Barclays Report on the Venezuelan Economy (July 15, 2010)

EMERGING MARKETS RESEARCH 15 July 2010 VENEZUELA The only constant is change The new exchange rate system (SITME) has transacted USD650mn in bonds that need Alejandro Grisanti to be considered as new supply to the international market. SITME needs more bonds, +1 212 412 5982 and some companies that import high-end goods and cannot access dollars through alejandro.grisanti@barcap.com SITME have higher demand, given the arrangements of the Christmas season. Unfortunately for bondholders, the government answer was exactly the same: new www.barcap.com issuance is coming. On June 9, the new parallel exchange market, fully controlled by the Central Bank (BCV), began to operate. Authorities say that this new system (SITME) will substitute for the old legal and flexible parallel market. To make this possible, certain legal amendments were made, but authorities have left the door open for more changes, as indeed we expect. For the time being, the BCV has imposed strong quantitative restrictions on the agents participating in the new system (a maximum of USD350,000 for companies and USD33,000 for families), with a much stronger exchange rate (VEB5.3/USD) than the closing reference price of the parallel market (VEB8.5/USD) in May. Big corporations and/or individuals are excluded from the new system, which substantially improves the economic position of small corporations. According to their access to hard currency, we can divide the private sector in three: 1) super-privileged entities, with access to CADIVI and buying hard currency at the official rates of VEB2.6/USD and VEB4.3/USD; 2) privileged ones with access to SITME and buying hard currency at VEB5.3/USD; and 3) other big companies and persons that do not have access to hard currency for importing high-end goods and capital flows. In this framework, the first question that arises is what will happen with this third group, which legally does not have access to hard currency, even in the case that the government increases the flows through CADIVI and SITME. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 4

Barclays Capital | Venezuela: The only constant is change After one month, how is SITME functioning Until now, the financial system According to Elias Jaua, between the government and the financial system there is a has sold USD650mn in gentlemen’s agreement in which the domestic financial system sells part of its hard currency Venezuela and PDVSA bonds position, principally Venezuelan and PDVSA bonds, until the government is ready to sell more Venezuelans bonds and/or other hard currency instruments through SITME. Although in a press conference Nelson Merentes (president of the BCV) said that the new securities market will have an initial supply of USD2.7bn of bonds (in notional value), of which USD2.0bn is from the private banking sector and US0.7bn belongs to public banks, we believe that given liquidity issues – some of these bonds are used as a collateral for international operations – the local financial system has the capacity to sell just USD1.0bn at notional prices (about USD600mn at real market prices). Given that it has already sold USD650mn, the domestic financial system still has USD350mn in notional bonds to sell, which, with an average selling amount of USD25.0mn per day, will be enough for the next three weeks (end of July). But after the financial system sells its hard currency positions, what could be next? Figure 1: SITME daily sales of bonds (USD, mn) 60 50 40 30 20 10 0 9-Jun 14-Jun 17-Jun 22-Jun 29-Jun 2-Jul 8-Jul 13-Jul Source: Venezuelan Central Bank Merentes also indicated that the total demand for dollars that the BCV estimates for that market during the year is USD5.0-6.0bn. Private companies that export could also sell part of their currency positions in the SITME, as well as to transnationals wanting to obtain hard currency; however, this offer is obviously very small, so we hope the offer is supplemented with new sovereign bond issues, PDVSA and/or Bonos Cambiarios. Merentes was pretty clear when noting that the new system is not designed for capital transactions or to repatriate profits, and orders must be justified and transferred to accounts in the name of the company or person who requests them. All roads lead to a new issuance Unfortunately for bondholders, the answer from the authorities to the two above questions has been the same as in the past seven years: new issuance (perhaps two) will come. It is not clear to us if the entity that issues will be the Republic and/or PDVSA. But we believe that we can give some clues as to the terms. If we assume that the new issuance is sold in VEB, without a premium, with an implicit exchange rate of VEB5.3/USD (the average price of the 15 July 2010 2

