Venezuela: Worse Before Better

CitiFX | Emerging Markets
Market commentary | April 2014
Stephen Leach
+1 212-723-9332
A structural shortage of foreign exchange
Exchange rate regime
FX accounting
The economy
Concluding thoughts
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%
| 2010 | 2011 | 2012 | 2013 | 2014 |
VENEZUELA: International Reserves
Billions of U.S. dollars
Source: Central Bank of Venezuela
A structural shortage of foreign exchange
VENEZUELA: International Reserves*
Liquid reserves
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
Reducing the hard currency amount of payment
arrears through devaluation
Exchange rate regime
Official rate
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
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
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.
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
This leads to a second issue: a growing lack of
economic data and suspicions of distortion in
the data that are published.
'07 '08 '09 '10 '11 '12 '13 '14 '15
Per cent
Source: Citi Latin America Macro & Strategy Outlook, April 2014; own forecasts
| '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
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
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 economy’s 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
ln any lnsLance where dlsLrlbuLlon of Lhls communlcaLlon ls sub[ecL Lo Lhe rules of Lhe uS CommodlLy luLures 1radlng Commlsslon (ºCl1C"), 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, ºClLl"). Sales and Lradlng deparLmenL personnel
are noL research analysLs, and Lhe lnformaLlon ln Lhls communlcaLlon ls noL lnLended Lo consLlLuLe ºresearch" 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. ÞasL 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 SlÞC. 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.