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Venezuela Quarterly Update Q3 2015


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Here is my quarterly update on Venezuela. Enjoy reading and feel free to get in touch with me for questions or comments.

Aquí esta mi actualización trimestral sobre Venezuela. Disfrutenla y ponganse en contacto conmigo si tienen preguntas o quieren comentar algo.

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Venezuela Quarterly Update Q3 2015

  1. 1. VENEZUELA Quarterly Economics Update – Q3 2015 Christian von Canstein, MSc
  2. 2. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Venezuela remains in a dire economic crisis. A decade of economic mismanagement by the Socialist governments of the late Hugo Chavez and his successor Nicolas Maduro are the structural cause for the current downturn. While the unsustainability of the country’s economic model had initially been concealed by high oil prices, the situation changed drastically over the past year, when oil prices tumbled by almost 60%. As an undiversified economy, Venezuela relies disproportionally on high oil prices to fund public spending; therefore, massive current account and fiscal budget imbalances have been revealed. A decade of nationalizations, expropriations and onerous regulations such as price controls combined with high levels of government intervention have taken a toll on private business and severely damaged the country’s productive capacity. In the era of high oil prices, the gap between domestic demand and supply could still be plugged via exports, as the country received sufficient US-dollar -denominated revenues to pay for them. In spite of this, long queues at government-owned supermarkets to buy basic goods had already become common. Central planning’s inability to match demand with supply has led to massive shortages. This trend has been exacerbated even more over the last year with soaring inflation as a result. One of the main factors that prevent a rebalancing of the current account is a chronically overvalued currency which is also tightly controlled by its government. Even though the currency has been officially devalued by almost 50% over the last five years, it still remains completely overvalued. Estimates of its actual fair price per US Dollar fluctuate around VEF 800, 130 times the official exchange rate. This has led to a persistent shortage in US Dollars which makes it impossible for producers to import material or capital goods that are needed to kick-start domestic production and thus tackle the chronic supply shortages. The security situation has deteriorated significantly, both in terms of political unrest and street crime, turning Caracas in the city with the highest homicide rate on the entire continent (the first is San Pedro Sula, Honduras). This is likely to have a negative impact on consumption, consumer confidence and business confidence. 2 Overview* 30/09/10 30/09/14 30/06/15 30/09/151 Year Change Estimated 2015 Real GDP Growth -0.22% -2.30% -2.30% -2.30% 0.00% -10.00% CPI Inflation 27.92% 64.01% 68.54% 68.54% 4.53% >100% Policy Rate 15.87% 16.97% 18.50% 19.68% 2.71%N/A Unemployment 8.40% 7.00% 7.90% 7.90% 0.90% 14.00% 10 Year Yield 16.12% 17.54% 15.91% 15.91% -1.63%N/A Business Loan Rate 16.36% 17.37% 19.31% 20.40% 3.03%N/A IBVC Index 65.28 2908.99 12857.25 11872.87 8963.88N/A Exchange Rate (VEF/USD) 4.2947 6.2921 6.2921 6.2921 0.00 800 * Reflects the latest data available as at 30/09/2015; Venezuela’s Central Bank has selectively stopped publishing macroeconomic statistics. 2015 estimates from the IMF (GDP Growth and Inflation), The Economist (Unemployment) and Dolar Today (Exchange Rate VEF/USD).
