Risk drivers and outlook

  • On October 7 2012, President Hugo Chavez won a fourth consecutive term, paving the way for continuity in terms of policy: high state interventionism and deepening of the Bolivarian Socialist model;
  • Economy is increasingly reliant on oil revenues and growth prospects remain sluggish amid high inflation as well as energy and input shortages;
  • Tight exchange controls are not sufficient to control capital flight. As a result, foreign exchange  reserves are depleting despite positive current account balance. As a consequence, the government is likely to devaluate the Bolivar, the domestic currency, in the coming months;
  • Endemic corruption and arbitrary state interventions characterize the business climate;
  • High MLT political risk still mitigated by moderate level of external debt and extensive oil reserves.

Facts & figures

Pros

  • Significant oil reserves
  • Moderate external debt and debt service

Cons

  • Uncertainty surrounding Chavez’ health and succession
  • Economy is highly reliant on oil
  • Price and foreign exchange controls
  • Endemic corruption, arbitrary state interventions, lack of transparency and high risk of devaluation

Main export products

  • Petroleum (91.1% of current account receipts), factor income (2.1%), manufactured goods (4%) and ores and metals (1.8%)

Income group

  • Upper middle income

Per capita Income (USD)

  • 11590 USD

Population

  • 28.4 mn

Description of electoral system

  • presidential: 6-year term; last election: 7 October 2012;
  • legislative: 5-year term; last election: 26 September 2010

Head of the State and the government

  • Hugo Chavez (since 1999)

Country risk assessment

President Chavez won a fourth consecutive term

On 7 October 2012, Hugo Chavez won a fourth consecutive term by a large margin despite the vigorous opposition campaign. After all, in contrast with the past elections, the heterogeneous opposition was united and presented a single candidate, Mr Capriles, the 40-year old former governor of the most populous state Miranda. Mr Capriles soon admitted defeat, limiting the potential risk of social unrest in a country characterized by high political polarization. The main challenge for the opposition is the upcoming governorship election of December 2012.

President Hugo Chavez took power in 1999 and gradually concentrated the power in his hands by amending the constitution, controlling the armed forces and the judiciary and interfering into the economy. Hugo Chavez has gradually taken steps to transform the Venezuelan economy to match his vision of “21st-century socialism”, which means he has increased government intervention in the economy, eroded private property rights and nationalized companies in various sectors (oil, steel, telecom, electricity, financial, food and construction sectors). Thanks to his social programs, poverty rate has sharply decreased from 48.7% in 1999 to 28.5% in 2009. No major policy changes are expected. As a consequence, state intervention in the economy is likely to increase further.

President Chavez underwent treatment for cancer - the exact nature and the extent of his illness have not been made public – in June 2011 and February 2012. He claimed to have recovered fully, yet doubt remains whether he will be fit for a fourth term. Hence, uncertainty surrounding Mr Chavez’s succession continues due to internal division within the ruling party (PSUV) between moderate socialism and Cuban-style socialism. If Mr Chavez dies in the first four years of his term, an election will be called according to the constitution. If it occurs in the last two years of the presidential term, the vice president will take over. It is Nicolas Maduro, a moderate close ally of Mr Chavez, who has been appointed vice president, therefore being a potential successor to Mr Chavez if he accepts to delegate more power to his vice president.

Foreign policy is characterized by anti-Americanism, even if both countries have so far been pragmatic when it comes to business, particularly with regard to the supply of Venezuelan oil to the US. Nevertheless, to offset US global dominance and to create a multi-polar world, Chavez has deliberately intensified relations with so-called pariah nations such as Libya, Syria and Iran, a strategy which has, of course, not been well received by the United States.

Venezuela joined the Mercosur trade bloc in July 2012, which was a diplomatic and political victory for Chavez. Since 2006 the country has sought to join Mercosur but, despite the approval of the parliaments of Argentina, Brazil and Uruguay, Venezuela’s accession was blocked by the Paraguayan senate.

Growth likely to decelerate in 2013 after strong growth in 2012

GDP rebounded in 2011, after contracting by 3.2% in 2009 and 1.5% in 2010. GDP growth is likely to reach 5% in 2012 on the back of fiscal spending ahead of the presidential election and the high oil prices. Growth will be disappointing in 2013 as it is still hamstrung by exchange and price controls, energy and input shortages, rampant corruption and arbitrary state interventions.

Despite strong growth, inflation moderates somewhat in 2012 to 20.4% compared to 27.6% in 2011 as the government introduced in July 2011 further price controls by adopting a “Law of Costs and Prices”, which authorises the government to establish the “fair” price of basic goods and services. In case of non-compliance, the government is authorised to impose fines, sanctions and even nationalize  businesses. As a consequence of price regulation, shortages of basic products such as pharmaceuticals are reported. In 2013, in the wake of currency devaluation, inflation is likely to surge and reach 40% by the end of the year.

Venezuela_Graph1EN

Venezuela_Graph2EN

Current account surplus maintained thanks to controls

Reliance on oil as a source of foreign exchange is high and has increased from 68.7% in 1999 to 91.1% of current account receipts in 2011. The performance of the non-oil sector is weak, owing to the overvaluation of the Bolivar, the domestic currency, and the uncompetitive manufacturing sector that represents a mere 4% of current account receipts. Despite the poorly performing non-oil sector and increasing reliance on imports for food and other basic needs, the current account surplus has been maintained as imports have grown more slowly than exports due to foreign exchange controls imposed in 2003, when the government put in place the CADIVI (Comision de Administracion de Divisas), an administration that grants authorization for releasing foreign exchange at a preferred exchange rate.

