Venezuela suffers from a structural shortage of foreign exchange, with no realistic possibility of improvement while the current government remains in place. The level of blocked funds is unknown, but it is easy to calculate a figure well in excess of US$10 billion for delayed import payments (including airlines) Venezuela is a'serial defaulter' on just about everything with the exception of its foreign currency denominated bond issues. The implied default probability based on five-year credit defaults swaps is 51%.
Venezuela suffers from a structural shortage of foreign exchange, with no realistic possibility of improvement while the current government remains in place. The level of blocked funds is unknown, but it is easy to calculate a figure well in excess of US$10 billion for delayed import payments (including airlines) Venezuela is a'serial defaulter' on just about everything with the exception of its foreign currency denominated bond issues. The implied default probability based on five-year credit defaults swaps is 51%.
Venezuela suffers from a structural shortage of foreign exchange, with no realistic possibility of improvement while the current government remains in place. The level of blocked funds is unknown, but it is easy to calculate a figure well in excess of US$10 billion for delayed import payments (including airlines) Venezuela is a'serial defaulter' on just about everything with the exception of its foreign currency denominated bond issues. The implied default probability based on five-year credit defaults swaps is 51%.
Market commentary | April 2014 Stephen Leach stephen.leach@citi.com +1 212-723-9332 Contents A structural shortage of foreign exchange Exchange rate regime FX accounting The economy Concluding thoughts 1 A structural shortage of foreign exchange Venezuela suffers from a structural shortage of foreign exchange, with no realistic possibility of improvement while the current government remains in place The problem is not the supply of foreign exchange per se, but rather that the demand for foreign exchange has increased as imports have displaced domestic production The level of blocked funds is unknown, but it is easy to calculate a figure well in excess of US$10 billion for delayed import payments (including airlines) Venezuela is a serial defaulter on just about everything with the exception of its foreign currency denominated bond issues. The implied default probability based on five-year credit defaults swaps is 51% 2 18 21 24 27 30 33 | 2010 | 2011 | 2012 | 2013 | 2014 | VENEZUELA: International Reserves Billions of U.S. dollars Source: Central Bank of Venezuela A structural shortage of foreign exchange 3 0 3 6 9 12 15 18 21 24 VENEZUELA: International Reserves* Liquid reserves Gold Other Source: Central Bank of Venezuela * An additional US$8-15 billion is thought to be held by other government agencies, but is probably illiquid PDVSA announced recently that its next coupon payments on dollar-denominated debt would be paid through the issuance of more debt The solution to the problem of severe payment delays will involve a combination of New payment delays Forcing haircuts on companies owed hard currency Reducing the hard currency amount of payment arrears through devaluation 4 Exchange rate regime 0 10 20 30 40 50 60 70 80 Official rate SICAD-1 SICAD-2 Black market Venezuela has among the most convoluted exchange rate regimes in the world With inflation reported to be close to 60%, there is little prospect that exchange rates can remain stable over the medium-term The allocation of hard currency at the official rate and SICAD-I is the responsibility of CENCOEX, the National Foreign Trade Center into which CADIVI (the previous exchange control authority was absorbed) The allocation of hard currency through SICAD-2 is the responsibility of the central bank. Exchange rate regime Official rate currently 6.30 per U.S. dollar Applicable in theory mainly to imports of necessary items, but huge payment delays SICAD-1 currently 10.0 per U.S. dollar Each week, up to US$220 million is allocated to importers of pre-selected products. The list of applicable imports changes each week, and can include items supposedly eligible for the official rate. This rate also applies to new airline tickets (again, in theory) The original stated intent was for SICAD-1 to be an auction mechanism, but it has never operated in that fashion SICAD-2 currently about 49.3 per U.S. dollar, in existence for four weeks The intention was that this was to be a transparent, market-driven rate for the sale and purchase of either hard currency or dollar-denominated bonds. But it has already degenerated into a quasi-fixed rate system with a complete lack of transparency and minimal liquidity. The illegal black market rate currently trading around 64 per U.S. dollar Based across the border in Colombia 5 Exchange rate accounting Theory: companies should translate their overseas assets using the exchange rate at which a dividend can be repatriated. If there is no applicable dividend rate then companies should use the weakest legal rate. Practice: The consensus is coalescing around the use of the SICAD-1 rate for the end of the first quarter. Companies had been using the official rate previously. The result is a series of bookkeeping losses. Few companies have adopted the SICAD-2 rate, thereby avoiding (delaying) even larger losses. * * * * * Foreign Exchange Agreement #25 Effective January 24, 2014, the government decreed that the SICAD-1 rate would apply to foreign investments and payment of royalties, use and exploitation of patents, trademarks and franchises, as well as technology import and technical assistance agreements. (emphasis added) Despite the absence of any specific mention of dividends or profits, it appears that companies are using this as justification for the use of SICAD-1. 6 The economy The Venezuelan economy is a disaster, with little prospect of any improvement. The defining feature is one of widespread shortages of basic products Shortages can be seen as a result of importers reaching their external credit limits and a lack of domestic production The extent of shortages is not known but the government had reported that 28% of goods in the consumer price basket were not available for sampling in January (the government no longer publishes the figure, arguing that it had become political) This leads to a second issue: a growing lack of economic data and suspicions of distortion in the data that are published. 7 -4% -2% 0% 2% 4% 6% 8% 10% '07 '08 '09 '10 '11 '12 '13 '14 '15 VENEZUELA: GDP Growth (%) Per cent Source: Citi Latin America Macro & Strategy Outlook, April 2014; own forecasts 8 0% 10% 20% 30% 40% 50% 60% | '09 | '10 | '11 | '12 | '13 | '14 | VENEZUELA: Consumer Price Inflation Per cent Venezuela has the highest inflation rate in the world despite extensive price & profit controls The combination of rapid monetary growth (74.7% y/y), severe shortages of even the most basic goods and the limited ability to obtain foreign currency implies that inflation will remain high or increase even more over the medium-term The government has shown no willingness to even consider a change in its (ill-defined) economic strategy Source: Bloomberg, Citi The economy Concluding thoughts Venezuela is in a downward spiral, economically, socially and politically, with no end in sight The economy is becoming more rather than less dependent on oil The private sector is reducing investment, as much by necessity as choice, further reducing the economys productive capacity The exchange rate regime can best be described as dysfunctional, with rapid inflation and a major shortage of foreign exchange likely to dictate further significant changes over the next few years The shortage of foreign exchange will lead foreign companies to reduce the scale of operations in the country and to accept large balance sheet losses 9 Disclaimer ln any lnsLance where dlsLrlbuLlon of Lhls communlcaLlon ls sub[ecL Lo Lhe rules of Lhe uS CommodlLy luLures 1radlng Commlsslon (Cl1C"), Lhls communlcaLlon consLlLuLes an lnvlLaLlon Lo conslder enLerlng lnLo a derlvaLlves LransacLlon under u.S. Cl1C 8egulaLlons 1.71 and 23.603, where appllcable, buL ls noL a blndlng offer Lo buy/sell any flnanclal lnsLrumenL. 1hls communlcaLlon ls lssued by a member of Lhe sales and Lradlng deparLmenL of ClLlgroup Clobal MarkeLs lnc. or one of lLs afflllaLes (collecLlvely, ClLl"). Sales and Lradlng deparLmenL personnel are noL research analysLs, and Lhe lnformaLlon ln Lhls communlcaLlon ls noL lnLended Lo consLlLuLe research" as LhaL Lerm ls deflned by appllcable regulaLlons. unless oLherwlse lndlcaLed, any reference Lo a research reporL or research recommendaLlon ls noL lnLended Lo represenL Lhe whole reporL and ls noL ln lLself consldered a recommendaLlon or research reporL. All vlews, oplnlons and esLlmaLes expressed ln Lhls communlcaLlon (l) may change wlLhouL noLlce and (ll) may dlffer from Lhose vlews, oplnlons and esLlmaLes held or expressed by ClLl or oLher ClLl personnel. 1hls communlcaLlon ls provlded for lnformaLlon and dlscusslon purposes only. unless oLherwlse lndlcaLed, (l) lL does noL consLlLuLe an offer or recommendaLlon Lo purchase or sell any flnanclal lnsLrumenLs or oLher producLs, (ll) lL does noL consLlLuLe a sollclLaLlon lf lL ls noL sub[ecL Lo Lhe rules of Lhe Cl1C (buL see dlscusslon above regardlng communlcaLlons sub[ecL Lo Cl1C rules), and (lll) lL ls noL lnLended as an offlclal conflrmaLlon of any LransacLlon. unless oLherwlse expressly lndlcaLed, Lhls communlcaLlon does noL Lake lnLo accounL Lhe lnvesLmenL ob[ecLlves or flnanclal slLuaLlon of any parLlcular person. ClLl ls noL acLlng as an advlsor, flduclary or agenL. 