Fitch Ratings today upgraded the long-term foreign currency and long-term local currency ratings of the Bolivarian Republic of Venezuela to 'BB-' from 'B+'. At the same time, Fitch upgraded the country ceiling to 'BB-'. The short-term foreign currency rating is affirmed at 'B', and the Outlook is Stable.
'The upgrade reflects significant improvements in external debt and liquidity ratios because of windfall oil export receipts, leaving them significantly better than peer 'BB' levels,' said Morgan Harting, Senior Director and lead sovereign Fitch analyst for Venezuela. Official reserves and bank foreign assets now represent about 208% of next year's debt service plus the stock of short-term external debt, compared with the 'BB' median of 133%. The public sector is expected to end the year as a net external creditor, one of only four such sovereigns in the speculative category to do so, together with India (long-term foreign currency rated 'BB+' by Fitch), Azerbaijan (long-term foreign currency rated 'BB' by Fitch) and Lebanon (long-term foreign currency rated 'B-' by Fitch). Fitch assumes broadly stable oil production rates going forward, but substantial reductions in output could put pressure on the credit.
Above-average oil prices have clearly underpinned the improvement in external indicators, a trend Fitch does not expect to be sustained beyond 2006. Lower prices assumed in Fitch's base case for 2007 will bring external liquidity ratios for the following year closer in line with 'BB' peers, but even in the event of a significantly larger price decline, liquidity would still be expected to remain near the peer median, and net public external debt would hold well below peers for the next two years.
Public finances would suffer in the event of an oil price decline, but as in the past, financing needs would likely be contained by an adjustment in the official exchange rate. This has the effect of reducing expenditures in U.S. dollar terms to limit expansion of the fiscal deficit. The overall public sector has also accumulated substantial assets in the past two years, some portion of which would presumably be available for central government financing. Fitch estimates that the various funds managed by the public sector may have accumulated as much as US$26 billion in assets over this period, although reporting is not adequate to verify the figure, and there is no certainty that such assets would be fully available for debt service. In the event that oil prices remain favorable, Fitch expects that some portion of these assets will be used to retire existing public sector debt.
Harting cautions that, 'Should oil prices decline by 2007, as Fitch expects, the economy is likely to fall into a recession because an offsetting increase in oil production volumes is not anticipated and because the non-oil sector is poorly positioned to compensate for lost oil revenues.' Capital account outflows would likely accelerate in this scenario, and the fiscal deficit would widen because it will be politically difficult to reduce spending commensurately with lost revenues, even allowing for some fiscal benefit from devaluation. As government outlays are curtailed, political tensions would likely rise. The expectation of this scenario notwithstanding, Venezuela's ability to service debt over the rating horizon appears consistent with other 'BB' sovereigns.'
Venezuela's creditworthiness could improve if credible policies were implemented to reduce its vulnerability to oil price fluctuations. Reviving a rules-based stabilization mechanism to smooth the effect of oil price volatility on public finances and the balance of payments would be beneficial. Steps to reduce state intervention in the economy to improve the private sector's ability to absorb shocks are also important. Repayment of public debt is anticipated in the current rating assessment, but an even faster deleveraging process would support creditworthiness. As for potential sources of downward pressure on the credit, oil price declines are central to most such scenarios. Price declines within historical ranges need not harm Venezuela's credit standing per se, rather, the policy response to such an event will be critical. It will be important to monitor how quickly public finances adjust to lower revenues and how the adjustment is achieved. Responses that emphasize targeted spending reductions rather than blunt adjustment to real spending levels through inflation would be more supportive of economic growth and fiscal sustainability. Fitch is also monitoring a trend of increased interference in private contracts and property rights out of concern that it could spill over into attempts to alter terms of government debt agreements, too.