Venezuela's long-term rating affirmed with negative outlook - S&P

PRESS RELEASE

By S&P

February 28

RATING ACTION

On Feb. 28, 2017, S&P Global Ratings affirmed its 'CCC' long-term foreign and local currency sovereign credit ratings on the Bolivarian Republic of Venezuela. The outlook on both long-term ratings remains negative. We also affirmed our 'C' short-term foreign and local currency sovereign ratings. In addition, we affirmed our 'CCC' transfer and convertibility assessment on the sovereign.

RATIONALE

Our rating on Venezuela reflects our assessment that the sovereign is vulnerable to default absent unforeseen positive financial and economic developments. Moreover, Venezuela's credit profile reflects its monetary, exchange rate, and fiscal inflexibility and limited external liquidity, compounded by weak institutional and governance effectiveness. We believe that the sovereign's ability to service its debt is under severe strain due to continued economic contraction, high inflation, growing impoverishment, and heightened political tensions.

We estimate that the economy will contract at least 2% in 2017 in real terms, following a contraction of around 10% in 2016 and 6.2% in 2015. Per capita GDP growth is estimated to have been negative 4% on average during 2012-2016, a much worse performance than most other energy-based economies. It is likely to remain negative during 2017-2018.

The combination of poor monetary, fiscal, and other policies has resulted in rising inflation. Doubts about the accuracy of reported economic data (whose disclosure has decreased, and delays in reporting have mounted since early 2016) have weakened market confidence and made it more difficult to make forecasts. The latest published information shows a 180% inflation rate in 2015. We estimate inflation was 460% in 2016 and that it will accelerate in 2017.

We expect that Venezuela's politics will remain highly polarized between the government, led by President Nicolas Maduro of the leftist Chavista political movement, and an opposition that won a majority in the National Assembly in elections held in December 2015. The central government, along with the Chavismo controlled Supreme Court, has been in open confrontation with the National Assembly. Political tensions are likely to remain high, exacerbated by growing shortages of basic goods, high inflation, and falling living standards.

Low oil prices have undermined fiscal policy, resulting in large budget deficits and inflationary financing from the central bank. Fiscal information is not available since 2014, but estimates made by different private sources and by the International Monetary Fund suggest that the general government deficit was around 20%-25% of GDP last year. It is likely to be at a similar level in 2017.

Venezuela's reported low debt stocks and interest burden are misleading as the government uses the preferential foreign exchange rate of 10 bolivares (VEF) per $US1 to account for external debt. Venezuela's fiscal deficits will be mostly financed by domestic sources, but if the preferential exchange rate were to depreciate at the same pace as S&P Global Ratings' inflation rate expectation (900% in 2017), as our base-case scenario suggests, the increase in Venezuela's net general government debt could be as much as 40% of GDP in 2017. Under our base-case scenario, net general government debt could spike toward 45% of GDP and interest payments toward 25% of general government revenue in 2017.

Prolonged low oil prices have exacerbated the consequences of inconsistent macroeconomic policies, which have led to the currently poor state of the economy. Venezuela derives about 15% of its GDP, about half of government revenues, and 95% of exports from the hydrocarbons sector. In December 2016,

S&P Global Ratings reviewed its Brent and WTI price assumptions to remain steady at US$50 over 2017-2018 (see "S&P Global Ratings Raises Its Oil And Natural Gas Prices Assumptions For 2017," published Dec. 14, 2016).

Very low external flexibility continues to constrain our rating on Venezuela. As of year-end 2016, we estimated non-gold international reserves around US$3 billion to US$4 billion, and gold reserves were below US$8 billion. We estimate that foreign direct investment and the restricted funding available from external debt markets will not be enough to fully finance the current account deficit, which we estimate will be 4% of GDP in 2017. As a result, we expect the country's already low level of international reserves to decline further this year, raising the risk of default. The government is already incurring substantial arrears to nonfinancial creditors.

The government has not published balance of payments and international investment position data since September 2015. We estimate that the country's gross external financing needs in 2016 were around 200% current account receipts (CAR) plus usable reserves, likely similar to its projected level for 2017, and twice the level in 2013. We expect Venezuela to finance this need by the public sector running arrears with most of its suppliers and noncommercial creditors, and liquidating external assets. We expect Venezuela's external debt net of reported public- and financial-sector assets will remain around 250% of CAR during 2016-2018.

With nearly 300 billion barrels of proven oil reserves, Venezuela has a rich resource endowment. Nevertheless, its state-owned energy company, Petróleos de Venezuela S.A. (PDVSA), continues to miss its production targets. Crude oil output likely declined to 2.4 million barrels per day in 2016 from 2.7 million barrels per day in 2015 (down from 3.3 million in 2004). Oil output may decline again as Venezuela has been unsuccessful at attracting new investment.

Although the central government has given priority to paying external debt servicing over current expenditure, we believe pressure is growing for it to reschedule its commercial debt or undertake a debt exchange that we would view as tantamount to default.

In October 2016, PDVSA performed a distress debt exchange, which led us to lower our rating on PDVSA to 'SD' (selective default). In November, we raised the PDVSA rating to 'CCC-' with a negative outlook, reflecting S&P Global Ratings' expectation that PDVSA could default again in the first half of 2017.

The company faces US$9.5 billion external debt service in 2017. PDVSA's debt is not guaranteed by the government, and the government's debt does not have cross-default clauses connected with the debt of the national oil company.

OUTLOOK

The negative outlook reflects the heightened risk of the Venezuelan government defaulting or undertaking a distressed debt exchange due to prolonged low oil revenues, high budget deficits, rising inflation, and severe economic contraction. Failure to introduce substantial corrective measures to stabilize the economy, alleviate shortages, and strengthen public finances could further weaken the government's ability to finance itself. That, along with lower external assets and sustained political polarization, underpins our assessment that there is at least a one-in-three chance of a government debt default over the next year or two.

Steps to defuse the heightened political tensions in Venezuela would reduce the risks of eroding governability and high volatility in economic policies.

That, along with prompt, corrective reforms that begin to address the country's economic imbalances and to strengthen its external liquidity, could lead to a stabilization of the ratings at their current level.