  3. 3. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Real GDP Growth (annualized)* With at least three quarters of negative economic growth, the country’s economy is expected to contract by up to 10% this year, based on recent IMF estimates. This would make it by far the weakest performing economy in the whole of Latin America. Other countries in the region that are also going through slowdown such as Argentina and Chile are still expected to see some moderate growth this year. Oil prices obviously play an important role, as 96% of export revenues come from oil which also constitutes 40% of government revenues and 11% of GDP. Still, most Latin American countries rely disproportionately on commodity exports without going through such a severe recession. Neighboring Colombia, another major oil exporter, is even expected to grow by 2.5% - 3% this year. Venezuela’s economy is mainly suffering from the impact of increasing state control and interventionism in form of price controls, profit caps and labor market regulations that have been crowding out the private sector. Compared to Colombia, where a free floating currency offset the fall in oil prices and created opportunities for exporters, the Bolivar Fuerte remains overvalued at official rates, making it hard for exporters to compete internationally, especially when pretty much all free floating Latin American currencies have seen double digit depreciations. At the same time, dollar shortages have hurt all companies that rely on imports. In essence, Venezuela is equally affected by falling commodity prices as its regional peers, but the bulk of its poor economic performance can be explained by a decade of accumulated economic mismanagement. Venezuela remains in recession 3 *Venezuela has not published GDP growth data since Q3 2014 -0.22% -2.30% -2.30% -2.30% -2.50% -2.00% -1.50% -1.00% -0.50% 0.00% Real GDP Growth 30/09/10 30/09/14 30/06/15 30/09/15
  4. 4. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 CPI Inflation (year on year basis)* Venezuela has undoubtedly entered into hyperinflation, whose threshold is often defined as more than 50% inflation in a given year. However, the government has stopped providing inflation data at the end of 2014. Estimates from the IMF put consumer price inflation at 190% for this year and 210% for 2016. There are two main causes behind the current astronomical inflation levels. Even when oil prices remained high, Venezuela imported twice as much as it received in export revenues as price controls, arbitrary expropriations and other socialist policies had gradually eroded domestic production, making the country increasingly reliant on imports. To fund the gap, its government compelled the central bank to print money. As increasing amounts of money started chasing a limited amount of goods, inflation started to pick up steadily. After the introduction of capital controls by the late Hugo Chavez, US Dollars are officially only available through the government (which receives most of the oil revenues) at heavily subsidized rates. A net of corruption and cronyism has led to US Dollars being allocated mainly to regime friends who tend to sell them at black market rates at a large profit instead of expanding their inventory and alleviating massive supply shortages. As a consequence, many truly private companies have been unable to manage their working capital. The result of these shortages is hyperinflation, misallocation of capital and a severe disruption of the country’s economy as even the most basic goods become hard to obtain and a large part of the population has to spend long hours in queues to do their daily grocery shopping. A country mired in hyperinflation 4 *Venezuela has not published inflation data since Q4 2014. 27.92% 64.01% 68.54% 68.54% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% CPI Inflation 30/09/10 30/09/14 30/06/15 30/09/15
  5. 5. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Unemployment* Unemployment remains below double digit levels based on official figures last published in January 2015 but IMF estimates put the actual figures as high as 14%, expected to increase to 18% next year and 21% in 2017. According to Venezuela’s Chamber of Commerce (Fedecameras), an estimated 600,000 jobs have been lost over the last five years, as capital controls, hyperinflation and government policies have driven an estimated 7,000 companies out of business during this period. Even in the era of relative prosperity when oil prices were above $100 per barrel, unemployment remained worryingly high, given the state of the country’s economy and the performance of regional peers. Venezuela is gradually moving towards the soaring unemployment rates of Southern Europe. As the current downturn is likely to continue, one could expect that unemployment continues its upwards trend in line with IMF forecasts which would further exacerbate the country’s severe social crisis. Venezuela’s unemployment rate holds steady for now 5 *Venezuela has not published unemployment data since January 2015. 8.40% 7.00% 7.90% 7.90% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% Unemployment 30/09/10 30/09/14 30/06/15 30/09/15
