Venezuela - Economic Briefing February 2002

Political Instability Mounts as Economic Prospects Worsen and Currency Drops

President Chávez is facing an increasingly hostile opposition, as popular unrest mounts and the President’s popularity dwindles. Meanwhile, the recent decline in oil prices is undermining economic activity, already plagued by low investment and persistent capital flight. Declining confidence in international and domestic markets is mounting pressure on the exchange rate, which experienced one of its strongest declines in the past month.

Currency pressure mounts as reserves drop and confidence dwindles further

Mounting political instability as well as a lack of adequate economic policy measures to restore investor confidence and stem the persistence of capital flight are undermining Venezuela’s international reserve position.  The combination of accelerated capital flight combined with a scenario of lower oil prices is prompting investors to question the sustainability of the government’s current economic policy framework, particularly to overvalued bolivar.  The Central Bank has been able to maintain the currency stable with the bolivar depreciating just 0.2% in January.  However, the currency has plummeted in the first week of February dropping 3.6% through 8 February – one of the biggest weekly declines observed since 1996.  The cost of declining confidence in terms of international reserves and interest rates has been high.  Central Bank data indicate that international reserves dropped by US$ 1.2 and US$ 1.8 billion in December and January respectively and declined by an additional US$ 309 million through 8 February.  In addition, the Central Bank has had to raise its discount rate five times since 13 December from 35% to 50% to curtail the US$ outflow.  The persistence of the current international reserve loss may force the government to either adopt capital and exchange controls or consider an adjustment to the current currency regime.  Panellists expect the exchange rate to depreciate strongly this year, well above the 10.0% envisioned by the current exchange rate regime.  It is also important to note, that some panellists apparently do not expect the currency band to hold this year, anticipating a devaluation of the bolivar. 

Government financing dries up as market conditions worsen

The Venezuelan country risk premium, as measured by the J.P. Morgan EMBI+ spread of the benchmark sovereign debt over comparable US Treasuries, widened by 103 basis points in January and an additional 77 basis points through 8 February.  Venezuela’s spreads are now the second highest in the world after crisis-ridden Argentina.  As a result of the continued deterioration in Venezuelan fundamentals, Fitch Ratings decided to downgrade Venezuela’s foreign currency denominated debt from ‘B+’ to ‘B’.  Fitch claims that the recent deterioration in oil prices is likely to affect Venezuela’s fiscal balances and that the resulting increase in the fiscal deficit will significantly raise the country’s financing requirements, which the rating agency claims could reach 8% of GDP this year (assuming a fiscal deficit of 4.2% of GDP and the balance in debt amortization payments).  The Consensus expects the fiscal deficit to reach to a level, which would raise financing needs by an additional 0.7% of GDP, or US$ 1.0 billion.  The Fitch scenario assumes that Congress will approve the government’s legislative proposal to levy a new 0.75% bank debit tax, impose a luxury tax and eliminate exemptions to the 14.5% value-added tax.  In the event that the legislation fails, financing requirements could rise up to 10% of GDP.  An easing of the current exchange rate regime could serve to bolster fiscal accounts, since public revenues depend heavily on US$-based revenues, principally from oil income, which finances predominantly bolivar based expenditures.  However, if authorities decide to maintain the current crawling peg, oil prices remain subdued and capital market conditions remain adverse, then external financing is likely to dry up and force the government to dig into the US$ 6.2 billion in resources of the Investment Fund for Macroeconomic Stabilization (FIEM) or to make spending adjustments in a time when popularity is waning and pressures to open the public purse remain strong.

Growth likely to remain subdued as oil price unlikely to recover strongly

In the past year, the public sector has provided for the lion share of the boost that the economy experienced, as political uncertainty and policy ambiguity have kept private sector activity subdued.  The oil price continued on the downward trend observed since September of last year.  The oil price for the Venezuelan basket of crude oil dropped further in January from US$ 16.30 per barrel at the end of December to US$ 15.35.  The oil price recovered a bit through 8 February to reach US$ 16.01 per barrel but still remains 32.6% below levels in January last year.  Participants expect the more subdued price levels to persist this year with the average price closing the year at US$ 16.90, which will is well below the government’s 2002 budgeted price of US$ 18.00 per barrel.  The Finance Ministry has announced that the decline in oil revenues may require budget cuts in the order of 7-10%.

As a result of the drop in the oil price, economic activity is expected to decelerate significantly.  Growth is forecast at 0.9 percentage points below last month's projection.  Several participants expect the economy to enter into recession this year with the contraction ranging from 0.6% to 2.0%.

Note:  The above text is an abridged version of the LatinFocus Consensus Forecast briefing on Venezuela.  For more details please click here.

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