Barclays Capital | Venezuela: The only constant is change SITME operations), a 2.0% commission, and a VAT rate of 14% (just over the commission), the international price of the bond needs to be 83%. 1 If authorities issue through In this scenario, if PDVSA is going to issue, we need to take into consideration that all of its PDVSA, we expect a bond with bonds have very similar coupons of from 4.9-5.5% (with the exception of the PDVSA11, maturities in 2012 and 2013, which is a zero-coupon bond). If PDVSDA maintains this low coupon strategy and given that under local law and a coupon the oil industry does not have any amortization in 2012 and 2013, we expect the PDVSA to below 4.9% issue in the short end of the curve. Additionally, given that all issuances with maturities before 2017 are under a local law umbrella, our base scenario is that PDVSA will issue a local law bond with a maturity of 2-3 years and a coupon below 4.9%, which is that of the PDVSA14. Given the important difference in spread between the local law bond, and the New York law ones, we cannot discard some economic rationality, and PDVSA may change its strategy and issue under international law. If this is the case, the willingness to pay will counteract the negative effect that the new issuance will likely have over the PDVSA curve. If it is through the Republic, For the case of the Republic, it is a bit harder to reach a conclusion. First, among the sovereign the bond will likely have a bonds, there are significant differences in coupons, which range from 5.375% to 13.625%, maturity in 2017 with a and these differences do not depend on the maturities of the bonds. It is true that in the last coupon higher than 10% two issuances, the coupons were about 9.0% and all sovereign bonds were issued under international law. As for the amortization schedule, there are several years of zero amortization, in the short, medium and longer parts of the curve (2012, 2017, 2021-22, 2026, 2029-33, 2035-37). Therefore, if Venezuela issues the bonds, and given the high value that they need to have, we expect it to do so under international law and in the medium part of the curve (2017 and/or 2022) with a coupon higher than 10%. Some additional caveats The central bank can buy the The expected new issuance needs to satisfy two goals: first, provide hard currency to those part of the PDVSA issuance in corporations that are not receiving dollars from either SITME or CADIVI in order to import the primary market and resell goods for Christmas; second, provide the central bank and/or the financial system with more smaller amounts through SITME bonds in order to maintain the supply of hard currency in SITME. Remember that at the end of last year, the National Assembly changed the central bank law to allow it to buy PDVSA bonds in the primary market (the central bank cannot buy sovereign bonds in the primary market). We believe that there is a high probability that if the new issuance comes from PDVSA, the central bank will buy it in the primary market and resell smaller amounts to the private sector through SITME, thereby minimizing the negative effect on the Venezuelan and PDVSA curves. For these reasons, a PDVSA issuance would better satisfy the demand that came from SITME, and a sovereign issuance would satisfy the demand of those corporations that do not have (or have limited) access to CADIVI and SITME. In this scenario, we cannot reject the possibility that both the Republic and PDVSA will issue this year. The domestic financial system A second important point is that the domestic financial system will likely not buffer the will likely not cushion the negative effect of the new issuance. Until last year, each time that either the Republic negative effect of the new and/or PDVSA issued, banks and brokerage house bought significant amounts of it (in issuance as it used to do either the primary market and/or to their clients) and resold them to international markets in smaller amounts. This year, the authorities dissolved the brokerage house, and with the 1 The implicit exchange rate is equal to the VEB that the participants pay: the price of the bond in VEB (100% in this example) times the official exchange rate of VEB4.3/USD plus commission and the value-added tax of the commission over the international price of the bond. A weaker exchange rate would result in a lower bond price, but we expect the BCV to be consistent with the average exchange rate imposed over the SITME. 15 July 2010 3

Barclays Capital | Venezuela: The only constant is change pressure that puts on the banks, we believe that all corporations that receive bonds and basically want hard currency will sell these bonds at any price, increasing the negative effect of the new issuance on the Venezuelan curve. If they issue before or after it The third issue that it is not clear yet is if Venezuela will issue before or after it pays the pays the GL10, the amortization GL10. The amortization of the GL10 is scheduled for August 7 (given that this date is is the same, given that the Saturday, Venezuela will need to pay on Monday, August 9), or slightly more than three authorities will receive VEB weeks from today. In our opinion, the authorities already have the resources to make these payments (for example, through Fonden). As a reminder, we expect the government and/or PDVSA to issue in a VEB/USD scheme, in which either of them receives VEB instead of dollars. In this scheme, if Venezuela issues before or after, this amortization should not have any effect on the Venezuelan curve. Nevertheless, if they issue after the amortization, this could be a positive signal for the market, based on the wrong perception that the country is showing a capacity to pay. Venezuelan credit will remain Under this scenario, it is not possible to recommend the Venezuelan credit. If authorities under pressure until the continue believing that the only way to sell cheap dollars to the private sector is through authorities realize that there new issuance, the credit will remain under pressure no matter if PDVSA and or the Republic are other ways to sells is the one to issue. We are of the opinion that the worst-case scenario is a new issuance dollars to the private sector from PDVSA local law, without any buffer to international markets. International bond law, from either the republic or PDVSA, will lead to higher demand. Last but not least, imagine that the authorities realize that they cannot continue just issuing debt and decide to make buybacks in order to resell these bonds to the private sector. Clearly, this is a completely different scenario, and with the right signals, Venezuelan credits would easily outperform the market. Unfortunately, we are of the opinion that the authorities are not thinking of these market-friendly solutions. 15 July 2010 4

Analyst Certification(s) I, Alejandro Grisanti, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi- bin/all/disclosuresSearch.pl or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

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Barclays Report on the Venezuelan Economy (July 15, 2010)

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