  6. 6. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 10 Year Yield Government Bond Yield* The recent rally of Venezuelan debt is not due to any improvement in its outlook but merely reflected investors betting on Venezuela’s willingness to meet its obligations for as long as possible even though its ability remains questionable. A slight recovery in oil prices raised hopes that the country might make it into 2016 at least. With a yield of almost 16% and assuming a coupon of 7.625%, Venezuelan bonds are priced at around $27 to the par value, meaning that investors are clearly pricing in a default at some stage. Implied default probability in derivative markets are consistent with this view, suggesting a default probability of above 70% within the next year and almost 100% within the next five years. Given the situation Venezuela has gotten itself into, the trade-off between using future US Dollar revenues to honor its debt or to pay for basic goods and medicine becomes increasingly evident. With the private sector almost destroyed, the country completely relies on imports to feed itself. With violent crime already soaring, the government cannot afford to see the food shortages deteriorate even more. The estimated $15 billion left in foreign reserves would hardly cover this year’s and next year’s maturing bonds. Venezuela has not been willing to enter into default so far, as its global oil assets could be seized by foreign courts. A possible solution to the situation would be to seek a bailout from the International Monetary Fund (IMF). Whether the Socialist government would be willing to implement any of the economic reforms that would come as a condition is another question, however. Right now, the only certainty seems to be that bondholders are unlikely to be repaid in par and bar an IMF program or sudden rally in oil prices, a default in 2016 might still be on the table. A default in 2016 remains a risk 6 *Based on IMF Data. 16.12% 17.54% 15.91% 15.91% 15.00% 15.50% 16.00% 16.50% 17.00% 17.50% 18.00% 10 Year Yield 30/09/10 30/09/14 30/06/15 30/09/15
  7. 7. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Policy Rate Monetary conditions seem tight in Venezuela with the the policy rate at 20.7%. In inflation-adjusted terms, however, the policy rate remains deep in negative territory. Its impact for the real economy seems trivial. Current hyperinflation suggests that monetary authorities have lost control over inflation a long time ago. Given governing Party’s track record on systematically weakening institutions and eroding all checks and balances on executive power, it is unlikely that its central bank can still be considered independent. Instead it is being used to print any amount of money the government asks for to keep it afloat, which is the main cause of the current astronomical levels of inflation. For a normal economy, business loan rates at these levels would be considered fairly high but in a hyperinflationary environment, nominal rates do not mean much, as pointed out in the paragraph above. Credit spreads (the difference between the yield on corporate debt and government debt which constitutes the risk premium) should increase in theory, as many companies rely on oil. As oil prices have been falling drastically over the last year, their revenues can be expected to have fallen which also reduces cash flows and net income in the sector. This would naturally deteriorate the credit standing of such companies with exposure to oil markets and therefore warrant a higher risk premium. Nominal rates do certainly not compensate the investor for inflation. This might explain the capital flight into equities which will be further discussed on slide 9. Interest rates in hyperinflation become meaningless 7 Business Loan Rate 15.87% 16.97% 18.50% 19.68% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% Policy Rate 30/09/10 30/09/14 30/06/15 30/09/15 V 16.36% 17.37% 19.31% 20.40% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% Business Loan Rate 30/09/10 30/09/14 30/06/15 30/09/15
  8. 8. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Exchange Rate (VEF/USD) – Official Rate Venezuela currently has three fixed exchange rate systems that all overvalue the Bolivar Fuerte to varying degrees. The only rate that reflects reality, however, is the black market rate. According to the Miami-based website Dolar Today which estimates the market value of the Bolivar Fuerte through transactions in the Colombian border town Cucuta, the implied market exchange rate is over VEF800 per USD, or more than 130 times the controlled exchange rate. At that rate, the current monthly minimum wage of around VEF 7,422 would be worth only USD 9.2. Based on these calculations, the highest denominated banknote is worth only 13 US cents. This has made daily transactions challenging and shortages in banknotes have started to emerge. If liberalized, the exchange rate could on one hand help rebalancing the economy as exports would become very competitive at a global level. On the other hand, a massive capital flight would likely ensue and hyperinflation would even accelerate more if basic goods were immediately priced at actual market rates. Due to Venezuela’s heavy reliance on imports, such a sudden change could also lead to a complete breakdown in public order. The recently introduced third tier SIMADI might be an attempt to gradually move the official exchange rate closer to market. If hyperinflation continues at its current pace, the Bolivar Fuerte might lose its relevance as legal tender, as people turn to parallel currencies such as the US Dollar or the more readily available Colombian Peso and the economy would become dollarized, as happened in Ecuador. The expected move of the government to introduce bills of higher denomination instead of tackling the underlying causes of inflation will only add more fuel to the flame. It seems that history of hyperinflation as lived in the Weimar Republic or Zimbabwe is about to be repeated. The official exchange rate could not be farther from reality 8 4.2947 6.2921 6.2921 6.2921 0 1 2 3 4 5 6 7 Exchange Rate (VEF/USD) 30/09/10 30/09/14 30/06/15 30/09/15
