Chavez 67% Spending Surge Sets Up Devaluation After Vote

Venezuelan President Hugo Chavez’s 67 percent increase in government spending is setting the stage for a currency devaluation after national elections next month. Photographer: Tomohiro Ohsumi/Bloomberg

Venezuelan President Hugo Chavez’s 67 percent increase in government spending is setting the stage for a currency devaluation after national elections next month.

As the 58-year-old president boosts wages and builds houses for the poor to win a third term, the bolivar is tumbling in unregulated markets to a level 62 percent weaker than the regulated exchange rate, compared with a 50 percent difference at the end of 2011. Most individuals and businesses now pay 11.19 bolivars per dollar versus 8.63 at the start of the year and the fixed 4.3 bolivar official rate.

Chavez’s August spending surge is swelling the budget deficit that will compel him to devalue the currency after the vote to bolster revenue from oil exports and shore up government finances, according to Barclays Plc and Bank of America Corp., which said in a report yesterday that spending grew 41 percent on an inflation-adjusted basis. Chavez is favored to win the race against Henrique Capriles Radonski, according to the latest poll by Datanalisis, giving him another six-year term to deepen his revolution with more state control of the economy.

“The market is pricing in an imminent currency devaluation in 2013 regardless of who wins,” said Carlos Fuenmayor, the Miami-based chief executive officer of BancTrust & Co., an investment advisory firm.

The government and state-run oil company Petroleos de Venezuela SA have been providing foreign currency to a central bank market at a second official exchange rate of 5.3 bolivars per dollar. Investors in the market buy dollar-denominated bonds locally with bolivars, then sell the securities abroad for U.S. currency.

Dollar Demand

This year, the government has only sold local currency debt and PDVSA’s one sale, a $3 billion offering, was allotted to the central bank and state-run banks in a private placement, fueling dollar demand in the unregulated market.

Venezuela supplies a limited amount of dollars at the official rates to meet import needs. Those who aren’t given approval to buy dollars at those rates turn to the unregulated market.

Chavez, who first imposed exchange controls in 2003, said Sept. 11 that he has no plans to devalue the official rate and that the economy is stable. “Our currency policy is working,” he said at a press conference in Caracas.

In 2010, the government shut an unregulated currency market administered by brokerages in a bid to clamp down on imports that were adding to surging inflation, closing it when the exchange rate hit 8.2 per dollar. The bolivar weakened 4 percent last year, according to Lechuga Verde, ending 2011 at 8.63 per U.S. dollar.

Jail Time

A weaker exchange rate bolsters the amount of bolivars Venezuela gets from oil exports, which are sold for dollars and generate 95 percent of the country’s export revenue.

Central bank President Nelson Merentes told Chavez in August 2011 when asked about the unofficial rate that it was “under control.” The government prohibits local media from publishing or talking about specific rates for the bolivar beyond the official price, while the trading of dollars outside regulated channels is punishable by fines and jail.

Venezuelans have turned to using new names to talk about dollars such as “lechuga,” which means lettuce, to skirt the government’s rules.

2011 Deficit

Officials at the central bank and Finance Ministry didn’t reply to e-mails and telephone calls seeking comment on the possibility of devaluation or the rise in government spending.

Venezuela’s central government reported 42.4 billion bolivars ($9.8 billion) of spending in August, excluding public debt payments, compared with 25.5 billion bolivars the same period a year earlier, according to the National Treasury website. Venezuela posted a deficit of 4 percent of gross domestic product in 2011, the latest figures available from the Finance Ministry.

“The government had been able to control the rate mostly through dissuasion of the largest buyers due to the legal uncertainty and with a lot of bond sales, but this year there hasn’t been an escape valve,” Alejandro Arreaza, an economist at Barclays in New York, said in a phone interview. “On top of that there are expectations of a devaluation and everyone is going out to cover themselves.”

Yield Spread

The extra yield investors demand to hold Venezuelan debt over U.S. Treasuries surpassed Argentina yesterday for the first time since Aug. 1 and became the highest among major Latin American nations. Venezuela’s yield spread widened 13 basis points to 963, or 9.61 percentage point, as of 1:11 p.m. in Caracas, while Argentina’s fell 15 basis points to 929, according to JPMorgan Chase & Co.’s EMBI Global index.

While the bolivar’s slide has accelerated in the unregulated market, Chavez has managed to slow annual inflation for nine consecutive months to 18.1 percent in August by having the government step up imports of food at the official rate. Food accounts for 37 percent of the inflation index, the largest weight on the price gauge.

Chavez has devalued the official exchange rate twice since 2010, from 2.15 to the current 4.3 rate, while maintaining the central bank’s currency market rate of 5.3 since its inception in June 2010 to replace the shuttered brokerage market.

Venezuela will devalue the bolivar 31 percent to 6.2 per dollar in the first quarter of 2013, according to the median estimate of 14 analysts surveyed by Bloomberg in July. The central bank rate will be weakened 18 percent to 6.5 per dollar, according to the average estimate of 11 analysts.

‘Parallel Market’

Executives from Visa Inc. and Procter & Gamble Co. have said this year that they’re expecting a devaluation after the elections. Arcos Dorados Holdings Inc., the operator of McDonald’s restaurants in Latin America, had been raising prices in line with the unregulated exchange rate of the bolivar, Chief Executive Officer Woods White Staton said on Aug. 7.

“We’ve raised prices to cover the cost of importing things in Venezuela,” Staton said during a teleconference. “We’ve got much higher prices to cover the - to reflect - the value of the money on the parallel market at which our imports are brought into the country.”

Chavez, who says that it’s “impossible” for him to lose the election and that the only variable is how wide of a margin of victory he obtains, has bolstered government spending on wages and social programs to curry favor with voters.

Latest Poll

Chavez had 43.1 percent support compared with 30 percent for Capriles in a Datanalisis poll taken between Sept. 3 and 8. The poll, which surveyed 1,200 people by telephone, had a margin of error of 2.8 percentage points.

The 58 percent annual surge in the money supply, as measured by the M2 monetary gauge, helped weaken the currency, according to Francisco Rodriguez, a New York-based economist at Bank of America Merrill Lynch.

“The black market exchange rate essentially responds to excess liquidity,” he said in a telephone interview. “That’s a sign that the government is in the midst of its last stretch of the campaign and is spending as one would expect it to.”

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