Venezuela:
Revisiting the economy
By
The
Devil's Excrement
I have been meaning to write about the economy, but between
work, travel and the recent events, it has been hard to sit
down and do it. The Venezuelan economy continues to be dominated
by the distortions that I have described before, except that
they are much worse than they were last time I wrote a long
article about it. In September of last year, economic variables
looked much better than they do today. International Reserves
were higher, the deficit was lower, inflation was lower, monetary
liquidity was lower, the parallel rate was lower and Venezuela
had a healthy balance of payments pictures. Thus, the economic
outlook has deteriorated, but the authorities continue to act
as if there was no problem In fact, the new Minister of Finance
Rodrigo Cabezas, insists that what is needed is a policy of
increasing Government spending in order to maintain growth,
but it is precisely the high growth of Government spending,
which has been the primary driver in the creation of these
distortions. Spending has grown by 25% in real terms for the
last two years, which is simply unsustainable and this has
created a wide variety of distortions in the economy, which
will sooner or later lead to a financial crisis of such proportions,
that it will take years to overcome it.
While
the Government hailed the growth in first quarter GDP, which
came at 8% over the same quarter of 2007, the numbers
are less pretty than they may look at first sight. First, while
the non-oil economy grew at a 10.6% clip, fueled by high Government
spending, the non-oil economy dropped 5.6% due to lower oil
production. Within non-oil sectors, those that grew were propelled
by Government spending and high monetary liquidity with the
commerce, construction and financial sectors growing by over
20% and more worrisome 9 of the 12 showed slower growth. Unfortunately,
we don't know much about the agricultural sector, as it is
no longer reported by the Central Bank (funny, no?) individually,
but grouped with "others".
But it was the balance of payments numbers that looked worrisome,
which showed a deficit of US$ 5.21 billion, down from a surplus
a year earlier. The current account surplus, which has been
running positive in Venezuela and the rest of Latin America
thanks to the commodities boom, was only US$ 3.6 billion down
47.7% from the same period in 2006. This was the result of
the drop in oil exports, but also due to the high levels of
imports during the first quarter. Imports were US$ 9.1 billion,
a huge number for what is typically the slowest quarter for
imports in the year and up 47$ over the first quarter 2006.
To put the deficit in the balance of payments in perspective,
it is the largest of the last ten years, at a time when oil
income is booming. What this means is that once again, the
economy is being run on the back of the oil cycle and it is
simply oil income which is providing growth, while internal
variables continue to deteriorate. Nothing new on the mishandling
of the Venezuelan economy, all previous recent crisis in '82,
'89, '94 and '02 were not that different. What is probably
different this time around is that the huge imports are destroying
both agricultural and industrial capacity, as local inflation
and fear of controls have limited investment and made local
production less competitive.
In the end, the balance of payment numbers indicate that devaluation
is looming in the horizon, no matter what the Government says.
Unfortunately, the more it is postponed, the larger it will
be and the bigger the crisis facing the country as these adjustments
always lead to a contraction of the economy and it takes time
for people to recuperate their purchasing power and for the
economy to settle.
Then, the Ministry of Finance just published expenditures
for the first quarter and during those months, the Government
spent US$ 15.2 billion and the deficit was US$ 3.8 billion
an remarkable clip for what is typically the slowest quarter
of the year. What is worse is that since then, the Government
has cut the VAT, will cut it again on July 1st. and will have
to budget some US$ 3 billion for the salary increase for public
workers announced on May 1st. Thus, the revenue/expenses pictures
will simply get worse.
The problem is that this time around there may be too many
distortions in the system to make the adjustment a normal one.
First of all, interest rates are deeply negative, which encourages
people to spend and go into debt, creating a potential time
bomb for the financial system. But even worse, in previous
crisis, the Government had some way of making and adjustment
but this time around, it has little room for maneuver:
Inflation:
May inflation just came in and the rate continues to accelerate.