  9. 9. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Equity Market The IBVC Index includes the 15 most liquid and highest capitalized stocks, trading on the Caracas stock exchange but is heavily weighted towards two components (Banco Provincial and Mercantil Servicios Financieros) that constitute 90% of the index. When savers face a hyperinflationary environment, the only way to somehow preserve capital is to either deposit holdings in a more stable foreign currency or to invest in inflation-linked financial assets or real assets of any kind. As capital controls make the former option close to impossible, Venezuelan investors’ only option left is the stock market; as companies are assumed to have some pricing power, stocks are expected to provide partial inflation-linkage through dividends and exposure to the real assets of the underlying companies. Venezuela’s apparent stock market rally (in spite of a slowdown over the third quarter) is thus not a reflection of a strong economy but rather the fact that equities are the only divisible asset that can be easily bought by investors; other assets with inflation protection such as property or land require far higher cash outlays and are more at risk of arbitrary expropriation by Venezuela’s government. Capital flight into real asset boosts stock performance 9 65.28 2908.99 12857.25 11872.87 0 2000 4000 6000 8000 10000 12000 14000 IBVC Index 30/09/10 30/09/14 30/06/15 30/09/15
  10. 10. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Relevant events over the quarter 10 In an apparent move to distract from domestic problems, President Maduro had the border between Venezuela and Colombia closed and had thousands of Colombians deported. President Maduro made unfounded claims that Colombian paramilitary forces were de-stabilizing his country when the problem is large scale smuggling due to price controls in Venezuela that have distorted large parts of its economy by imposing below market prices on goods such as gas. The real reason for the border closure was, however, Venezuela’s attempt to put pressure on Colombia not to extradite two Colombian drug traffickers to the United States who have information on the activity of Venezuela’s Cartel de los Soles which is said to include high-ranked members of Venezuela’s military and government. Venezuela has been accused of human right violations against Colombians in the country as many who were expelled were not given the opportunity to collect their belongings. The border closure led to a diplomatic standoff between both countries with Colombia’s President Santos pointing out that Venezuela’s “revolution” is self-destructive and its self-inflicted economic problems should not be blamed on Colombia. In its most recent October global economic update, the IMF warned that Venezuela could face a contraction of up to 10% for this year and 6% next year, making it the worst performing economy in the world. Inflation is estimated to go above 200% in the coming year. At the same time, the IMF confirmed that over the last 15 years, Venezuela has turned from Latin America’s fourth largest economy into its seventh largest economy after it was overtaken by Peru this year. In the meantime, shortages for basic goods are getting worse. According to a leaked government document, there are at least 15 food items and 26 hygiene products are hardly available with 70% of the visited store being out of stock. Examples are wheat flour, beef, milk powder and chicken as well as soap, diapers, shavers and toilet paper. At 67% of the stores visited, there were queues. After the dramatic sentencing of opposition leader Léopoldo Lopez on politically motivated charges, Manuel Rosales, another opposition leader, was arrested on similar dubious charges when returning from exile. Venezuela’s government was embarrassed when one of its state attorneys, Franklin Nieves who was involved in the Lopez case fled to the United States and declared that all the evidence against Lopez was fabricated and that Lopez was innocent. Concerning signs that Venezuela’s government will not hold a fair and free election in December emerged when its government refused to let observers from the Organization of American States (OAS) establish their election observation mission there. Nicolas Maduro also stated that the “revolution” will not be surrendered and that he would win at all costs, implying that the government might try to maintain its power by all means.
  11. 11. APPENDIX: LONG-TERM STATISTICS* 11 *Data as at 31/10/2015 but in some cases, the last data release was before then. The actual data is always the data that was made available for the last data release.
