Economists See Heavy Post-Election Hangover In Venezuela

| Thursday, August 2nd, 2012 | No Comments »

Article originally appeared in the Wall Street JournalBY KEJAL VYAS

CARACAS–From free housing and food to straight up cash for senior citizens and pregnant mothers, Venezuelan President Hugo Chavez has been showering his constituency through a slew of social programs over the last year to shore up support ahead of his hotly contested October re-election bid.

But the leftist leader’s spending frenzy is having repercussions for this resource-rich South American country, which should be flush with cash thanks to record-high oil prices. Venezuela’s surging fiscal deficit and the economic imbalances spawned of its strict capital and foreign exchange controls are raising the odds it will be struck with a major economic shock as soon as next year, economists say.

At the heart of the matter are Mr. Chavez’s heavy expenditures and tight restrictions on Venezuelans’ access to dollars, which have cut the value of Venezuela’s “Strong Bolivar” currency in half on the black market from its fixed exchange rate of VEF4.3 per dollar.

“It’s a perfect example to the rest of the world on how not to run an economy,” said Russell M. Dallen Jr., managing partner at brokerage Caracas Capital Markets.

Despite expectations for gross domestic product to grow more than 5% this year thanks to government spending, analysts warn that a sharp reversal is in store for next year as many anticipate a steep currency devaluation in early 2013 and a reeling in of the profligate public spending, regardless of who wins the election.

The Economist magazine last week tagged the bolivar as 83% overvalued, the most in the world according to its Big Mac index, a yardstick that measures pricing disparities for McDonald’s (MCD) signature hamburger in various countries.

In a Wednesday research note, Normura analyst Boris Segura said he expects the fixed rate to be depreciated 51% and an economic contraction of 1% next year. Bank of America Merrill Lynch is even more pessimistic, forecasting a 74% devaluation and a GDP loss of 3.5%.

The Chavez administration will need a correction to the exchange rate to help it meet its ever-growing list of expenditures on state projects and programs, and narrow its fiscal deficit, which Barclays estimates will reach 19.5% of GDP by the end of 2012, compared with 5% just four years ago.

A spokesman at Venezuela’s Finance Ministry said no officials were available to comment. The president of the National Assembly’s finance committee, Ricardo Sanguino, didn’t respond to calls seeking comment.

A devaluation will increase Venezuela’s bolivar income when it converts the dollars it earns through oil sales. But that is also likely to stoke inflation, which at north of 20% annually already ranks near the highest in the region.

The hydrocarbons-rich country has enjoyed high prices for its mix of heavy crude oil and oil derivatives so far this year, with its oil basket most recently fetching $106.10 a barrel. That’s above the 2011 record average of $101.06, and the $100-a-barrel mark that Oil Minister Rafael Ramirez frequently says is a fair price for the commodity that makes up around 95% of Venezuelan exports.

Still, Venezuela has turned to financing itself through local-currency debt, selling nearly all of the VEF81.7 billion ($19 billion) in debt provisioned at the start of the year to local financial institutions.

The funds appear to have been used up quickly as Venezuelan officials hiked their debt ceiling last month by another VEF30 billion ($7 billion) to pay for state pensions. In 2011, the government also had to nearly double its debt limit midway through the year to finance a string of social projects.

“They’re accumulating a lot of debt even though they’re in an environment of very favorable oil prices, according to their own numbers,” said Erich Arispe, a director at Fitch Ratings in the sovereign credit group.

The country’s total debt, which includes money owed by state oil monopoly Petroleos de Venezuela, is forecast rise to more than $160 billion by the end of December, more than five times the level when Mr. Chavez took office in 1999.

To be sure, economists say Venezuela should be able to service its debt. It’s the rate of accumulation that alarms them, as total debt is on track to hit around 52% of GDP by the end of 2012, more than double the 23% of GDP in 2008.

A lack of transparency in the country’s finances only adds to the concerns. Details on more than $32 billion in loans from China and billions in off-budget discretionary funds controlled by Mr. Chavez aren’t published.

Though Mr. Chavez’s government has never defaulted on its debt obligations, the lack of clarity into the country’s coffers makes its dollar-denominated bonds rank among the riskiest in the developing world, according to J.P. Morgan’s Emerging Market Bond Index Global. Its risk premium is on par with Argentina, which has defaulted in the past, and below only Belize and Pakistan.

Mr. Arispe, whose agency put Venezuela’s sovereign credit rating on review for a downgrade in April, noted a “big gap in information” on the budget.

Both Fitch and Standard & Poor’s have Venezuela at B+, four notches below investment grade. Moody’s Investors Service tags the sovereign credit B2, which is five notches into junk territory.

Jose Guerra, a former Venezuelan central-bank official and now adviser to opposition presidential candidate Henrique Capriles, recently called the surge in debt “irresponsible” and deemed the double-digit yields Venezuela pays on bonds “rates paid by bankrupt countries.”

In Venezuela, strict currency controls imposed to prevent capital flight mean access to dollars is illegal unless acquired through the government. Unlike most countries where debt is raised for budget financing, dollar bond offers in Venezuela have gone to feed that scarcity of greenbacks.

The shortage of dollars, critics say, has crippled the local private sector, which needs hard currency to conduct overseas business. As Venezuela imports around three-quarters of what it consumes, dollars for imports are a critical necessity.

As part of the government’s economic stimulus plans, the central bank has boosted the amount of dollar securities it makes available for distribution into the private sector this year. But, however much it might alleviate dollar demand at the moment, stepped-up dollar bond sales are likely to have a short shelf life.

“You can’t extrapolate too much from what we’ve seen because a lot could change after October,” warned Mr. Dallen, who floated the idea of these being temporary pre-election strategies to keep the economy afloat through the Oct. 7 balloting.

Mr. Chavez holds a double-digit lead over his rival in many voter polls, but one major pollster, Datanalisis, has found more than a fifth of Venezuelans still undecided.

Regardless of the election outcome, economists say the current, highly unorthodox policy mix simply isn’t sustainable. By the same token, they add that the capital, foreign exchange and other controls also couldn’t be unwound quickly or easily, given the risk of a collapse in the value of the currency, hyper-inflation, deep economic contraction and, potentially, social unrest.

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