VENEZUELA: Moment of truth

The currency devaluation boosted government coffers this year, but may end up doing more harm than good

  • By Rachel Jones
  • 22 Mar 2010
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The scale of the troubles facing Hugo Chávez, Venezuela’s president, is hard to overstate. The country is still mired in recession – its first since 2003 – while many other Latin economies are rebounding strongly. Oil revenue, which accounts for 94% of export income, has dropped off substantially, limiting fiscal spending; inflation is running at the highest rate in Latin America; and an energy crisis has forced widespread electricity and water rationing.

Chávez’s government has tried to address some of these problems, most recently with a devaluation of its currency, the bolívar. But while the move will likely benefit public coffers before September’s parliamentary elections, it may also undermine the country’s growth prospects and push up inflation in the medium term.

As a result, Chávez’s government may find itself up against even weightier trials in the lead-up to the presidential elections in 2012.

On January 8, Chávez announced his government would implement a dual exchange rate of Bs2.6/$ for goods considered a priority, and Bs4.3/$ for non-essential items. Since 2005, the bolívar had been pegged at a fixed rate of Bs2.15/$. But dollars – which are severely restricted under government currency controls – have been selling for three times that rate on Venezuela’s parallel market, making the currency highly overvalued.

“There was a very high demand for dollars and a very reduced supply because of the shortage of oil money,” says Domingo Maza Zavala, a former central bank director. “It wasn’t sustainable.”

Chávez has relied on Venezuela’s state oil company to fuel his self-styled revolution, funding social programmes that provide everything from literacy to subsidized food. But when world oil prices dropped to roughly half their 2008 peak, so did the country’s income. During the first half of 2009, net profits at state-run Petróleos de Venezuela SA, or PDVSA, fell 67% over a year earlier to $3.15 billion.

Meanwhile, oil production fell 8% over the year to 2.16 million barrels per day in 2009, according to the International Energy Agency, a Paris-based advisory group. Chávez’s government disputes these figures, saying Venezuela has been producing 3 million barrels a day following Opec (Organization of the Petroleum Exporting Countries) cuts of 364,000 barrels per day.

Regardless, there have been fewer dollars to go around – and, when exchanged at the former overvalued rate, fewer bolívars. This was a problem for PDVSA, which desperately needed local currency to meet national obligations such as outstanding debts with oil contractors, salaries for an expansive payroll and social obligations such as food distribution.

“All of these national components require income in bolívars,” says Andreas Faust, an economist at Banco Mercantil in Caracas. “PDVSA couldn’t survive.”


Now, thanks to the devaluation, Barclays Capital estimates that the government will obtain an additional Bs78 billion in income this year, and will likely issue no more than $6 billion in debt. This money can be used to pay off PDVSA’s debts and also boost public spending on social projects before the parliamentary elections, and invest in key sectors such as electricity.

Hydroelectric power supplies some 70% of Venezuela’s electricity, but months of sustained drought have forced Chávez’s government to implement water and electricity rationing. Critics accuse the government of failing to invest sufficiently in thermoelectric power plants, and have organized occasional protests. Analysts, meanwhile, warn the energy crisis will only deepen the recession due to a sustained loss of productivity.

Even with investment in the electricity sector this year, analysts say, such spending will do little to stimulate growth in Venezuela. The economy contracted by 3.3% in 2009 and, because Venezuela exports little other than oil, it’s unlikely to benefit from the usual productive stimulus of a devaluation. While Chávez’s government has said it’s aiming for GDP growth of 0.5–1% this year, analysts predict Venezuela’s economy will contract – anywhere from 1.7% to 6%.

“The effect on the real economy is rather recessionary and not expansive,” says former central bank president Ruth de Krivoy, who heads the financial consultancy Síntesis Financiera in Caracas. “The big challenge is to get the country into a pattern of sustainable growth with low inflation, because that’s the only way to improve the well-being of the citizens.”

Venezuela’s inflation is running at 24% – Latin America’s highest – and the devaluation will contribute to inflation by raising the price of imports, upon which Venezuela is heavily reliant. Nevertheless, says Pavel Gómez, a professor at the IESA business school in Caracas, price gains will also likely be mitigated by the effects of the recession. “Devaluation has an inflationary effect ... but, consumption has slowed,” he says.

