GS on Venezuela: Bad to Worse

The performance of real activity deteriorated significantly since late 2008 as the decline in oil export revenue exposed brewing imbalances that had been contained by a wall of liquidity during 2003-08. Under the weight of years of interventionist policies, hopeless central planning, lax fiscal and monetary policies, and currency misalignment, the economy is now experiencing clear symptoms of Dutch Disease (withering of non-commodity tradable sectors of the economy) and stagflation (inflation remains high despite the ongoing severe contraction of the economy).

Real GDP declined a large 5.8% yoy during 1Q2010 (the same magnitude of yoy decline recorded during 4Q2009 and the fourth consecutive quarterly yoy decline). This is line with our -5.5% yoy forecast. There are, however, lingering doubts whether the official statistics are currently capturing the full extent of the real economic contraction. Activity during 1Q2010 was impacted by serious emery supply issues, difficulties in accessing foreign exchange to finance imports critical for the many production chains, and the growing burden of macro and micro inefficiencies.

The very poor performance of real GDP during 1Q2010 was driven the very large 17.8% yoy decline in domestic demand. Private consumption declined -5.9% yoy during 1Q (-6.7% yoy during 4Q), and investment spending retrenched a very large -27.9% yoy (from -19.6% yoy during 4Q). Public consumption posted a marginal -0.2% yoy variation during 1Q. Private consumption spending continues to slow down as entrenched inflation (average core inflation above 34% yoy during 1Q2010) is eroding real disposable income and credit growth is decelerating fast while investment has been impaired by a business-unfriendly policy mix.

The external sector prevented a deeper contraction in real GDP, but the level of import repression is unsustainable. Exports declined 8.1% yoy in real terms during 1Q2010; we highlight that over the last 17 quarters only once did real exports show a positive yoy growth rate, which attests to the growing lack of competitiveness of the Venezuelan economy. The retrenchment of imports reached a very high -39.7% yoy during 1Q, driven by declining domestic demand and the limitations imposed by CADIVI in the delivery of dollars to the economy. Due to the very sharp decline in import penetration the contribution of the external sector (net exports) to growth reached a whopping +12.0 percentage points of GDP during 1Q2010. That is, was it not for the external sector the economy would have contracted in double digits.

Non-oil GDP growth decelerated to -4.9% yoy during 1Q2010 from -4.0% yoy during 4Q2009. The oil sector declined 5.0% yoy during 4Q2009.

On the supply side, the most dynamic sectors during 1Q were allegedly communications (+9.7%) and government services (+2.8% yoy). The contraction of manufacturing production accelerated to -9.9% yoy. Again, the non-tradable sectors of the economy were the most dynamic—which is symptomatic of Dutch disease triggered by the significant appreciation of the real exchange rate—but even the non tradable activity posted a significant contraction from a year ago.

Comment: (-) Venezuela is currently trapped in a bad stagflation equilibrium. In addition, in recent months, distressed monetary and FX dynamics have taken center stage. In fact, while all other economies in the region are currently experiencing a solid cyclical recovery (even in countries that are pursuing heterodox policy experiments, such as Argentina), Venezuela is still mired in a protracted recession despite favorable oil prices, and nominal variables (such as inflation and the VEF) have developed a worrisome drift. Finally, the policy approach is turning definitely more state-centered and private sector-unfriendly as we move closer to a classic command economy. These developments are understandably raising concerns about the medium-term outlook for the credit.

Lax fiscal and monetary policies, a policy framework and official rhetoric that discourage domestic and foreign investment, stifling regulation that distorts the optimal allocation of resources, and weak protection of property rights and the sanctity contracts, are just a few examples of the broad range of problems facing the economy and the private sector. Hence, it comes as no surprise that the economy’s overall efficiency has been deteriorating (with the pace of deterioration likely accelerating at the margin), and that inflation has been entrenched at a very high level for quite some time: core annual inflation has been cemented above 30% since December 2007. Finally, we underscore that investment spending retrenched by 3.3% in 2008 and another 8.2% in 2009. Furthermore, with the -27.9% yoy variation posted during 1Q2010 the level of investment at end March 2010 (in real terms) is at the level seen during 1H2005.

