(from my colleague Dr. Win Thin)
INTRODUCTION
Venezuela has issued the world’s first sovereign cryptocurrency. We think this is just a gimmick that cashes in on the current crypto craze, aims to circumvent existing sanctions, and avoids addressing the nation’s deep structural problems.
INVESTMENT OUTLOOK
Venezuela launched an oil-backed cryptocurrency called the petro last week. The deal was first announced in December. Details remain sketchy, but (at least for now) a petro is meant to represent a claim of some sort on Venezuelan crude oil. President Maduro has at times said that the petro is backed by the country’s oil reserves, at other times that it reflects the price of a barrel of oil. However, there is no specific mechanism in place yet.
Maduro’s comments suggest that the value of a petro should somehow be determined as a combination of oil prices and credibility of the Venezuelan government. By definition, cryptocurrencies are decentralized and not dependent on some sort of authority like a central bank or government. By issuing a cryptocurrency that’s implicitly backed by a centralized entity, Venezuela is moving into a gray area.
That this particular government has little credibility and can seemingly do no right simply compounds the problem. Last summer, the Maduro government started laying the groundwork and created the Superintendency of Cryptocurrency. A senior member of the constituent assembly was put in charge, despite having no experience with cryptocurrencies. Rather than building its own blockchain system to create the petro, officials decided to build within an existing network. However, there have been conflicting accounts as to whether its Ethereum or Nem.
The government put 38.4 mln petros on private pre-sale that runs through March 19. These will be sold with a series of increasingly smaller discounts in an effort to boost early demand. After that date, another 44 mln units will be sold in a public Initial Coin Offering (ICO). These units will also be sold with four increasingly smaller discounts for each 5 mln sold until the fifth and final tranche of 24 mln units is sold with no discount.
A total of 100 mln units will be sold, with the government reserving the remaining 17.6 mln units. Officials say that no more petros will be created unless approved by the Superintendency for Cryptocurrency. The government believes Venezuelans will eventually be able to use the petro to make payments to government institutions, including tax payments. However, it appears that petros can only be purchased with USD. This makes the use of the petro as a medium of exchange for the local economy basically impossible.
The opposition believes issuing the petro is an illegal act by Maduro. Because it appears to be a form of debt, they claim it must be approved by the legislature. The US Treasury has also weighed in. Officials have warned that the petro "would appear to be an extension of credit to the Venezuelan government" and could "expose US persons to legal risk" if they invest in the scheme.
Note that Venezuelan Economy Minister Zerpa visited Russia last week. Press reports suggest that discussions will center around the petro. This could have several angles, since 1) Russia is a creditor to Venezuela and restructured its debt last November and 2) Russia is also subject to international sanctions and may be interested in ways to circumvent them.
President Maduro said late last week that Venezuela is preparing another new cryptocurrency called “petro gold” that will be backed by the precious metal. It’s clear that Maduro and his policymakers really don’t understand what a cryptocurrency is and what it is meant to represent. If investors wanted assets backed by oil and gold, why not just buy the commodities themselves?
US sanctions remain in place for the foreseeable future. Besides targeting various individuals in the Maduro administration, the sanctions have also effectively prevented Venezuela from raising money in international markets by banning any US trading in new Venezuelan bonds. This has contributed greatly to its inability to service its external debt.
S&P moved Venezuela to Selective Default on November 13. It noted that Venezuela had “failed to make $200 mln in coupon payments for its global bonds due 2019 and 2024 within the 30-calendar-day grace period.” Fitch was next and moved Venezuela to Restricted Default on November 14. Inexplicably, Moody’s has keep its rating at Caa3 since January 2015.
Venezuela has not clarified what it plans to do with regards to its debt. While Maduro has tossed around notions of restructuring, so too has he pledged to honor the country’s obligations. The World Bank estimates Venezuela’s external debt at $113 bln at the end of 2016. To us, the issuance of petros is simply a gimmick to raise money even as sanctions choke off the economy.
Our own sovereign ratings model shows Venezuela’s implied rating at D. What will Venezuela do with the petro proceeds? Will it resume servicing its external debt when reserves are dwindling and its own citizens are facing chronic shortages of food and medicine? Or will the money be used to buy basic goods for the impoverished populace? No one except Maduro knows for sure.
