VENEZUELA
Venezuela represents the dark side of an oil bounty. “Oil tends to be a curse and few countries can emulate Norway,” says Roberto Lampl at Alquity Investment Management, where he runs the Latin America fund.
It is impossible to find anyone in international finance who has a single good word to say about Venezuela’s economic management, particularly now that low oil prices have undercut it.
It takes a special kind of incompetence to have supposedly the largest oil reserves in the world and yet to contrive a society in which people queue around the block for goods that very likely won’t be there to buy when they get to the front.
Venezuelans have to grapple with inflation running at anything from 120% to 600% depending on whom you believe, and the currency lost four-fifths of its value in 2015 alone (officially — much real business takes place at an unofficial rate, never a sign of a stable economy).
And yet most of this miserable situation was the case even with high oil prices. Now that they are low, the country is facing economic ruin. Between 96% and 98% of its exports are oil or oil-related, according to Julius Baer, and since 25% of GDP is represented by exports therefore 25% of the economy is direct exposure to exported oil. “That’s the highest number in Latin America,” says Alejandro Hardziej, fixed income analyst at Julius Baer. “We believe they are in the worst spot of them all. There is really limited transparency on data from Venezuela but we believe the economy could contract by as much as 10% this year, basically because of oil prices.”
There is no disagreement on this. “Venezuela is the biggest sufferer with low oil prices,” says Lampl. “It is managed by a bunch of delusional [people] and I can’t say it any more clearly than that. These people are living in some other galaxy with a different understanding of how to run a country and they have done a disastrous job.
“It has taken a long time for Chavez’s house of cards to collapse, and with oil where it is, the goose isn’t laying golden eggs anymore,” Lampl continues. “The risk of a default is really a question of when, not if.”
Xavier Hovasse, head of emerging equities at Carmignac Gestion, puts the investment case succinctly. “The equity market is not investable in our view. The country will probably default on its debt and their currency regime is completely distorted.”
Is there hope? The government is trying to co-ordinate a reduction in supply, with its oil minister flying to Saudi Arabia and Russia, but stands little hope with Saudi Arabia apparently intent on keeping oil production constant, plus Iran’s return to the international markets. “What they need to do is clearly depreciate the currency because there is no money flowing into Venezuela,” says Hardziej. “Who wants to be paid eight bolivars for one dollar when on the black market you get 200? It is highly distorted and there needs to be some adjustment there but these measures are very unpopular.” He also believes local prices for gasoline should be lifted from their enormously subsidised levels in order to help tackle the deficit.
There was a glimmer of hope late last year when the opposition party won a significant majority in the national assembly. “I was quite optimistic about that,” says Hardziej, “because after the elections, [President Nicolás] Maduro said to the press: we have to admit defeat and fight an economic war. The fact that he admitted it seemed a step forward.” But it didn’t last: since then policy has been more confrontational. “So the level of optimism is decreasing. Change won’t happen as fast as we thought it would.”
Venezuelans themselves have become quite used to doubting their leader and recent shenanigans will have done little to change that view. Before the national assembly elections, clearly sensing he would lose them, Maduro changed the law to ensure that the central bank would have to follow decisions from the executive branch — essentially Maduro himself — and in political appointments since the elections, he has continued to go for Chavez-era figures, particularly in the economic portfolio. “These measures show he doesn’t really want to turn around the country despite the defeat,” says Hardziej. And there isn’t a presidential election due until April 2019.
BRAZIL
Brazil is more complicated but also a much bigger deal, given its size and the proportion of the Latin American economy it represents, to the point that some people tend to see it inaccurately as a proxy for the whole continent. “Often the press says Latin America is going into recession,” says Lampl. “What they mean is: Brazil is going into recession.”
Although oil is crucial to Brazil, it is actually not a major exporter and in fact according to the World Bank was actually a net importer, modestly, in 2014. On top of that it has a variety of other assets from iron ore to soft commodities. Hardzej says that in terms of broader commodities, it has “only moderate exposure relative to its economy”.
So blaming oil for the Brazilian malaise is wrong. “At first glance, it would appear that the oil price decline since the summer of 2014 is the reason behind the Brazilian economic slowdown since it was concomitant with a sharp deterioration of both the country’s current account and budget deficit,” says Stephanie de Torquat, investment strategist at Lombard Odier.
“However, Brazil’s fundamentals had already been deteriorating for the better part of 10 years, even as commodity prices were booming.”
The idea that Brazil equals oil is a misconception that perhaps begins with Petrobras. “The company that people associate with Brazil is Petrobas and most people think it is fully exposed to oil, but actually it’s almost neutral,” says Hardziej, because of the structure of its exports to downstream operations. “The outlook for the country is more tied to the lack of political progress. It’s the level of debt that is leading to downgrades to the country.”
Maarten-Jan Bakkum, senior emerging market strategist at NN Investment Partners, agrees. “The problem in Brazil is not only to do with commodity prices going down. It’s the corruption scandals and the weakness of Petrobras affecting everything around it.”
CORRUPTION
The corruption scandal Bakkum is referring to concerns the diversion of an estimated $2bn from Petrobras by various construction companies between 2004 and 2014. When it was finally discovered, more than 50 Brazilian politicians were investigated including the president, Dilma Rousseff, and former president Luíz Inácio Lula da Silva. The former treasurer of Rousseff’s Workers’ Party received a 15 year prison sentence for accepting bribes from Petrobras. Thus oil and corruption are explicitly linked in Brazil. “In a way you can say it is positive: they are locking up people,” Bakkum says. “But we are still in this process and there are a lot of people who have to be found and judged.”
And it’s not just the corruption. Lampl describes Brazilian policy as “extremely irresponsible in the sense that they saw Petrobras as the printing press when it made its big discovery in 2007. They thought that oil was going to flow forever and generate high amounts of money and they could start spending it today. They were irresponsible in the way they managed their government: spending the money when it wasn’t there.”
This has been complicated, he says, by the way government expenses are structured and the fact that about 90% of its fiscal expenditure (others say 75%) is now mandatory and can’t be cut. “They have a lack of flexibility and have not been focusing on productivity.”
For Bakkum the key problem is fiscal. “They have a fiscal deficit of more than 10% of GDP and still rising, and that’s mainly because of social spending that has gone completely out of hand,” he says. “They’ve given far too much to the wrong people, mainly pension costs to state workers with high income who get their pension too early. It’s unsustainable and Brazil needs to do something about it.”
The combination of low oil prices, political deadlock, corruption and inefficiency is proving lethal. “From an economic standpoint, this is now a catastrophe,” says Karine Hervé, in strategy and economic research at Amundi Asset management in Paris. “The current recession would have been less under the impact of a more rigorous policy mix. Political problems have only delayed and complicated the implementation of the fiscal consolidation needed to maintain the credibility of Brazilian policy.”
GETTING RID OF ROUSSEFF
In what circumstances could one become positive about Brazil, clearly a country of enormous potential? “I believe that if they were able to get rid of Rousseff, that would be a good first step,” says Lampl. There are, he says, other candidates who have at least written about plans for economic restructuring. “Otherwise it’s a muddle-through scenario with high inflation, a weak currency and overseas companies coming in and buying decent companies at low valuations and, in currency terms, a low dollar price.”
For portfolio investors, it’s a question of whether the sell-off to date now represents value. “In Brazil, poor fundamentals — lower growth, higher inflation, punitive interest rates and taxation — continue to be clearly pessimistic for equities, especially for domestic exposed names,” says Hovasse. “Thus we keep our negative view and remain highly selective.” That said, he believes the depreciation of the currency, FDI inflows and resuming M&A activity are all positive factors. “But apart from that not much has changed. A political shift is a painful but necessary change for the future growth of the country.” He says he sees more opportunity on the fixed income side than equity.
In this respect, he and Hardziej are in agreement. “When we look at the outlook for these bonds, a lot of valuations have already adjusted,” Hardziej says. “While we recognise the challenges, we believe valuations are already very low and investors can find opportunities in the country.”
So, with a long term view, there might still be opportunity for Brazil at least on the debt side. “Nobody really expects Brazil to disappear from the map,” says Hardziej. “At some point either Rousseff will be impeached or there will be some kind of agreement. When will that happen? Nobody knows.” Meanwhile, Julius Baer expects the economy to contract between 3% and 3.5% this year.
But oil price rises wouldn’t fix it. “For Brazil it would be very good news if oil and other commodity prices were to rise; it would take the pressure off,” Bakkum says. “But it would not solve their problems. We have gone too far to be able to say that now.”