End Of Petrocaribe Would Elevate Systemic Risk
BMI View: Caribbean economies are highly vulnerable to a sharp spike in energy import costs as Venezuela is beginning to signal its growing discontent with supplying much of the region with subsidised oil. In the event that a dismantling of the Petrocaribe programme by the Venezuelan government occurs, already weak external positions would be further exacerbated and the risks of a number of balance of payments crises across the region would rise.
The Venezuelan government's unilateral decision to alter the terms of its Petrocaribe programme, through which it provides subsidised oil shipments to member states in the Caribbean and Central America, marks a shift in policy by Caracas and could pave the way towards the full dismantling of the preferential terms offered by Venezuela to its regional neighbours. Such a prospect poses substantial macroeconomic risks to the wider region, with Caribbean member states being particularly vulnerable to a sharp increase in import costs and could ultimately default on outstanding oil loans . Moreover, higher oil import prices would lead to a substantial increase in domestic prices and undermine already fragile economic outlooks across much of the region. In the absence of an alternative source of subsidised fuel supplies, therefore, we believe that most of the region will be negatively affected should the Petrocaribe programme be dismantled over the coming years.
We have previously flagged up the likelihood of further credit events in the region, in light of poor macroeconomic outlooks and widely unsustainable balance of payments dynamics ( see 'Additional Credit Events Only A Question Of Time', June 4 ). Moreover, with policy options firmly limited, we note that existing exchange rate regimes, many of which entail a de facto currency peg to the US dollar, could also come into question ( see Rising Risks To Exchange Rate Regimes', June 28 ). Against this backdrop, we would view an end to both discounted oil shipments and extended repayment periods at low interest rates , as particularly alarming, highlighting that rising oil import costs could serve as a catalyst for a series of balance of payments crises in the region .
|Will Venezuela Turn Its Back On The Region?|
|Map of Petrocaribe Member States|
E ven if the Petrocaribe arrangement were to remain in place in its current form over the coming years, the possibility of exchange rate devalu ations in the Caribbean could impede member states' ability to continue paying for oil imports, especially with interest rates on deferred payments already climbing higher. This would particularly affect those Petrocaribe members with fixed exchange rates, such as Antigua and Barbuda, Bahamas, Cuba, Dominica, Grenada, St Kitts and Nevis, Saint Lucia, St Vincent and the Grenadines, and Suriname. As we have previously highlighted, however, foreign reserve positions remain sufficiently robust for the time being, to minimise such a risk , with the median foreign reserve import cover in the Caribbean above 4.0 months in 2012. This is not to say that if a dismantling of Petrocaribe were to occur prior to any exchange rate devaluations - resulting in a sudden spike in oil import costs - this could not lead to a rapid draw-down in foreign reserves and increasingly undermine central banks' ability to defend exchange rate pegs.
Early Indications Of Things To Come?
Venezuelan state oil firm Petróleos de Venezuela SA (PdVSA) has recently signalled that it is looking to alter the terms of the preferential treatment it gives to Petrocaribe members. There have been recent ind ications from several Petrocaribe recipients that PdVSA doubled the interest it charges on oil loans (from 1.0% to 2.0%) and increased interest on social programme funding from 2.0% to between 4.0% and 6.0%. This comes on the back of PdVSA 's own deteriorating financial position, which has suffered as a result of chronic underinvestment and offering 25-year oil loan terms at very low interest rates , with upfront payments usually accounting for just 5-25% of the total import bill .
|Highly Vulnerable To Changing Terms Under Petrocaribe|
|Caribbean - Exposure To Higher Fuel Import Costs|
Facing its own large external imbalances, limited access to foreign currency and ongoing goods shortages, Venezuela's policy of subsidising Caribbean and Central American fuel imports under the banner of the Bolivarian revolution, propagated by late Venezuelan former president Hugo Chávez, is coming at an increasingly high economic cost for the country. With growing indications that Petrocaribe members' ability to honour oil loan payments could weaken further, this is likely to increasingly test the Venezuelan government's resolve to maintain the current programme. Our Oil & Gas team believes that following this seemingly first step in a larger policy shift by PdVSA, further changes to the Petrocaribe agreement over the course of H213 and throughout 2014 could act as an important litmus test for whether the programme will be dismantled altogether ( see 'Ending Petrocaribe Will Not End PdVSA's Woes', July 29).
|Hooked On Cheap Oil|
|Petrocaribe - Daily Oil Import Quota, % of Daily Oil Consumption|
Substantial Implications For Sovereign Risk
One key conclusion to draw in the event t hat Petrocaribe is discontinued is that sovereign risk in the Caribbean would rise more than what we are already factoring into our forecast scenarios . Indeed , recent reports suggest that the Dominican Republic owes more than US$3.0bn in debt to Venezuela as part of Petrocaribe, dating back to 2005, when the programme was initially launched. There is good reason to believe that these vast sums of unpaid loan are increasingly unlikely to ever be repaid in full.
|Oil Dependence On The Rise|
|Caribbean - Fuel Import Value, % of Total Goods Imports (CIF)|
This will have far-reaching implications for countries' creditworthiness, undermining both the ability of a sovereign to pay down debt and honour interest payments, as well as hurting the pe rceived willingness to pay debt. This is likely to exacerbate already difficult debt dynamics in much of the region. Jamaica's government estimates that the removal of Petrocaribe would see a US$600mn increase in the country's already large current account deficit, which measured 11.4% of GDP in 2012. Although a formal arrangement with the IMF and ongoing debt restructuring talks reduce the risk of a more pronounced balance of payments correction for Jamaica, our back-of-the-envelope calculations suggests that based on government figures, Jamaica's current account deficit would likely reach 14.2% and 12.2% of GDP in 2013 and 2014 respectively, in the event of an immediate discontinuation of the Petrocaribe programme. Barring this, however, we still forecast the current account deficit to narrow to 8.7% of GDP in 2014.
|A Potential Game Changer|
|Jamaica - Current Account Balance|
Everyone Is At Risk
Although smaller island economies with large current account deficits and a high fuel import-to-total imports ratio - for example Grenada - are arguably most vulnerable to a discontinuation of subsidised oil imports, we believe that all Petrocaribe members are on the hook for painful balance of payments adjustments if the Venezuelan government continues to change the terms of the Petrocaribe programme, or altogether dismantles the initiative in its entirety. While Cuba maintains a current account surplus, it is by far the most dependent on cheap oil imports from Venezuela, receiving the highest daily quota (98,000 b/d according to Petrocaribe), and has the biggest fuel imports dependency ratio in the region (fuel imports accounted for 45.6% of total imports in 2012). Meanwhile, although St Vincent and the Grenadines is considerably less dependent on fuel imports relative to Grenada, Jamaica, Antigua and Barbuda, and Cuba, it has among the largest current account deficits in the entire region, measuring 26.5% of GDP in 2012, only exceeded by Grenada at 26.7% of GDP last year - the latter is already in the process of ongoing debt restructuring talks, with the risk of a disorderly default still looming large ( see 'Significant Roadblocks To Debt Restructuring', May 28).
|Note: *2011 figures, **2012 figures (incl. BMI estimates); Source: BMI, Petrocaribe, Respective central banks|
|Supply Quota ('000 b/d)||Oil Consumption* ('000 b/d)||Member Since||Mineral Fuel Imports (% of Total Imports)**||Current Account (% of GDP)**|
|Antigua and Barbuda||4.4||4.0||2005||36.8||-8.0|
|St Kitts and Nevis||1.2||1.8||2005||2.8||-11.4|
|St Vincent and the Grenadines||1.0||1.5||2005||21.0||-26.5|