Chavez Campaign Spending Boom Seen Spurring 31% Devaluation

Chavez Spending Boom Seen Spurring 31% Devaluation Post-Election
After leaving the official rate unchanged for five years, Venezuela President Hugo Chavez devalued the currency in January 2010 and threatened businesses with expropriation if they raised their prices. Photographer: Noah Friedman-Rudovsky/Bloomberg

Venezuela will devalue the bolivar for the third time in as many years after October elections to help narrow a budget deficit swelled by President Hugo Chavez’s spending binge, according to a survey of analysts.

The government will weaken the official rate 31 percent to 6.2 per dollar in the first quarter, generating more revenue in local currency from each dollar of oil exports, according to the median estimate of 14 analysts surveyed by Bloomberg. Venezuela, Latin America’s largest oil exporter, boosted spending 34 percent in the first half from a year earlier, and Bank of America Corp. forecasts the deficit will almost double to 7.8 percent of gross domestic product by the end of 2012.

“The bolivar is the most overvalued currency in Latin America,” said Juan Pablo Fuentes, an economist at Moody’s Analytics Inc. in West Chester, Pennsylvania, who predicts the bolivar will fall to 5.3 per dollar in the last quarter of this year from the current 4.3. “They don’t care about competitive exchange rates, but they do care about government revenue.”

The devaluation will contribute to a recession next year as oil, which accounts for 95 percent of export revenue, falls and limits government investment in housing, a pillar of Chavez’s re-election campaign that helped drive 5.6 percent growth in the first quarter, according to Bank of America’s Francisco Rodriguez. Chavez, a 58-year-old former paratrooper, leads challenger Henrique Capriles Radonski in most voter polls.

Officials at the central bank and Finance Ministry, who asked not to be identified in accordance with government policy, declined to comment on the possibility of a devaluation after the vote.

Currency Peg

The bolivar has weakened 63 percent since it was first pegged to the dollar in 2003 following a two-month general strike that drove the economy into recession and caused Venezuelans to pull assets out of the country, draining reserves by $1.2 billion to $11.3 billion. Over the past nine years, government spending has been sustained by a tripling in crude prices. Venezuelan oil, which accounts for about half of government revenue, may fall next year to an average $100 a barrel from $105.75 this year, Rodriguez said in a June note.

Brent oil will average $111.90 a barrel in 2013, in line with its $112.01 average so far this year, according to the median estimate of 37 analysts surveyed by Bloomberg. Brent is a benchmark for Venezuela’s export basket.

“The Venezuelan government has been undertaking a highly expansionary fiscal policy while trying to maintain a strong exchange rate to avoid the political cost of an adjustment before October’s presidential election,” Alejandro Arreaza and Alejandro Grisanti, analysts at Barclays Plc, wrote in a July 24 report.

Post-Election Moves

Should Chavez win re-election, Venezuela’s situation would be similar to 1988, when fiscal shortfalls forced President Carlos Andres Perez to push through economic reforms following an election that he won with a 12 percentage point margin, Bank of America’s Rodriguez said. The next year, Perez implemented an International Monetary Fund-sponsored plan to raise fuel and transport prices while allowing the bolivar to float. The cost-of-living increases ignited riots that left hundreds of people dead, and became known as the “Caracazo.”

Chavez, who has had three operations related to an undisclosed form of cancer in the past 14 months, will avoid the kind of price increases that set off demonstrations by devaluing the currency instead, Rodriguez said.

“With a single decree you can increase government revenue by 30 to 40 percent, so there’s a huge temptation to do that,” said Rodriguez, who predicts the bolivar will be devalued 43 percent to 7.5 per dollar. “What they associate with the Caracazo is increases to gasoline prices and removing price controls. That’s something they won’t do.”

Sitme Rate

Venezuela will also devalue the rate at the central bank’s Sitme currency market by 18 percent to 6.5 per dollar, according to the median estimate of 11 analysts surveyed by Bloomberg. Sitme is used by individuals and companies that can’t obtain access to foreign currency through the Foreign Currency Board known as Cadivi at the official rate.

People who aren’t able to access foreign currency through either market pay as much as 9.32 per dollar in a black market, according to Lechuga Verde, a blog that tracks the rate.

Visa Inc., the world’s biggest payments network, expects there to be a devaluation in Venezuela, Chief Financial Officer Bryon Pollitt said on a July 25 conference call. Visa isn’t able to hedge against a devaluation, he said.

Bond Returns

“The outlook for devaluation I would say is -- nothing’s a certainty, but at some point, it looks like we’re heading to that,” Pollitt said. “So is that a bit of a drag on our Latin America business? Yes.”

Venezuelan dollar-denominated bonds have returned 19 percent this year as investors seek higher yielding assets amid near-zero rates in the U.S. and Europe and on speculation that Chavez’s battle with cancer may accelerate a change in government. The notes have handed investors the best return in emerging markets this year after Ivory Coast, according to JPMorgan Chase & Co.’s EMBI Global index.

The yield on Venezuela’s 9.25 percent benchmark bonds due in 2027 fell 17 basis points, or 0.17 percentage point, to 11.56 percent at 4:30 p.m. in Caracas, according to data compiled by Bloomberg. The bond’s price rose 1.01 cent to 83.64 cents on the dollar.

‘Big Negative’

“A devaluation is a big negative for bondholders because your debt-to-GDP ratio just doubled,” Alfredo Viegas, the managing director for emerging markets at Knight Capital in Greenwich, Connecticut, said in a phone interview. “But it’s viewed as positive contextually because the economy becomes more competitive in theory.”

Chavez had 47 percent support against 30 percent for Capriles in the most recent poll conducted by Caracas-based Hinterlaces, which surveyed 1,500 people from July 4 to July 14. The survey had a margin of error of 2.7 percentage points.

“The status quo expectation in the market right now is that he’ll make it through the election and that he’s going to win,” Viegas said of Chavez.

Chavez, who has declared himself “totally free” of illness after undergoing three operations related to cancer in his pelvis, says that he will win re-election in a “knock out” to extend his term in office through 2019.

Capriles, a 40-year-old former governor, says that as president he would gradually undo currency controls while inviting foreign investors to develop the world’s largest oil reserves.

Opposition Plans

The winner of the Oct. 7 vote will be sworn in Jan. 10.

“If the opposition wins there would be a devaluation, but it would come along with a change to the currency system that would keep some controls while announcing a medium-term plan to get rid of them,” Fuentes said.

Chavez said on July 11 that he began talks with Finance Minister Jorge Giordani about the average exchange rate and oil export basket price to be used in the drafting of the 2013 budget, without providing more details.

After leaving the official rate unchanged for five years, Chavez devalued the currency in January 2010 and threatened businesses with expropriation if they raised their prices. The latest move, when Chavez eliminated a preferential exchange rate offered to some importers, was announced in the midst of New Year’s celebrations on Dec. 30, 2010.

“In Venezuelan history you never devalue before an election, and when it’s extremely unpopular they announce it on a Friday before a holiday weekend,” Bank of America’s Rodriguez said. “You devalue when you believe you have enough political capital to offset short-term costs.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE