“Venezuela is on track to implement a sizable fiscal and exchange rate adjustment that will strongly improve public finances,” the strategists wrote in a market note explaining why they upgraded Venezuelan bonds to overweight.
The bolivar fell 42% on the black market this year, according to Bloomberg, which also reported there was speculation that Venezuela, which has not issued dollar-denominated bonds since October last year, will do so in order to create supply of dollars for the central bank to exchange at official rates.
Bank of America said Venezuelan newspapers reported that there were ongoing discussions within the government on setting up a new exchange rate system that can ensure adequate financing of government activities for next year and bring the black market exchange rate under control, a system that would include a devaluation of the exchange rate.
There are other signs of macroeconomic adjustment, the strategists said, noting that spending fell 13% year-on-year in real terms over the 7 weeks following the re-election of Hugo Chavez as president compared with a 19.7% rise in the first 9 months of the year, while the flow of foreign exchange to the private sector “has already fallen considerably.”
“Because of the combined effect of devaluation and the reduction of expenditures, we see Venezuela’s central government budget deficit falling from an estimated 8.8% of GDP in 2012 to 2.2% of GDP next year,” they said.
Chavez’s surprise announcement earlier in the week that he was going to Cuba for further cancer treatment “introduces an additional element of uncertainty,” the strategists said.
“There is the risk that government paralysis resulting from his absence could delay the adoption of an exchange rate adjustment, but this is partly offset by the likely positive reaction that the market would have if Chavez were to step down due to a deterioration of his health. “ The Bank of America Merill Lynch’s upgrade is based on factors including potential devaluation of the bolivar, reduced supply of Venezuelan bonds and possible change in leadership.
“A front-loaded, significant devaluation, which we expect in early 2013, would be very credit positive, especially at the front end. The spending cuts taking place now will result in little external debt issuance,” the strategists said.
“Lastly, although there has been some rotation out of Argentina into Venezuela in the last month, we expect more as the likelihood of Argentina default rises. In our view these forces are strong enough to override the potential exposure of risky assets resulting from the fiscal cliff,” they added.