High risk of devaluation in 2013

In 2005, the Bolivar (VEB) was pegged at 2.15 per US dollar. The official fixed exchange rate could only be obtained through the CADIVI. A parallel legal FX market that supplied hard currency at a higher rate had emerged. In 2010, Hugo Chavez devalued the Bolivar to 2.6 per US dollar for imports of ’priority’ goods such as food and medicine and to 4.3 per US dollar for ’non-essential’ products. In addition, the government shut down the parallel FX market and created a new system: the SITME (Sistema de Transacciones con Titulos en Moneda Extranjera), which is monitored by the central bank and provides hard currency under very strict conditions at a floating exchange rate (5.3 VEB per USD in October 2012). Late December 2010, the government decided to further devaluate the Bolivar by abolishing the dual exchange rate system, fixing the exchange rate at 4.3 Bolivar per USD for all goods through the CADIVI.  In coming months, Hugo Chavez is likely to carry out a major devaluation as foreign exchange reserves are depleting (as shown by the graph). Moreover, tighter foreign exchange controls are likely to be  imposed to protect foreign exchange reserves.

High liquidity risk amid low level of foreign exchange reserves

The level of foreign exchange reserves has fallen sharply despite high oil prices and exchange controls. The level of reserves nearly reached a decade low in May 2012. The depletion of reserves is due to high private capital outflows (capital flight) and the transfer of “exceeding” foreign exchange reserves to the development fund FONDEN. As a result, the foreign exchange reserves covered only 0.9 months of imports in July 2012, which is extremely low compared to international standards and the historical level of Venezuela’s foreign exchange reserves.

PDVSA: key source of funding for the government

Since Chavez came to power in 1999, Venezuela’s oil production has gradually decreased due to underinvestment in oil producing capacity (as shown by the graph). Chavez has replaced PdVSA’s labour force with loyalists following the 2002-03 protests and has used PdVSA cash for social spending, leading to underinvestment. As a consequence, maintenance work is sloppy and infrastructure suffers from repeated failure and multiple stoppages due to accidents, the biggest one being the explosion at the Amuay refinery in August 2012. In addition, the investment climate has deteriorated under the Hugo Chavez administration, which acts on social ideals, an anti-business agenda and its ambition to control strategic sectors, deterring crucial foreign investment. In 2007, for instance, President Chavez nationalised oil joint ventures with ExxonMobil and ConocoPhillips. In April 2011, the government raised taxes on oil income. In January 2012, the government withdrew from the International Centre for the Settlement of Investment Disputes (ICSID), which implies that, since July 2012, investors no longer have the right to recourse to an international arbitration. On the positive side, Venezuela’s proven oil reserves are among the biggest in the world and have risen recently.

Venezuela commits, under the Petrocaribe scheme, to sell oil under preferential financing terms to countries in the region. The participating countries (from the Caribbean and Central America) purchase oil from PDV Caribe, a subsidiary of PdVSA, on conditions of preferential payment. The alliance was launched in June 2005. The payment system allows to buy oil at market value but only a part is paid up front; the remainder (5 to 50% of oil bill) can be paid through a 17- to 25-year financing agreement at 1% interest with a grace period of up to two years. In addition, it allows for nations to pay part of the cost with other products provided to Venezuela, such as bananas, rice, and sugar. This agreement places a large financial burden on PdVSA and is likely to go on as it is a key aspect of Chavez’s foreign policy.

Deterioration of public finances

Public debt has more than doubled between 2008 and 2011. As public spending surges in 2012, the budget deficit is likely to deteriorate further and public debt to continue to increase despite high oil prices. As a result, a devaluation of the Bolivar will be welcomed as it will increase oil revenues in domestic currency terms.

In view of Venezuela’s deteriorating public finances, PdVSA has become a key source of funding for the government as the company is a large contributor to social programs but is also increasing debts through loans in exchange for future oil shipments. These loans provide necessary funding for strategic social government projects such as housing construction or electricity infrastructure but weaken the financial position of PdVSA and restrain its capacity to invest. Following Chavez’ re-election, pressure on PdVSA to step up government financing is likely to continue, which would deteriorate further the financial position of the company.

On the positive side, Venezuela’s external debt remains at a moderate level as well as external debt service, which mitigate somewhat the high MLT political risk. Nevertheless, if the country continues to rely on PdVSA as a source of external funding, external debt is likely to increase, deteriorating the ability of the country to pay off its external debt.

Risk outlook

The re-election of President Chavez paves the way for continuity. He is likely to deepen his social agenda, tighten foreign exchange controls and further increase state intervention in the economy.

In the coming months, Hugo Chavez is likely to carry out a major devaluation as foreign exchange reserves are depleting and covered less than one month of imports in July 2012, which is extremely low compared to international standards and the historical level of Venezuela’s FX reserves. If foreign exchange reserves continue to follow their downward trajectory, the ST political risk, which reflects the liquidity of the country, will be revised downward ceteris paribus. ONDD classified the commercial risk at the highest level due to the difficult business environment and risk of further devaluation in 2013. The MLT political risk is likely to remain stable as no major policy shift is expected.

Analyst: Pascaline della Faille, p.dellafaille@credendogroup.com