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12. LAW

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Feature

Venezuela: Playing the odds of regime change

Patrick Esteruelas
Patrick Esteruelas
Investment Team
January 2019

The combination of building external and domestic pressure against Venezuelan President Nicolás Maduro has made it increasingly likely that he will not survive in office beyond this year, let alone complete a full six-year term that only began on 10 January 2019. What might follow remains highly uncertain, but we look to what followed the 1958 coup against former President Marcos Pérez Jiménez under relatively similar circumstances to potentially offer us some clues. Nonetheless, we believe that the path to recovery will be a long and protracted process that will depend on many factors, not least the growth rate of oil production post regime shift.

President Maduro’s hold on power has always been more fragile than commonly believed, despite the Chavista regime’s absolute institutional control. In order to force a breaking point, we believe that a combination of sustained intense external and domestic pressure is needed. On the external front, pressure against the regime has been consistently growing thanks to a systematic tightening of US-led international sanctions designed to cut off virtually all available sources of funding and diminish President Maduro’s ability to distribute ‘pork and patronage’ in order to reinforce his presidency. This has recently culminated in recognition by a large majority of governments, in and outside of Latin America, that National Assembly President Juan Guaidó is the legitimate interim president of Venezuela. This was also prescribed by the Venezuelan Constitution given last year’s fraudulently held elections and the power vacuum that should have followed the end of President Maduro’s first term. On the domestic front, continued sharp declines in economic activity, hyperinflation, and shortages of food and medicine which are now at critical levels, have kept President Maduro’s approval ratings depressed at approximately 20% since the summer of 2016, with over 75% of recent poll respondents urging President Maduro to resign immediately. However, President Maduro has been able to keep tensions at bay thanks to enhanced Cuban-led surveillance leading to a crackdown of potential dissident activities, outward migration that has primarily been made up of more upwardly mobile citizens and students who were at the forefront of previous protests, and a divided political opposition. This, however, appears to be changing as President Maduro’s opposition has found new reserves of energy under the unassuming leadership of Mr. Guaidó, and has attracted mass protests in recent weeks in numbers that have not been matched since the large anti-government marches of spring 2017. Mr. Guaidó is also astutely pursuing a new strategy of non-confrontation that looks to tip the loyalty of the armed forces by initially showing that the flow of funds and access to revenues have switched from one actor to another (1) and then proposing an amnesty for members of the armed forces willing to support a transition.

What will follow the end of President Maduro’s presidency is perhaps the toughest question of all. We look to the 1958 coup against former President Marcos Pérez Jiménez, which took place under relatively similar circumstances, for some guidance. Much like today, Mr. Jiménez enjoyed near absolute power, the opposition had been completely ostracized, and the economic bubble of the 1950’s had produced massive fiscal and financial imbalances and a debt hangover by the end of the decade. Again, much like today, Mr. Jiménez violated the 1953 Constitution, which he himself had approved to give his military government an unfair advantage, to substitute promised Presidential elections, that he may have lost, with a yes or no plebiscite on his continued rule. Despite winning the plebiscite on 15 December 1957, Mr. Jiménez was ousted in a coup less than six weeks later by a collection of forces who felt he had gone too far and were wary of the precariousness of their own position. A governing council was established in his place, made up of representatives of all political forces, the Church and the armed forces presiding over a one-year transition before new general elections were called 11 months later. With the opposition tentatively showing a readiness to negotiate with would-be defectors, particularly in the armed forces, a similar set-up could result in replacing President Maduro.

Although the economy has continued to shrink, we believe that the potential reduction in the face value of Venezuela’s debt should be contained by the possible recovery of the economy. While the lack of data and large price distortions (2) make it difficult to pinpoint the exact size of the economy in US dollars today, consensus points to an economy of at least USD 100 billion today after shrinking by approximately 50% since 2013. The potential of an economic recovery, in our view, will be very much tied to the future recovery of the oil sector, which has collapsed from close to 2 million barrels per day in September 2017 to approximately 1.2 million barrels per day today. We believe that this has largely been due to years of critical underinvestment as well as the significant impact that sanctions against PDVSA (3) have had on the company’s ability to retain contractors and maintain normal servicing. That said, assuming there is a change in government and a shift to a more market-friendly regime with greater operational control granted to foreign companies, a real depreciation and unification of the exchange rate, and an adjustment of domestic fuel prices, we believe oil production should increase comfortably in excess of the historical annual average growth rate of 150,000 barrels per day, which we have seen during periods of expansion of the oil sector in Venezuela.

Taking into account Venezuela’s long-run ratio of exports to US dollar GDP, which has historically averaged approximately 4.5, and, conservatively assuming oil exports can increase from 900,000 barrels per day today to 1.9 million barrels per day over the subsequent five years, Venezuela’s US dollar GDP could potentially grow to at least USD 170 billion with WTI prices constant around today’s levels. This would then cause total debt, which currently stands at approximately USD 110 billion (4), to shift from 110% of long-run GDP to approximately 65% of long-run GDP (without taking into account additional assistance from multilateral lenders that will be sorely needed at first). Based on these figures alone, Venezuela could be in a considerably better position than other highly distressed sovereigns, such as Argentina and Greece, at the time of their respective defaults, which, according to Moody’s methodology, led to recoveries of 27 and 37 cents respectively.

(1) With the help of the US government transfer of Venezuelan export receivable accounts and assets in the US to Mr. Guaidó’s interim government.

(2) Overvaluation of the official exchange rate artificially increases the value of nominal GDP while price controls artificially lower it.

(3) Petróleos de Venezuela, S.A. is the Venezuelan state-owned oil and natural gas company.

(4) Net of ICSID claims that are typically converted into hard assets in subsequent settlements, and arrears with importers that are likely to go unrecognized.

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Feature
29 January 2019
Argentina Outlook 2019
Mark Franklin, Patrick Esteruelas, Jens Nystedt
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