8eclplenLs of Lhls communlcaLlon should obLaln advlce based on Lhelr own lndlvldual clrcumsLances from Lhelr own Lax, flnanclal, legal and oLher advlsors abouL Lhe rlsks and merlLs of any LransacLlon before maklng an lnvesLmenL declslon, and only make such declslons on Lhe basls of Lhe lnvesLor's own ob[ecLlves, experlence and resources. 1he lnformaLlon conLalned ln Lhls communlcaLlon ls based on generally avallable lnformaLlon and, alLhough obLalned from sources belleved by ClLl Lo be rellable, lLs accuracy and compleLeness cannoL be assured, and such lnformaLlon may be lncompleLe or condensed. Any assumpLlons or lnformaLlon conLalned ln Lhls documenL consLlLuLe a [udgmenL only as of Lhe daLe of Lhls documenL or on any speclfled daLes and ls sub[ecL Lo change wlLhouL noLlce. ClLl ofLen acLs as an lssuer of flnanclal lnsLrumenLs and oLher producLs, acLs as a markeL maker and Lrades as prlnclpal ln many dlfferenL flnanclal lnsLrumenLs and oLher producLs, and can be expecLed Lo perform or seek Lo perform lnvesLmenL banklng and oLher servlces for Lhe lssuer of such flnanclal lnsLrumenLs or oLher producLs. 1he auLhor of Lhls communlcaLlon may have dlscussed Lhe lnformaLlon conLalned Lhereln wlLh oLhers wlLhln or ouLslde ClLl and Lhe auLhor and/or such oLher ClLl personnel may have already acLed on Lhe basls of Lhls lnformaLlon (lncludlng by Lradlng for ClLl's proprleLary accounLs or communlcaLlng Lhe lnformaLlon conLalned hereln Lo oLher cusLomers of ClLl). ClLl, ClLl's personnel (lncludlng Lhose wlLh whom Lhe auLhor may have consulLed ln Lhe preparaLlon of Lhls communlcaLlon), and oLher cusLomers of ClLl may be long or shorL Lhe flnanclal lnsLrumenLs or oLher producLs referred Lo ln Lhls communlcaLlon, may have acqulred such poslLlons aL prlces and markeL condlLlons LhaL are no longer avallable, and may have lnLeresLs dlfferenL from or adverse Lo your lnLeresLs. lnvesLmenLs ln flnanclal lnsLrumenLs or oLher producLs carry slgnlflcanL rlsk, lncludlng Lhe posslble loss of Lhe prlnclpal amounL lnvesLed. llnanclal lnsLrumenLs or oLher producLs denomlnaLed ln a forelgn currency are sub[ecL Lo exchange raLe flucLuaLlons, whlch may have an adverse effecL on Lhe prlce or value of an lnvesLmenL ln such producLs. 1hls documenL does noL purporL Lo ldenLlfy all rlsks or maLerlal conslderaLlons whlch may be assoclaLed wlLh enLerlng lnLo any LransacLlon. ClLl accepLs no llablllLy for any loss (wheLher dlrecL, lndlrecL or consequenLlal) LhaL may arlse from any use of Lhe lnformaLlon conLalned ln or derlved from Lhls communlcaLlon. 1hls documenL may conLaln hlsLorlcal and forward looklng lnformaLlon. asL performance ls noL a guaranLee or lndlcaLlon of fuLure resulLs. Any prlces, values or esLlmaLes provlded ln Lhls communlcaLlon (oLher Lhan Lhose LhaL are ldenLlfled as belng hlsLorlcal) are lndlcaLlve only may change wlLhouL noLlce and do noL represenL flrm quoLes as Lo elLher prlce or slze, nor reflecL Lhe value ClLl may asslgn a securlLy ln lLs lnvenLory. lorward looklng lnformaLlon does noL lndlcaLe a level aL whlch ClLl ls prepared Lo do a Lrade and may noL accounL for all relevanL assumpLlons and fuLure condlLlons. AcLual condlLlons may vary subsLanLlally from esLlmaLes whlch could have a negaLlve lmpacL on Lhe value of an lnsLrumenL. ?ou should conLacL your local represenLaLlve dlrecLly lf you are lnLeresLed ln buylng or selllng any flnanclal lnsLrumenL or oLher producL or pursulng any Lradlng sLraLegy LhaL may be menLloned ln Lhls communlcaLlon. 1hese maLerlals are prepared solely for dlsLrlbuLlon lnLo [urlsdlcLlons where such dlsLrlbuLlon ls permlLLed by law. 1hese maLerlals are for Lhe lnLernal use of Lhe lnLended reclplenLs only and may conLaln lnformaLlon proprleLary Lo ClLl whlch may noL be reproduced or redlsLrlbuLed ln whole or ln parL wlLhouL ClLl's prlor consenL. AlLhough ClLlbank, n.A. (LogeLher wlLh lLs subsldlarles and branches worldwlde, "ClLlbank") ls an afflllaLe of ClLl, you should be aware LhaL none of Lhe flnanclal lnsLrumenLs or oLher producLs menLloned ln Lhls communlcaLlon (unless expressly sLaLed oLherwlse) are (l) lnsured by Lhe lederal ueposlL lnsurance CorporaLlon or any oLher governmenLal auLhorlLy, or (ll) deposlLs or oLher obllgaLlons of, or guaranLeed by, ClLlbank or any oLher lnsured deposlLory lnsLlLuLlon. l8S Clrcular 230 ulsclosure: ClLl and lLs employees are noL ln Lhe buslness of provldlng, and do noL provlde, Lax or legal advlce Lo any Laxpayer ouLslde of ClLl. Any sLaLemenLs ln Lhls communlcaLlon Lo Lax maLLers were noL lnLended or wrlLLen Lo be used, and cannoL be used or relled upon, by any Laxpayer for Lhe purpose of avoldlng Lax penalLles. Any such Laxpayer should seek advlce based on Lhe Laxpayer's parLlcular clrcumsLances from an lndependenL Lax advlsor. 2014 ClLlgroup Clobal MarkeLs lnc. Member SlC. All rlghLs reserved. ClLl and ClLl and Arc ueslgn are Lrademarks and servlce marks of ClLlgroup lnc. or lLs afflllaLes and are used and reglsLered LhroughouL Lhe world. 10