Fitch Drops Venezuela to CCC - "Default is a Real Possibility"

12/19/2014

NEW YORK -- Fitch Ratings has downgraded Venezuela's Long-term foreign and local currency Issuer Default Ratings (IDRs) from 'B' to 'CCC'. The issue ratings on Venezuela's senior unsecured foreign and local currency bonds are also downgraded from 'B' to 'CCC'. The Country Ceiling is downgraded from 'B' to 'CCC' and the Short-term foreign currency IDR from 'B' to 'C'.

Fitch defines CCC as "Substantial credit risk -- Default is a real possibility."

According to Fitch, Venezuela's downgrade reflects the following key factors:

• International oil prices have declined sharply in Q4'14 increasing balance of payments pressures in the context of reduced external financing flexibility and rising macroeconomic instability. Venezuela's commodity dependence is high, as oil is expected to account for an estimated 92% of current external receipts (CXR) and 50% of central government revenues in 2014. Low oil prices will erode the main source of FX for the economy.



• The capacity of the Venezuelan economy to respond to this external shock is constrained by the relatively low level of international reserves, constraints to their operational liquidity, and limited sources of external financing. International reserves, at USD21.4 billion, are about half the level of end-2008 when Venezuela last confronted the sharp oil price decline resulting from the global financial crisis. In addition, operational liquidity of reserves is constrained, as 72% of international reserves are held in gold and most of these are held at the central bank in Venezuela. Nontransparent off-budget FX funds will likely come under pressure, as central bank and extraordinary oil revenue contributions will be curtailed.



• Venezuela's sources of FX financing are limited, the sovereign does not have direct access to international debt markets, and significant multilateral funding is not expected in 2015-2016; China remains the sovereign's main source of financing. Nevertheless, there is no indication that China will increase its exposure to Venezuela beyond the roll-over of existing facilities.



• Macroeconomic instability has increased, driven by the inconsistency between FX, and fiscal and monetary policies. Continued rationing of FX, widespread price controls, and monetary financing have fueled inflationary pressures. Inflation averaged 55% in the first eight months of 2014. The spread between the official and parallel exchange rates continues to widen at a rapid pace, thus further fueling inflation and currency pressures. Fitch estimates that the economy may have contracted by close to 4% in 2014 and expects Venezuela to remain in recession in 2015.



• In addition to lack of transparency in government off-budget funds, transparency and timely reporting of official data for inflation, balance of payments and national accounts has suffered since 2013. Continued deterioration in terms of data provision and/or accuracy of official statistics could not only further dent confidence, but also pose limits to the capacity to assess the overall fiscal and external strength of the sovereign.



• Venezuela sovereign amortizations average 1.2% of GDP in 2015-16 with external debt repayments at 0.4% of GDP (3.5% of exports), using Fitch GDP estimates. As the state-owned oil company PDVSA faces an average of USD3.4 billion (0.6% of GDP) in external bond amortizations, average annual public sector external bond amortizations equal close to 22% of the current level of international reserves.

• While the sovereign has a track record of servicing debt through periods of high political and financial stress, the lagging policy response to address external pressures and macroeconomic imbalances, and the present decline in international oil prices materially weaken Venezuela's capacity to service debt.



• A high level of political polarization, the social impact of the ongoing economic crisis, marked divisions within the government in terms of economic policy, and the expectation of a heavily contested electoral cycle in 2015 could limit policy adjustments and increase the risk of social unrest.

RATING SENSITIVITIES

According to Fitch, the main factors that could, individually or collectively, result in a downgrade are:

--A sustained decline in oil prices that leads to further build-up of external and fiscal financing constraints;

--Further deterioration in Venezuela's external accounts and international reserves position;

--Signs of weakening willingness to service debt;

--Political instability that compromises FX revenues and results in further deterioration of Venezuela's policy environment.

In Fitch's calculus, the main factors that could, individually or collectively, result in an upgrade are:

--Policy adjustments that lead to reduced external and macroeconomic vulnerabilities;

--A recovery in oil prices that eases financing constraints for the economy;

--Strengthening of Venezuela's external and fiscal buffers and increased data transparency.

KEY ASSUMPTIONS

The ratings and Outlooks are sensitive to a number of assumptions:

--Fitch recognizes that there are material downside risks to its current oil price average of USD83 (Brent) in 2015 and USD90 in 2016.

--Fitch assumes that China will continue to provide financing to Venezuela through the renewal of existing oil facilities.

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