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02/27/2013

Venezuela (2013): No Surprise, No Relief

Daniel Volberg, New York.

This article appeared in the February 2013 issue of Current Economics with permission of the author.

Key Concepts: Devaluation | Exchange Rate | Bolivar Fuerte

Key Economies: Venezuela

Venezuela (2013): No Surprise, No Relief

While the precise timing of Venezuela’s move to devalue the bolivar fuerte from 4.290 to 6.292 was unknown, the move had long been anticipated by Venezuela watchers as well as by the parallel rate (see Exhibit 1, below). And while the aim of the devaluation announced on Friday, February 8 was to shore up a deteriorating fiscal balance and stimulate an economy that has been suffering from significant shortages of basic goods in recent months, we are skeptical on both fronts. Indeed, our initial reading from the timing of the move is that it demonstrates that the authorities feel comfortable that they have solidified their base and that they expect they will be able to avoid having to call an election any time soon even in the event that the president’s situation deteriorates further.

While we believe that the devaluation was long overdue, we doubt that it will be enough to arrest the macro deterioration in Venezuela. We would highlight three macro and political economy impacts of the devaluation.

Too Little, Too Late
First, even after the 32% devaluation, we estimate that the exchange rate remains overvalued. While the devaluation was expected early in the year, the move on Friday February 8th falls short of expectations. We had been forecasting a devaluation to 7.50 based on accumulated inflation since the previous devaluation in 2010. Indeed, a simple real effective exchange rate-based model of equilibrium exchange rate suggests that, unlike the previous devaluation, the early February move fell short of what was necessary (see Exhibit 2, below).

 

The devaluation has so far failed to arrest the slide in the parallel exchange rate, which is now trading at nearly Bs$23/dollar (see Exhibit 1). While in our view that level may be artificially weak – driven partly by rationing of hard currency to certain sectors of the economy, it still signals that even post devaluation the official exchange rate remains misaligned. Furthermore, the decision to eliminate the SITME system for international bond trading reduces an important source of hard currency previously available at the 5.3/dollar exchange rate. Importers in need of hard currency are now left with the National Currency Commission (CADIVI) that has a track record of dragging out for many months the process of filling requests.

No Course Correction
Second, we suspect that the devaluation is insufficient to provide a course correction to Venezuela’s economy. We are concerned that Venezuela’s fiscal, inflation, balance of payments and growth dynamics all are likely to remain under stress.

We doubt that the devaluation is big enough to turn around Venezuela’s troubled public finances. While there is a paucity of up to date fiscal data in Venezuela, we estimate that the maximum potential improvement in the fiscal accounts due to the devaluation is roughly 2.7% of GDP and indeed we suspect that the likely impact is closer to 1% of GDP. While devaluation provides more bolivares fuertes for every dollar of oil revenue, Venezuela has seen an important increase in US dollar-denominated expenditure. Whichever estimate turns out to be right, it is far short of the needed adjustment. After all, in 2011, before last year’s election-related spending binge, Venezuela posted a fiscal deficit of -11.6% of GDP; a fiscal deficit greater than the budget shortfalls of all the other major economies in the region combined. And during 2012 – an election year – the fiscal results only deteriorated as spending soared. We are estimating that the fiscal shortfall in 2012 may have exceeded 12% of GDP despite elevated oil prices.

 

Nor does the devaluation materially alter the trade-off between inflation and shortages of basic goods.
Venezuela has seen an important reduction in inflation last year, but it has been accompanied by increasing shortages of goods. We expect inflation to pick up from the 20.1% posted last year. How much inflation will rise will depend on the efficiency with which authorities allow importers to access dollars, with less efficient access to dollars likely translating in less inflation at the cost of more persistent shortages – repressed inflation. After all, since November 2012, the dramatic reduction in SITME operations in supplying hard currency to importers was associated with a dramatic increase in shortages that hit the highest level since early 2008 (see Exhibit 3, above).

And the devaluation is unlikely to alleviate materially the dollar shortage in Venezuela. Official data reporting large current account surpluses appear inconsistent with independent estimates of Venezuela’s oil exports, dramatic decline in reserves and the large increase in external debt. Our estimate of an adjusted current account based on a combination of official data and independent estimates of Venezuela’s oil exports suggests that Venezuela’s balance of payments may be posting a current account deficit rather than the official surplus. That would help explain the dollar shortage prevalent in Venezuela. One way devaluation could potentially alleviate such a shortage is through reducing the demand for imported goods by making them more expensive. However, we suspect that this is unlikely to be a meaningful effect given that an increasingly interventionist state has curtailed domestic production of substitutes for many of the imported goods. Thus, until policymakers engineer a more wholesale policy regime change, we expect Venezuela will continue to rely on imports to satisfy domestic demand.

Nor do we expect the devaluation to relieve the dollar shortage by boosting exports. The combination of a still overvalued exchange rate with an inhospitable business climate means that we do not expect the devaluation to translate into a material increase in non-oil exports.

The only good news is that the devaluation’s impact on activity is likely to be modest – we expect no recession. Subdued but positive growth remains our base case scenario. After all, we expect solid domestic demand, financed in part by continued public sector largesse.

No Regime Change, No Elections
Third, while the devaluation is unlikely to provide a course correction to the economy, it does signal that regime change in Venezuela appears unlikely anytime soon. The timing of the devaluation – two months after the president left the country for cancer treatment in Cuba and one month after the Supreme Court ruled that he can effectively stay there indefinitely – suggests that the political establishment now feels secure about their ability to maintain control.

Furthermore, given the likely inflationary consequences of the devaluation, we suspect that it is evidence that authorities are not contemplating elections anytime soon. Indeed, the week before the devaluation, the authorities postponed the upcoming municipal elections from April to mid-July. Some Venezuela watchers continue to expect elections this year given that the constitution mandates elections 30 days after the president is found permanently absent. We suspect that the decision to devalue suggests that the political establishment is comfortable that the president’s health is sufficiently manageable that such an event remains highly unlikely.

Forecast Changes
In light of the devaluation we are revising our macro outlook for 2013 and 2014. We revise our currency forecast to 6.30, from 7.50 for both 2013 and 2014. In addition we are revising GDP growth in 2013 to 1.9% (from 2.1%) and in 2014 to 2.5% (from 1.7%). And for inflation we revise 2013 to 26.2% (from 27.2%) and 2014 to 27.9% (from 31.0%). We update all the other main macro forecasts in line with these changes (see Exhibit 4, above).

Financing Challenge
With the devaluation out of the way, the next big risk in Venezuela is likely the need to finance debt service, which is set to pick up in the second half of the year. After all, this year Venezuela’s debt service is set to nearly double relative to last year (see Exhibit 5, below). But after the Chinese reportedly declined to provide fresh financing in January, Venezuela needs to find another funding source. Notwithstanding announcements of a joint venture with Russia’s state oil company, it is unclear how much appetite there is for significant international investment in Venezuela. If true, it is increasingly likely that the authorities will turn to the international bond markets for financing in the months ahead.

Bottom Line
While some may argue that the devaluation is a signal that the authorities are now committed to a much-needed series of economic adjustments, we are less optimistic. We fear that the move signals that the macro dynamic in Venezuela has deteriorated significantly beyond the picture portrayed in official data and is likely to be closer to our assumptions. In that case, the devaluation, while needed, is unlikely to represent the beginning of the kind of course correction that Venezuela needs. Indeed we suspect that the move also signals a newfound degree of confidence among the political establishment that it will likely remain firmly in control with limited concerns over the risks of a regime change or the need for new elections.

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