Finance minister Alí Rodríguez has said that the devaluation aims not to increase government income, but rather to limit price gains for imported goods purchased with dollars at the inflated parallel rate. The devaluation should only boost inflation, which the government’s budget estimates at 20–22%, by three to five percentage points this year, Rodríguez said recently.

But analysts predict Venezuela’s 2010 inflation will exceed last year’s rate, reaching anywhere between 29% to 36%. That figure will largely depend on the success of government efforts to boost the bolívar’s value on the parallel market, where dollars still sell for more than double the official rate of Bs2.6/$.

While the central bank is able to intervene in the parallel market by selling short-term securities, such efforts have so far had little effect. “From the point of view of the government, inflation isn’t a priority,” says Alejandro Grisanti, an analyst with Barclays Capital in New York, pointing out that Venezuela has had years of moderately high inflation with relatively little political cost.

Still, sustained inflation has had a severe impact on citizens in Venezuela, where cars and apartments are viewed as long-term investments, and day-to-day price hikes are common. To prevent prices from rising still further, Chávez has threatened to intervene in businesses that “speculate” by raising prices following the devaluation. The state electricity company, meanwhile, has said it will suspend services to businesses that fail to comply with rules reducing electricity use by 20%.

Such strict controls, however, along with the government’s penchant for expropriations, are exactly what many analysts say is preventing Venezuela’s economy from recovering. Currency controls have put pressure on the bolívar, diminishing its value in the parallel market. Price controls on basic goods make it difficult for farmers and other producers to make a profit, leading them to seek other lines of employment.

Since 2007, Chávez’s government has nationalized major electricity, cement, steel and other companies, as well as four major oil projects. Chávez regularly announces such moves during his lengthy televised speeches, ordering, “Nationalize it!”

Gómez says the government must now restrict this vocabulary, and instead encourage private investment to spur growth. “The government needs to correct some distortions in terms of price controls and threats to the private sector, so that the private sector can have some trust,” he says. A more hostile attitude will likely have an even stronger effect on the economy given the current recessionary climate.

The government has made attempts to attract foreign investment, most recently with an auction for private and state-owned oil companies eager to exploit heavy oil reserves in its Eastern Orinoco region. Two consortia of companies – one led by Chevron Corp. with a 34% stake and the second by Repsol YPF, with an 11% stake – have agreed to join PDVSA in two $15 billion projects that aim to boost oil production by some 800,000 barrels per day by 2016. But these are extremely long-term projects that will do little to encourage growth in the medium term, Gómez says.


The government’s decision to devalue at this moment was likely political, aimed at avoiding the unpopular move closer to the 2012 presidential elections, Grisanti says.

Chávez’s popularity has dipped slightly in opinion polls, even before the devaluation and electricity rationing, and could be further threatened if the opposition makes gains in parliamentary elections. A devaluation was preferable to other unpopular methods of raising funds, such as hiking heavily subsidized gasoline or electricity prices, because it was the most beneficial for the government and PDVSA financially, Grisanti says.

But the question remains: What options are left for Venezuela if next year it finds itself in a similar situation, at a critical moment in Chávez’s presidency?

“I would say that next year is a big challenge,” says de Krivoy, pointing out that unemployment – which reached 10.2% in January, up 0.7 of a percentage point from a year earlier – is also on the rise.

Still, the dual exchange rate system has left the government with some flexibility. Grisanti says he expects the government will implement covert devaluation next year, selling fewer dollars at 2.60 and more at 4.30. “It’s another way of making an adjustment,” he says.

Maza Zavala claims that while Venezuela has faced lower oil prices and recessions in the past, it is today’s climate of discouraging private investment that makes the situation now so critical. “The Venezuelan economy is at its worst moment,” he says. “The government should aim for cooperation, collaboration and understanding to create a climate of security, a climate of optimism.”

Otherwise, he says, “another devaluation” may be the government’s only option.

  • By Rachel Jones
  • 22 Mar 2010

All International Bonds

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