selective default,” because this month Venezuela and its state-run oil company failed to make two big bond interest payments on time.

“We’re not sure whether the cat is alive or dead," Dallen says. "It’s partly in default, but maybe they’re going to get out of default. They’re kind of putting it in this gray area because Venezuela is continuing to say that they’re going to pay.”

Venezuela today is mired in the world’s worst economic collapse – but it has kept making payments on its $150 billion foreign debt. In fact, it puts those payments ahead of importing food, medicine and other desperately needed goods.

That’s because not making those payments – and going into default – means creditors can start seizing Venezuela's all-important oil assets the way a repo man can come take your car.

“Everything gets more aggressive if that happens," says Dallen. "They start trying to seize oil shipments on the high seas, because their job is to collect their debt.”

Here’s another reason creditors believe – or want to believe – Venezuela will keep making its payments. Venezuela’s economic crisis makes buying its debt very risky. But that also makes the rate of return on that investment very lucrative.

“A yield above 30 percent," says Dallen. "It’s so high that it’s essentially paycheck loans – it’s those kind of usurious rates.”

800-POUND CREDITOR

Still, it’s likely at some point Venezuela will not be able to keep paying, because Venezuela is running out of money – thanks to the collapse of oil prices but also to the regime’s gross economic mismanagement and neglect of its oil industry.

Venezuela’s foreign reserves are now less than $10 billion –and that’s almost what Venezuela owes in debt payments through next year. And until Maduro restores democracy, the U.S. has barred Venezuela from securing new debt in U.S. markets.

So what lifeline does Venezuela have?

“China," says Ray Zucaro, chief investment officer at RVX Asset Management in Aventura, which holds Venezuelan bonds.

"China is the 800-pound creditor in the room.”

Venezuela says Beijing – Venezuela’s ally and largest creditor – could provide new money next year to tide it over.

And if it doesn’t?

“You can play this game for a while – paying this bill but not paying that bill," says Zucaro. "But unless China extends out, you’re going to get to a point where you run off the cliff and trip into a full-blown default.”

RUNNING OUT OF MONEY: Venezuela's foreign reserves are only a third of what they were just five years ago.
Credit Banco Central de Venezuela

However, even if Venezuela does fall into financial default, Zucaro says the regime is already plotting how it can turn that to its political advantage.

He points to the meeting in Caracas last week where international bondholders were invited to renegotiate some $65 billion of Venezuela’s debt. President Maduro’s officials offered no renegotiation plan – just speeches blaming the U.S. sanctions for Venezuela’s inability to restructure that debt.

“The whole exercise was done for the domestic Venezuela audience," says Zucaro. "It gives Maduro an out if the problem gets worse and they do default.”

Default  – which would mean not having to make the onerous debt payment for a while  – may actually free up more money for Maduro to import more food for Venezuelans. And that would enhance his chances of winning the presidential election scheduled for next year.

In other words: hang on to power despite economic run. It’s happened before.

Last week was a good reminder. In Zimbabwe they finally started to push out dictator Robert Mugabe. He too destroyed his country’s economy – and Zimbabwe did default on its foreign debt.

But Mugabe has remained in power for 37 years.

(UPDATE: Mugabe resigned on Tuesday.)