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As Venezuela implodes, bondholders begin legal wrangling

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As Venezuela implodes, bondholders begin legal wrangling

If the closing weeks of 2018 are any indication, Venezuela could be facing the prospect of a near-complete economic and political collapse in the new year.

After halting payments on nearly all its bonds over the past year, creditors are now starting to circle. A group of investors this week reportedly demanded repayment on a $1.5 billion bond, while a small firm in Florida has filed a $34 million lawsuit against the country. The move likely will spur other creditors to follow.

"There are many more billions of dollars in judgments coming down the pipe," Russ Dallen, a partner at investment firm Caracas Capital, said in an interview. The problem is that with an "incredibly shrinking pie of oil, there is not enough to pay all these debts and feed your population."

OPEC data shows the country's oil production, which still represents more than 90% of total export earnings, tanking. Output averaged 1.17 million barrels per day in October, compared to nearly 2.35 million in 2013, and is expected to fall well below 1 million barrels next year. Venezuelan refineries, meanwhile, are believed to be operating at just 25% capacity. Internal documents suggest the country does not have enough resources to meet its own domestic fuel demand, forcing state-run oil firm PDVSA to import crude this year through swaps.

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Experts say the economic situation will only get exponentially worse in 2019. While Venezuela's real GDP contracted by an estimated 15.4% in 2018, the coming year could see a far more severe decline. The Economist Intelligence Unit expects nominal GDP to plummet by about 76.8% to just $69.42 billion. The country's unemployment rate is seen rising past 38% next year, while the state of hyperinflation could explode by a factor of 10.

Although the socialist administration of President Nicolás Maduro launched a range of measures earlier this year to combat the economy's freefall, those initiatives have largely fallen short. In August, the government removed five zeros from the local currency and renamed it the bolivar soberano, or "sovereign bolivar," tying it to the state-backed petro cryptocurrency in the process.

But as the government continued printing more money amid difficulties in obtaining fresh credit, the new sovereign bolivar did not fare any better than its predecessor and has depreciated significantly since its introduction and inflation has spiraled further out of control. The country's central bank stopped publishing economic indicators roughly three years ago, but according to IMF estimates, Venezuela's inflation rate will exceed 1,000,000% this year and in 2019 will skyrocket to 10,000,000%.

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With the severe economic deterioration, Venezuela's reserves have dwindled dramatically. Foreign currency reserves, which stood at $7.46 billion in 2014, will end at $1.17 billion in 2018 and drop to just over $500 million next year, according to estimates from the Economist Intelligence Unit.

In comparison, the country has built up roughly $8 billion in owed interest and principal since it halted its bond payments, according to Reuters.

The country is now in a desperate search for funds. It recently managed to garner a $500 million credit line from Banco De Desarrollo De América Latina, the Latin American development bank, in order to "mitigate risks" and contribute to "regional economic stability." However, the loan was strongly opposed by some of the multilateral lender's member countries, including Argentina, Colombia and Brazil, and reportedly only squeaked through after some countries were convinced to abstain instead of actively voting against it.

The Venezuelan government reportedly is also eyeing the repatriation of $550 million in gold from the Bank of England and is seeking financial support from Russia.

Venezuela is "turning over every stone" in its search for cash, Hans Humes, the CEO of New York-based investment adviser Greylock Capital, said in an interview. But the "current situation is unsustainable," he added.

Bondholders strike

As result, Humes, who is a member of one Venezuelan bondholder committee, said that investors holding billions of dollars in defaulted Venezuelan debt, and those impacted by Venezuelan expropriation, are now looking to target any valuable assets they can find in order to recoup their investments. The creditors are considering launching a "coordinated action," he said.

"There is going to be international competition for those assets," the executive added, noting that Chinese and Russian creditors already "are moving to lock some of them down."

With the country in dire straits, investor litigation aimed at chasing down Venezuelan assets will prove to be "a torturous process," Mitu Gulati, a debt restructuring specialist and professor at Duke University, said.

"They have one asset (oil), which has to be sold overseas to get income, which means it is highly vulnerable," Gulati said.

Even as its economy disintegrates, Venezuela continues to sit on a massive and valuable oil reserve — the world's largest according to the U.S. Energy Information Administration — estimated to be worth up to US$800 billion at current prices.

"In the long run, you have a liquidity crisis but you don't have a solvency crisis, because Venezuela has enough wealth under the ground to pay off all this debt," Dallen of Caracas Capital said,

However, Venezuela's deteriorated infrastructure would need an investment of $10 billion or more to be capable of extracting the resource, he noted. With the country's current financial situation, combined with U.S. sanctions against Maduro's social dictatorship, such an investment likely will remain out reach under the current government.

"Your best hope, as an investor, is regime change," Dallen said. "If there is, it will be like the Gold Rush was in the 1800s in America."

PDVSA and Venezuela's economic ministry did not respond to S&P Global Market Intelligence's requests for comment.

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