  12. 12. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Venezuela needs high oil prices to achieve sustained economic growth 12 -30.00 -20.00 -10.00 0.00 10.00 20.00 30.00 40.00 0 20 40 60 80 100 120 140 160 10/1/01 4/1/02 10/1/02 4/1/03 10/1/03 4/1/04 10/1/04 4/1/05 10/1/05 4/1/06 10/1/06 4/1/07 10/1/07 4/1/08 10/1/08 4/1/09 10/1/09 4/1/10 10/1/10 4/1/11 10/1/11 4/1/12 10/1/12 4/1/13 10/1/13 4/1/14 10/1/14 4/1/15 10/1/15 Oil Prices and GDP Growth Oil Price (LHS) GDP Growth (RHS)
  13. 13. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Unemployment holds steady but inflation has spiraled out of control 13 0 5 10 15 20 25 15 20 25 30 35 40 45 50 55 60 65 70 10/1/01 4/1/02 10/1/02 4/1/03 10/1/03 4/1/04 10/1/04 4/1/05 10/1/05 4/1/06 10/1/06 4/1/07 10/1/07 4/1/08 10/1/08 4/1/09 10/1/09 4/1/10 10/1/10 4/1/11 10/1/11 4/1/12 10/1/12 4/1/13 10/1/13 4/1/14 10/1/14 4/1/15 10/1/15 Inflation and Unemployment CPI Inflation (LHS) Unemployment (RHS)
  14. 14. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 The official exchange rate is far away from its fair market value 14 0 1 2 3 4 5 6 7 8 9 10 10/1/01 4/1/02 10/1/02 4/1/03 10/1/03 4/1/04 10/1/04 4/1/05 10/1/05 4/1/06 10/1/06 4/1/07 10/1/07 4/1/08 10/1/08 4/1/09 10/1/09 4/1/10 10/1/10 4/1/11 10/1/11 4/1/12 10/1/12 4/1/13 10/1/13 4/1/14 10/1/14 4/1/15 10/1/15 Exchange Rate (VEF/USD) Exchange Rate (VEF/USD)
  15. 15. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 An alternative approach to calculate the exchange rate shows how weak the Bolivar Fuerte has really become 15 50 70 90 110 130 150 170 190 210 230 250 270 290 310 330 350 370 390 410 430 450 470 490 510 530 550 570 590 610 630 650 670 690 710 10/1/01 4/1/02 10/1/02 4/1/03 10/1/03 4/1/04 10/1/04 4/1/05 10/1/05 4/1/06 10/1/06 4/1/07 10/1/07 4/1/08 10/1/08 4/1/09 10/1/09 4/1/10 10/1/10 4/1/11 10/1/11 4/1/12 10/1/12 4/1/13 10/1/13 4/1/14 10/1/14 4/1/15 10/1/15 Exchange Rate (Broad Basket vs VEF) Exchange Rate Broad Basket
  16. 16. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Markets are positioned for a possible sovereign default of Venezuela 16 11 12 13 14 15 16 17 18 19 10/1/10 4/1/11 10/1/11 4/1/12 10/1/12 4/1/13 10/1/13 4/1/14 10/1/14 4/1/15 10/1/15 10 Year Government Yield 10 Year Government Yield
  17. 17. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Hunt for investable assets in a hyperinflationary environment pushes Venezuelan equity markets to astronomical levels 17 0 1000 2000 3000 4000 5000 6000 10/1/02 4/1/03 10/1/03 4/1/04 10/1/04 4/1/05 10/1/05 4/1/06 10/1/06 4/1/07 10/1/07 4/1/08 10/1/08 4/1/09 10/1/09 4/1/10 10/1/10 4/1/11 10/1/11 4/1/12 10/1/12 4/1/13 10/1/13 4/1/14 10/1/14 4/1/15 10/1/15 IBVC Equity Index IBVC Equity Index
  18. 18. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Industry is negatively affected by government intervention and exchange controls 18 -50 -30 -10 10 30 50 70 90 110 130 150 10/1/03 4/1/04 10/1/04 4/1/05 10/1/05 4/1/06 10/1/06 4/1/07 10/1/07 4/1/08 10/1/08 4/1/09 10/1/09 4/1/10 10/1/10 4/1/11 10/1/11 4/1/12 10/1/12 4/1/13 10/1/13 4/1/14 10/1/14 4/1/15 10/1/15 Industrial Production Industrial Production
  19. 19. VENEZUELA–QUARTERLYECONOMICSUPDATE–Q32015 Contact & Disclaimer 19 In preparing this report, I have relied upon publicly available data supplied by third parties. Although reasonable care has been taken to gauge the reliability of this data, this report carries no guarantee of the accuracy or completeness and I cannot be held accountable for misrepresentation of data by third parties involved. This report is an opinion piece and for private information and is for discussion purpose only. This report does not constitute financial advice and should therefore not be used as a basis to make any decisions. This report is based on data and information available at the date of the report and takes no account of subsequent developments after that date. It may not be modified without my prior written permission. Under no circumstances do I accept responsibility for any consequences arising from any third party relying on this report or the opinions expressed therein. This report is not intended to form a basis of any decision by a third party to do or omit to do anything. This report has been written in private capacity and any opinions expressed therein should not be associated in any way with my current or previous employers or any professional organizations I belong to. If you have any questions or comments on this report, please feel free to contact me. Third Party sources that have been used are Banco de Venezuela and Bloomberg. Christian von Canstein, MSc Email: