Venezuela: Worse Before Better

CitiFX | Emerging Markets
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
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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.
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-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 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
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