CPI was 1.7% for May, giving an accumulated
value of 5.9% for the year, ahead of 2006, but this includes
a fairly artificial lowering of the inflation rate, because
the Government simply cut the Value Added Tax rate in March,
which gave the rate a one time kick down which has nothing
to do with fundamentals. Even more worrisome, food inflation
is 29.6% and that does not take into account the fact that
30% of the items under control can't even be found in the markets,
so the price remains "constant" according to the
Central Bank's methodology.
Inflation is not going down, because of the excess monetary
liquidity and the lower offer of goods as noted in the first
quarter report by the Central Bank. Simply put: Too much money
chasing for too few goods. There is little encouragement to
manufacture, if you can import the same product, get controlled
dollars and make the same profit at the end. That is why the
commerce sector is the best one to be in.
But even worse, such high level of inflation is what makes
the decision to devalue so difficult: Imagine adding fuel to
the fire, adding 20% devaluation to the currency. It would
be terrible for everyone, but would hurt the poor the most.
Unfortunately it is simply inevitable unless oil prices were
suddenly to jump up.
International
Reserves: International Reserves are currently at US$ 24.4
billion, an incredibly low level, given the strength
in oil prices. This is the result of removing the so called "excess" reserves
for the development fund Fonden, together with trying to fight
the high monetary liquidity using a PDVSA bond and buying the
CANTV and Electricidad de Caracas shares. We are told repeatedly
that this should be of no concern, as the Government has lots
of money in the development funds, but I do not expect them
to return these to the international reserves and in any case,
Fonden has already committed all but US$ 9.7 billion of its
funds, so the day they are needed they may not be there after
all.
While the Minister of Finance has said that he expects reserves
to recover near US$ 30 billion by the end of the year, even
if true, it will not help much given that monetary liquidity
is expected to increase by another 45% by year's end. And is
this huge growth in monetary liquidity that has been pressuring
the currency via the parallel market and the dropping reserves
have also begun to unnerve foreign investors. It is the typical
mismanagement of the oil cycle, where the Government feels
invulnerable to any setback in the oil markets, but it is more
vulnerable than ever.
Monetary Liquidity: The Government seemed to finally realize
that the huge growth in monetary liquidity last year was pressuring
the parallel market, which in turn was pressuring inflation.
Thus, it decided to do something and issued first Bono del
SUR II, and later US$ 7.5 billion in PDVSA bonds, a staggering
amount for a private issue. The theory was that this US$ 9
billion (There was US$ 750 million in a dollar linked bond
in local currency in the Bono del Sur) would push the parallel
rate lower, by increasing dollar supply to the market and reducing
monetary liquidity. The problem is that despite this huge issuance,
monetary liquidity is only US$ 3 billion below its peak and
pressures have not been reduced. And guess what? After an initial
psychological drop the parallel rate is above Bs. 4,000 once
again and not the Bs. 3,000 that Government experts had predicted.
As we describe below, this becomes worse going forward, as
the amount of issuance in the next few months is limited by
the announced withdrawal from the IMF as well as the fact that
the PDVSA bonds are still being digested by the market.
Parallel Rate: The parallel rate, which was at Bs. 2,700 last
September shot up near Bs. 4.500 early in the year, dropped
to Bs. 3,500 when the PDVSA bond was issued, but the impact
was only psychological and the price is now near Bs. 4,100.
And it seems extremely unlikely to drop at this time. There
are three factors that influence this market. Monetary liquidity,
psychology and Government intervention. Monetary liquidity
is excessive and unlikely to drop, psychology is very negative
as people worry about Government threats to the private sector
and dropping reserves and recent issuance shows that Government
intervention only has a very brief and temporary effect. Thus,
you can expect the parallel rate to simply drift lower between
now and the end of the year. And this, in turn, will continue
to pressure inflation.
Another problem with the parallel rate shooting up is that
arbitrage opportunities become more attractive. When the difference
between the official rate of Bs. 2,150 to the US$ and the parallel
rate was Bs. 400, the difference was not too significant for
people to find ways to play it. But today, with the parallel
rate at Bs. 4,100, the difference is almost 100% and it is
too interesting to pass up. First of all, everyone that can
do it takes advantage of requesting Internet dollars, which
everyone is entitled to US$ 3,500, at the official rate. I
have heard of the existence of outfits that go around buying
the Internet allocations for those that do not have the Bs.
