Andres Schipani: Venezuela: to act
or not to act, that is the question
One could talk about Venezuela's economic policy in Shakespearean terms. To devalue or not to devalue; to converge foreign exchange rates or not to converge; to raise the price of the world's cheapest gasoline or not to raise; to sell Citgo or not to do sell; to default or not to do so – these are the questions.
The distortions created by the government's foreign exchange and price controls – covering even Barbie dolls – keep playing a treacherous role in Venezuela's unfolding tragedy. Why is this happening instead of not happening? To some analysts, that is the question.
In a report this week, Francisco Rodríguez , senior Andean economist at Bank of America Merrill Lynch, outlined a few theories:
1) The predatory state hypothesis:
. . . the delay of internal adjustments is that it benefits the rent-seeking groups that control the allocation of scarce dollars and imported goods. Since these groups can reap benefits only for as long as they enjoy privileged access to foreign exchange, they will be the first ones to block any policy action (eg, devaluation) that erodes these rents. In other words, the rents from restricted access to foreign exchange are the cost that the government pays to maintain the support of key interest groups.
2) The policy mistake hypothesis:
. . . the choice of policies reflects a genuine policy mistake . . . The Maduro administration decided to carry out this adjustment via quantitative restrictions (restricting dollar sales) rather than via price adjustments (devaluation). The government thought that it could cover the fiscal cost of this strategy through financial repression and deficit monetization. In other words, the government underestimated the inflationary effects of printing money and overestimated its institutional capacity to enforce price controls.
3) The disorganisation view:
Two salient characteristics of the Maduro administration have been the high level of turnover of key executive positions and the frequent creation of new ministries, vice-ministries and government agencies . . . High turnover and large cabinet size are detrimental to state capacity. A state whose structure and members are continually changing does not generate incentives for these to frame stable policies. Policymakers lose capacity for coordination and respond much more to short-term incentives . . .
For Rodríguez, who subscribes to the final view, the problem is that messy states such as Venezuela, lose the ability to process and tackle complex problems – they “lose bandwidth”.
Since taking office last year the former bus driver, Nicolás Maduro, has struggled to coalesce the factions within his party , a squabbling that has produced a state of permanent crisis, even as Venezuela sinks deeper into the economic despair bequeathed by Hugo Chávez.
That may have led to unanswered calls to adjust via a devaluation, which some economists believe would help. Instead, against the backdrop of a hard currency crunch, the government has slashed imports, racking up billions of dollars in arrears. This has produced shortages of basic goods in the import-dependent nation.
Scarcity, long queues, and the introduction of fingerprint scanners at supermarkets , are all factors eroding the popularity of President Maduro, alongside others such as galloping inflation , as a byproduct of heavy money printing.
The World Bank forecasts the economy will contract 2.9 per cent this year. Sliding crude prices are another test of Venezuela's resilience, leading to even more uncertainity and likely worsening an economic situation in the oil-dependent country.
So the government is trapped in a vortex, which should be particularly worrying for the ruling socialist party ahead of parliamentary elections next year.
In the face of such mismanagement, some observers wonder if the administration will attempt to exercise a tighter grip or deliver populist policies, or both.
Why is all this relevant for investors? Because – although some analysts, including Rodríguez, believe a default is a bad call – Venezuelan debt keeps offering what an observer called “pornographic yields” of above 15 per cent.
As bondholders keep questioning the government's ability to continue servicing its foreign debt, they should also question the ability of a “low-bandwidth government” to make the right choices. For Rodríguez:
. . . low state capacity introduces a significant risk for bondholders. Much of the recent discussion regarding the likelihood of a Venezuelan default has highlighted that defaulting would be a mistake for Venezuela, given the high costs and limited benefits to the Venezuelan government. It has not shown that the Venezuelan government can be counted on not to make that mistake.
Essentially, to be capable or not to be capable – that is the question.
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