POLITICAL OUTLOOK
The next presidential election will be held April 22. Recent polls suggest Maduro has only about a 31% approval rating, though this is up from 20% recorded last summer. The Treasury Department criticized the nation's all-powerful Constituent Assembly for prohibiting three major opposition parties from participating in the presidential election. Other opposition parties have announced a boycott of the election.
Ahead of that, Maduro continues his efforts to consolidate power and marginalize the opposition. Maduro and other government officials have proposed early elections for the opposition-controlled congress on the same day as the presidential vote. This would cut short a term that doesn’t expire until 2020.
Maduro held a referendum last year that led to the creation of the new 545-member Constituent Assembly. It is stacked with his supporters that include his wife and son. Note that the duly-elected (and opposition-controlled) National Assembly was already rendered toothless last year by a Supreme Court ruling.
A recent poll by the Atlantic Council identifies the main problems facing the country. Conducted between January 17-29, 29% of the respondents said food shortages, 13% said inflation, 12% said an economic crisis, 8% said personal safety, and 5% said the national government.
The business environment is deteriorating. Venezuela scores poorly in the World Bank’s Ease of Doing Business rankings (188 out of 190). The worst components are starting a business and paying taxes, while the best are getting credit and registering property. Venezuela also does poorly in Transparency International’s Corruption Perceptions Index (169 out of 180 and tied with Iraq). Does this sound like a government that investors should trust?
ECONOMIC OUTLOOK
Most official economic data are no longer being released. As such, the country’s outlook is based on little more than educated guesswork. While the current economic crisis has its roots in the oil price collapse, it has now taken on a life of its own thanks to ongoing official mismanagement.
The economy remains in deep recession. The IMF forecasts GDP will contract -6% in 2018 after an estimated -12% in 2017. This latest leg up in oil would normally point to upside risks to the growth forecasts, but the broader economic performance remains decoupled from oil prices.
Hyperinflation is in place, though no one knows exactly how bad it really is. Most of this is caused by the central bank printing money to finance the budget deficit. The IMF forecasts inflation of 2350% in 2018 from “only” 653% in 2017. Widespread price controls have done nothing but create shortages of those goods. M2 rose 1311% y/y in January and is accelerating. Until the government stops monetizing its deficit, the introduction of the petro will not address hyperinflation.
Despite buoyant oil prices, foreign reserves continue to fall. At $9.3 bln in January, they barely cover 1 month of imports and are a mere third of its stock of short-term external debt. According to Bloomberg data, the nation is facing $12.1 bln of debt servicing needs in 2018, peaking at $13.7 bln in 2019. Maduro has put Vice President El Aissami and Finance Minister Zerpa in charge of the debt negotiations with its bondholders. Both of these men are on a US sanctions list, and so most US investors are not willing to meet with them.
FX OUTLOOK
On January 30, the government announced that it would unify the two official exchange rates by dropping the Dipro and using only the Dicom. Back in February 2016, the official Dipro rate (used for imports of food and medicine) was devalued from 6.3 to 10. After the Dipro was eliminated, the central bank held a Dicom auction on February 5 and devalued the bolivar by more than 80%. That was the first Dicom FX auction since August. One USD bought 25,000 bolivars at the February auction vs. 3,345 bolivars at the last Dicom sale last August. Since then, there has been another Dicom auction that saw the bolivar weaken to 28,964. Still, even these new rates are much, much stronger than the black market rate, which is around 226,500 bolivars per USD. We have found in recent years that the black market rate is often a reliable indicator of where the exchange rate should trade.
Rather than introducing a new cryptocurrency, totally freeing up the exchange rate would be a better move. If the exchange rate could be determined by the market, some FX shortages would be alleviated. Yes, there would be inflationary consequences but Venezuela is already experiencing hyperinflation. Other painful measures would have to be taken, but how could it be any worse than the current situation?
The longer the crisis goes on, the more likely that some sort of shock therapy is needed. That’s what Argentina chose when it introduced a currency board. But that requires technocratic expertise and a willingness to put faith in market mechanisms. That won’t happen under Maduro. Until we see a regime change in Venezuela that opens the door to market reforms, we doubt it can follow Argentina’s lead under President Macri.