The outlook for non-inflationary growth is poor as potential GDP continues to decline due to lack of private investment and the inefficiencies created by the ever-growing reach of the public sector: directly through spreading nationalizations and expropriations, and indirectly via overpowering regulation and moral suasion. For instance, the value added generated by the private sector declined 4.5% during 2009 and -6.0% yoy during 1Q2010

In addition, the economic base is increasingly narrow. Despite statements by public officials early in 2009 that the economy was well-insulated from the global economic and financial crisis and declining oil prices, the deep contraction of activity in 2009 attests to the fact that oil export income is still the ultimate engine of growth in an increasingly less diversified economy.

The capacity of the government to stimulate the economy is being impaired by the fact that the growth-multiplier of fiscal spending is declining rapidly due to the clear inefficiencies in fiscal execution (driven often times by political, rather than economic criteria), unsatisfactory internal spending controls, and the ongoing fast expansion of the public sector (retreat of private-sector activity) through a number of nationalizations/ expropriations of private businesses.

As we go forward, we expect the economy to benefit from a positive fiscal impulse ahead of the September legislative elections, but the positive impact of firmer terms of trade and fiscal activism is likely to be somewhat offset by engrained inflation, growing supply bottlenecks, power- and water supply restrictions during 1H2010, social and political confrontation, and a business/ investment-unfriendly environment which is discouraging private investment. In all, we expect the economy to contract again in 2010 despite the presence of markedly loose fiscal and monetary policies.

Source: Goldman Sachs

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2 Responses to GS on Venezuela: Bad to Worse

  1. Concerned - Fitch Ratings take on VEF says:

    (Source: Business Wire)Fitch Ratings today said that the recently passed amendment to the Law Against Illicit FX Transactions could further increase macroeconomic distortions present in the Venezuelan economy, adversely affect growth prospects, increase inflationary pressures, and possibly undermine the external position of the sovereign as a net external creditor, which in turn could weigh on the Bolivarian Republic’s credit quality.
    In an effort to control the volume of operations in the parallel market, the amendment places all operations in foreign currency and FX-denominated assets in Venezuela under the direct control of the Central Bank of Venezuela (BCV). Moreover, the BCV will have the power to determine which financial entities can participate in the FX market. The government’s main objective is to stem the depreciation of the VEF in the parallel market.

    Nevertheless, in Fitch’s view, the recently announced measures fail to address the structural factors behind the depreciating trend of the VEF in the parallel market. In general, the weaker parallel market exchange rate reflects an inconsistent macroeconomic framework, increased uncertainty about the direction of economic policy, high inflation expectations, and inorganic money creation through the yearly transfers of international reserves to the National Development Fund (FONDEN). More recently, the increased mismatch between the demand and supply of foreign exchange in the parallel market has added to the weakness of the unofficial exchange rate. As a result, the recently approved amendments, could further constrain the supply of USD to the private sector, which would do little to tame depreciating pressures on the currency.

    ‘In the absence of policy adjustments such as tighter fiscal and monetary policies that can increase the credibility, consistency and predictability of the macroeconomic framework, the parallel market rate will continue to face depreciating pressures, thus negatively impacting macroeconomic stability through higher inflation and real exchange rate volatility,’ said Erich Arispe, Director in Fitch’s Sovereign Group. In addition, due to the high degree of indexation currently present in the economy, a depreciated unofficial exchange rate could also adversely affect consumption and investment as imports become more expensive, thus further aggravating inflationary pressures and recessionary forces in Venezuela. Low private investment and supply bottlenecks in the electricity sector have detracted from economic growth, while inflation has topped 30% on an annual basis.

    Since Fitch believes that the debt strategy of the public sector has been influenced by the dynamics of the VEF in the parallel market in recent years, the sovereign, as well as public entities such as PDVSA, could resume issuance of USD-denominated securities in the local market to relieve pressures on the unofficial exchange rate. ‘In the absence of a recovery in international reserve levels, increased issuance of USD instruments could turn the sovereign into a net external debtor in spite of its status as an oil exporter, which would erode a key strength of Venezuela’s credit profile,’ added Arispe.

    While a high degree of macroeconomic and financial volatility has been incorporated in Venezuela’s ‘B+’ foreign and local currency Issuer Default Ratings, increased government intervention in the FX market could potentially worsen the fragile macroeconomic situation of the country. Fitch will continue to monitor the effects of the new legislation on the Venezuelan FX market and economy, since a disorderly adjustment from existing macroeconomic distortion could compromise the payment capacity of the sovereign. Moreover, greater than anticipated deterioration in Venezuela’s external solvency and liquidity indicators could also put pressure on the sovereign creditworthiness.


  2. Steve says:

    Who’s GS? CG response: Goldman Sachs.


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