To do it and even the credit card to do it. This seems to be
more widespread, as one hears about it more and more.
Then there is travel. After two and half years of fixed exchange
rate and significant inflation, buying airline tickets at the
official rate of Bs. 2,150 to the US$ is one of the best deals
in town, much like cars subsidized at that rate are such a
bargain. Thus people are traveling more and more and taking
advantage of the US$ 5,400 per person everyone is entitled
to. (Of course, only the well to do can afford it!)
Then there is the fact that if you get official dollars for
whatever you sell or make, with the inflation rate running
at 20%, people are actually borrowing to import products and
raw materials and bringing two to three years of stock at the
favorable official exchange rate.
And then there is of course, corruption.
Sovereign bonds: For the last three years the Venezuelan Government
has used the issuance of dollar denominated bond in local currency
as a way of relieving some of the pressures in the economy.
The strategy worked for a while, but as shown by the issuance
of the PDVSA bond, the impact of these issues is not what it
used to be due the huge growth in monetary liquidity. But now,
with the decision to withdraw from the IMF, the Government
ahs complicated matters by announcing a measure which most
international analysts find illogical due to its consequences.
Basically, Chavez himself made this decision and it was clear
that the full consequences were not known to him or his collaborators.
The main problem is that all of Venezuela's debt was issued
with conditions among which was one which if this happened,
25% of the holders of each bond issued by the country could
get together and ask for the acceleration, the early payment
of the bond.
Obviously, if the bond is above 100, you have no interest
in doing this, but if it is below 100, you can make some money
by voting to accelerate. As the Government keeps saying that
it will withdraw, investors have been buying bonds below 100
and going short those above 100. Essentially when you go short,
you borrow the bond from someone else and sell it, in the belief
that it will go down and you can buy it at a lower price later.
Combine this with lower reserves, deteriorating balance of
payments and there has been an important sell off of Venezuelan
bonds in the last two months. On top of that, many investors
have been selling Venezuelan bonds to purchase PDVSA ones,
because they have a higher yield and because PDVSA owns CITGO,
which is worth more than the amount of bonds outstanding of
PDVSA and thus CITGO represents a guarantee if the company
ever decided to stop making payments.
This sell off and volatility in the country's bonds limit
the ability of the country to place new debt, so, for the time
being at least, the main strategy used by the Government in
the past to reduce the distortions in the economy, will not
be available. Even if it were, the large PDVSA issue and the
small impact it had on monetary liquidity and the parallel
rate, demonstrates that the Government is running out of tools
to control the economy.
It
is somewhat ironic that by threatening to withdraw from the
multilateral
agencies, the Chávez Government has
exchanged institutions that do show some degree of solidarity
with countries, for the biggest investors and speculators on
the planet, who are the primary investors in the country's
debt. These investors could care less about Venezuela and are
always looking to make an extra amount using a variety of complex
strategies.
At the current clip, there is only so much longer that the
country can continue to spend, create monetary liquidity without
something yielding and creating a crisis. The obvious solution
would be to slow the spending rate, but it is clear that this
is not being contemplated. Unfortunately, the longer this continues
without any adjustment, the bigger the crisis that will take
place in the end. There is, of course, the perverse obvious
solution, which is simply to devalue. When this type of adjustment
comes, it will be the average Venezuelan that will be hit,
inflation will accelerate, consumer loans will default, imports
will become very expensive helping local industry temporarily,
but given the distortions the adjustment may have to be so
large, that its consequences may be simply unpredictable.
The Devil's Excrement is a most interesting Venezuelan news
blog (http://blogs.salon.com/0001330/). Petroleumworld
not necessarily share these views.
Editor's
Note: This commentary was originally published by The Devil's
Excrement, June
8th, 2007 Petroleumworld reprint
this article in the interest of our readers.
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