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  HOME | Opinion (Click here for more)

Molano: Venezuela is Priced for Failure

By Walter Molano

The dank must of impending doom hangs heavily over Caracas.

The downward march of commodity prices, the ongoing collapse of the global financial system, and the end of a year-long political campaign to end term limits marks a downward shift in consumer confidence.

The basket of Venezuelan crude is trading at roughly two-thirds the 2009 budget assumption. Continued turmoil in the commodity markets means that the government will have to reset its budget assumptions, triggering major reductions in expenditures.

Venezuela was also broadsided by the recent wave of financial scandals. The implosion of Stanford Financial Group was a tremendous blow. More than 40% of the $7 billion that were invested in Stanford CDs were from Venezuelans depositors. Many investors perceived that the U.S.-owned bank, with close ties to the previous administration, was a refuge from the country’s Bolivarian mayhem.

Last of all, the successful ratification of the referendum marked an end to 18 months of endless political spending. President Hugo Chavez spearheaded three major campaigns, distributing billions of dollars to boost his popularity. In the end, Chavez got what he desired: the opportunity to run again in 2013, but he depleted the country’s coffers. There is less than $30 billion in international reserves, and about $15 billion in FONDEN.

This is about half the financial resources that were available a year ago. Therefore, there is a realization that the government has no other to choice, but to act decisively with heavy-handed macroeconomic policies.

Last week, Finance Minister Ali Rodriguez announced that several new initiatives would be introduced in a fortnight. Locals are expecting a large reduction in expenditures, subsidies and a possible devaluation of the bolivar.

There are signs that the exchange rate peg will be reset at 3.15, from the current level of 2.15. Such a move indicates a 46% devaluation of the currency, which will trigger major inflationary pressures – as well as having an adverse effect on the lower income strata. Import prices will rise, forcing many households to cut back on their consumption of basic goods and vitals.

Nevertheless, a level of 3.15 is much less than the exchange rate which is being offered in the parallel (or black) market. The parallel market rate for the bolivar is 5.50/5.75. Many people thought that the government would wait some time after the referendum to devalue the currency, in order to make it less obvious that it was artificially propping up the exchange rate.

However, the global situation is deteriorating faster than anyone imagined and the government is running out of money. PDVSA is arrears with most of its suppliers. Many companies have not been paid for more than 90 days. Chavez is also backtracking on some of his nationalization announcements. It looks like he will not nationalize Banco de Venezuela, and it would not be too surprising to see him walk away from some of his other acquisitions, including the cement and steel tube companies.

The government is also considering other measures, including the introduction of new taxes and the imposition of import controls to improve its balance of payments.

Therefore, it is not too surprising to sense the melancholy in the air. The petroleum boom is clearly over, and tough times lie ahead. Venezuela had a blast, enjoying a consumer boom that was not been seen for more than two and a half decades. A fleet of new cars grace the urban streets and highways. High-end restaurants and gourmet chefs brighten the night life and plasma television sets adorn the walls of most Venezuelan homes.

However, not much was done to capitalize on the oil windfall. The government spent recklessly on international political adventures and screwball investments. Very little was done to improve the national infrastructure, and the country’s reserves are almost gone.

These are the reasons why Venezuelan bonds are trading at such distressed levels. However, important measures are on the way. Venezuela’s debt service is relatively small, as well as PDVSA’s. Therefore, it may be a reasonable option. Many Venezuelans investors and institutions are swapping out of their international swill and moving into local assets. After Madoff, Stanford and the panoply of principal-protected notes and hedge fund products, the Bolivarian mayhem does not seem to be such a bad option – especially when the government is finally ready to adopt the tough medicine it postponed after a year of endless elections.

Dr. Walter Molano is Head of Research at international investment bank BCP and an Adjunct Professor at Columbia University. A member of the Council on Foreign Relations, Dr. Molano received a PhD from Duke University after graduating from the US Naval Academy.
 

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