ARTICLE from FORBES ON THE ECONOMIC OUTLOOK FOR VENEZUELA AND THE MOODY DOWNGRADE> INVESTING 1/13/2015 @ 10:16PM 86,353 views The Impending Collapse Of Venezuela Comment Now Follow Comments On Tuesday January 13th, the ratings agency Moody’s downgraded Venezuela to Caa3, one step above default. This comes as no surprise – markets have been pricing in the likelihood of default for some time now. Curiously, though, Moody’s changed the outlook from negative to stable: The stable outlook is based on Moody’s view that even if the oil price drops further, expected losses to bondholders are likely to be consistent with a Caa3 rating and unlikely to reach levels associated with lower ratings. This is too generous. Moody’s assessment assumes that Venezuela’s problem is mainly a balance of payments crisis caused by a rapidly falling oil price and inadequate foreign reserves. But the reality is different – and far worse. The balance of payments problem is bad enough. The falling oil price is causing a widening foreign exchange gap. Venezuela needs an oil price of $100 per barrel to balance its external accounts, but oil is falling rapidly towards $40 per barrel and so far, Venezuela has failed to persuade other oil producers to reduce production in order to support the price. Venezuela’s foreign exchange outflows now substantially exceed its inflows, not least because it is supporting a complex and unhelpful exchange rate system: its US$ reserves are down to $22bn and falling fast. Venezuela will probably attempt to staunch the bleeding with tighter price and exchange controls, but all this will do is accelerate demonetization of the economy as more and more trading shifts to the black market. But the real issue is Venezuela’s domestic economic problems. Venezuela has been in deep recession for most of the last year. Its budget deficit in October 2014 – before the most recent catastrophic oil price falls – was 17%. Inflation is officially at 65%, unofficially probably far more. Import controls, inflation and the overvalued bolivar are causing shortages of essential goods. Empty shelves in a Venezuelan store. Photo credit: CIPE Empty shelves in a Venezuelan store. Photo credit: CIPE Shortages are nothing new in Venezuela. Indeed, a shortage of toilet paper has been the subject of global amusement for quite some time. But recently, the shortages have become much worse. Last week, a government official was jeered for saying that long lines indicated that “Venezuela has plenty of food”, when rows and rows of empty shelves in stores were telling a different story. Bloomberg reports that people are queueing overnight for necessities such as soap, milk and diapers. This is very dangerous. Venezuela is already one of the most violent societies on earth. And when shortages start to affect little children, people get angry. Fearful of public unrest escalating into something more serious, the government has now deployed troops to control queues of disgruntled shoppers at the country’s half-empty stores. And it has introduced a system of rationing, limiting shoppers to two days per week at government-controlled stores. As Bloomberg cynically put it, “Venezuela reduces lines by trimming shoppers, not shortages”. President Maduro returned empty-handed from his recent whirlwind global tour: China didn’t want to lend him any money, and oil producers didn’t want to cut production. However, he does seem to have swung some sort of financing deal with Qatar to soften the balance of payments problem. But in his absence, his opponents seized the opportunity to liven things up. Claiming that the country was “in a state of emergency”, the opposition leader Henrique Capriles called for people to “mobilize in the streets”. It is all too easy to see where this is headed. Why Does Venezuela Think Russia Is Its Friend? Continued from page 1 Comment Now Follow Comments But more worrying is this chart, which shows that a large proportion of the import increase is uncoded – i.e. not subject to exchange controls: Venezuela sector 99 It seems that despite repeated reforms to the exchange rate system to combat unofficial trade and fight associated inflation, the black market is thriving in Venezuela, and much of it comes from Russia. But Russia is supposed to be Venezuela’s friend, isn’t it? Friend, indeed. Uncoded trade is regarded as a proxy for under-the-counter arms deals. And the close correlation between uncoded and sector 99 trade suggests that the deals are official. Venezuela’s arms imports from Russia are reportedly zero. But in reality, Venezuela is estimated to have been responsible for three-quarters of all Russian armament purchases in Latin America in the last decade. In 2011, the Mosow-based Center for Analaysis of World Arms Trade (CAWAT) reported that Venezuela was Russia’s largest purchaser of armaments for ground forces. Russia has also been helping Venezuela to develop its own arms manufacturing capability: I suppose you could call this “foreign direct investment”, of a sort. But the huge increase in uncoded imports from Russia represents a substantial loss of dollar income for Venezuela. The fact is that Russia has been draining dollars from Venezuela for the last five years. The loss of dollars is one of the factors threatening to bankrupt Venezuela. Some friendship. In reality, the friendship is largely one-sided. Arms sales, official or not, have only one objective as far as Russia is concerned: gaining access to Venezuela’s oil revenues. And bears can turn very nasty when they don’t get what they want. The “friendship” will evaporate like the morning mist if those dollar flows are impeded or stopped. So whatever reforms are announced on January 3rd are unlikely to include anything that would upset President Putin. Maduro’s remark that the reforms would “perfect” the exchange rate system is ominous. It needs abolishing, not perfecting. But I fear that what will be introduced is more complexity: perhaps a fourth or even a fifth tier and more price and import controls (which Russian “friends” can evade). Meanwhile the dollars that Venezuela desperately needs will continue to drain away, domestic scarcities will get worse, inflation will continue to rise and essential bills will not be paid. Maduro will no doubt continue to construct conspiracy theories to explain away Venezuela’s dire situation and shore up his crumbling popular support. But the reality is economic mismanagement on an epic scale. Venezuela has the largest oil reserves in the world, but it is frittering away the income from them on armaments, vanity projects and – above all – maintaining an utterly unrealistic valuation for its national currency. It is tragic that Venezuela is repeating the mistakes of the past – not only its own, but those of other Latin American countries too. High budget deficits and unrealistic currency valuations always end the same way: depleted foreign exchange reserves, default and painful restructuring. Russia will not protect Venezuela from the consequences of its folly. Nor will China. They may look friendly, but in the end they are only interested in themselves. They will bleed Venezuela dry if it suits them. The people of Venezuela deserve better than this. Devaluation and fiscal reform is urgently needed before it is too late. Bring it on. Source: Forbes. Frances Copola
Posted on: Thu, 15 Jan 2015 22:03:52 +0000