The Weekly Report: A LATAM Focus on VENEZUELA

3 October 2012


Even before Chairman Bernanke’s announcement of ‘unlimited’ or responsive quantitative easing, which sent ‘risk assets’ like stocks and emerging market securities rallying, Latin America has been a very attractive place for investors in both equities and fixed income securities.

Just this quarter, we have seen upgrades for Uruguay, Paraguay, Peru and Ecuador, while Mexico, Venezuela and Colombia bonds have rallied due to different reasons. It is likely that we will see additional upgrades in Chile and possibly in Colombia in the next 6 months. The region contains some of the world’s largest commodity exporters across metals, energy and agricultural commodities, while also featuring robust, consumer driven internal economies that have seen incomes and social mobility increase substantially in the last decade. Additionally, while the region was a basket case for credit investors for the better part of the last 3 decades, many Latin governments now have some of the most solid fiscal positions in the market — much better than many of the countries which helped rescue them from the brink in the 1980’s and 1990’s.

Firstline has been developing expertise in the region’s corporate and sovereign bonds, and constantly monitors and identifies opportunities tied to Latin America across both equities and fixed income. We will explore a number of opportunities on a regular basis through our LatAm Focus blog series.

This week we will delve into the election in Venezuela and how it might affect opportunities for investors in Venezuela risk going forward.

VENEZUELA

Venezuelan sovereign and corporate bonds such as PDVSA and Electricidad de Caracas have been on a tear in 2012 due to speculation that Henrique Capriles Radonski, a 40 year old centre-left state governor, could actually beat incumbent President Hugo Chavez in the upcoming elections scheduled for October 7th.

Capriles is an extremely charismatic and youthful governor of Miranda state – which contains some of Venezuela’s most affluent areas as well as some of its most underdeveloped. While he comes from an established and wealthy family that has already been involved in politics in the past, he has set himself apart as a governor and a candidate through a number of populist policies, and a relatable personality for the public and media.

Capriles has been campaigning exhaustively throughout the country, visiting an average of 4 towns a day over the last 3 months and has been steadily gaining in the polls since winning the opposition primary in January 2012. Capriles has gone from the lower 30% range in January 2012 to the mid 30% to mid 40% range in August.

Most pollsters have estimated the undecided vote in Venezuela at between 15% and 20%. We can reasonably expect that many of the ‘undecided’ voters are remaining close-lipped given the fallout from the 2004 referendum vote to expand President Chavez’s powers, when the names of citizens who voted against President Chavez were made public, and thousands of people were laid off from government or state owned corporations based on what side of the referendum they were on.

There is significant room for Capriles to make major gains against President Chavez, who has not gained any points in recent polls and has hovered in the 45% to 47% range. Interestingly, Capriles trails President Chavez by just about the amount of undecided voters—15% to 20%. The electorate is increasingly wary of Chavez’s health conditions after he was diagnosed with cancer in 2012. Additionally, the crime situation has continued to deteriorate, leading many Chavez supporters, especially in the lower-income ‘barrios,’ to reconsider whether to support him in upcoming elections.

Notwithstanding all of the above, we doubt that Capriles can win the election on October 7th.


It is highly unlikely that President Chavez will allow himself to be defeated. In the past, President Chavez has always responded to threats to his power in a very direct way, leveraging his considerable legislative and extra-legislative power to dispatch any organization or individual who stands in his way. The examples are abundant but the closure / takeover of the oldest and most-watched private broadcasting company is one of the more poignant instances of the lengths he is willing to go to. In Trini terms, it would be the equivalent of Prime Minister Persad-Bissessar or Minister Warner forcibly closing and then taking over CCN TV6.

Even more pointed was his reaction to protests in 2007 at the Universidad Central de Venezuela (UCV), one of the largest and oldest public universities in Latin America (founded in 1721) and a focal point of leftist ideology, socialism and general political activism in Venezuela. Students and professors at UCV were protesting a number of social ills as well as recent government policy decisions regarding the university, when a number of armed gangs of President Chavez supporters, mounted on motorbikes, descended on the campus. Chaos ensued as the Chavistas reportedly rode their bikes through the crowds, running over protestors while maiming, shooting and cutting others.

While President Chavez disavowed that he directly ordered these groups to attack the protestors, he reportedly still admonished the protestors and implied that they had deserved the brunt of the violence. Intervention by ‘motorizados’ or motorcycle-riding  ‘activists’ at Anti-Chavez events  had become a pattern in the years leading up to 2007, which the government regularly turned a blind eye to. While there have not been similar incidents since then due to the widespread outcry to the ‘motorizados’ violent acts, there is no saying whether similar actions might not be taken in future.

It is reasonable to think that between possible strong-arm tactics and allegations of election fraud, in addition to last minute electoral fix ups like public employee salary boosts and local road repair projects, President Chavez will get another 7 year term and extend his 14 year rule.

Additionally, there have been a number of snafus with Capriles’ election campaign. An economic policy document from within his coalition was released which allegedly details the reintroduction of a number of neoliberal economic policies similar to those implemented in the 1990’s, which many Venezuelans of all political persuasions blame for their economic decline during that decade. The leaked document also differs markedly from Capriles’ economic policy platform which he has campaigned on since earlier this year. While Capriles has said that his signature on the document was forged, and that he does not agree with most of the proposed policies, it has nevertheless cast doubt on his candidature, as well as on his populist economic rhetoric.

A top Capriles aide was also caught on camera accepting a bribe from an unidentified foreign business person, in order to set up meetings with the candidate. Capriles has responded by immediately firing the aide, but after the policy document leak, it has debilitated many people’s favourable perception of him—especially since the business-person is a foreigner, and with the neoliberal policies espoused in the paper (which many Venezuelans reject as a ‘foreign’ ideology as opposed to local petro-populism), makes him especially vulnerable to accusations of being a puppet of international interests.

President Chavez has wasted no time, declaring at a rally on September 11th that “behind his democratic mask is the most horrendous thing in politics. Behind his deceptive message of progress and social welfare is the most savage neoliberal capitalist package that has been known in Venezuela and Latin America,” according to Venezuelanalysis.com. Subsequent to both events, 4 smaller members of the MUD (Democratic Roundtable) opposition coalition have withdrawn their support for Capriles, dealing yet another blow to his campaign.

Regardless of who wins the election, there are many daunting economic realities that face Venezuela.

Particularly, the risk of currency devaluation is very high. President Chavez increased government spending by 67% in August as he seeks to build houses and increase salaries for government employees to win them more firmly to his side. Venezuela has an official, two tiered US Dollar conversion rate regime, one for financial institutions which is mediated through the Central Bank, while the other applies to everyone else. However, due to strict currency controls, there is a parallel, underground US Dollar market that is often a leading indicator of devaluations, and which has seen 20% to 30% increases in US Dollar conversion rates over the last 2 months, according to Bloomberg.

President Chavez has devalued the official rate available to the general public twice since 2010, in instances when he needed to increase public spending to bolster his political position. When the currency is devalued, it increases the amount of Bolivars the government gets for each US Dollar, which then facilitates higher spending. Venezuela earns most of its foreign currency through PDVSA, the state owned oil company, and with oil prices remaining high—and PDVSA’s production declining continuously every year—the pressure for President Chavez to further devalue the currency to get more bang for his buck is enormous.

A devaluation further weakens Venezuela’s fiscal position and credit attractiveness. Venezuela already has the largest fiscal deficit in Latin America, at 11.6% of GDP, according to Bloomberg. The country’s international reserves have fallen by 41.6%, or USD $17 billion since 2008, to USD $ 25.6 billion, according to Morgan Stanley. These factors, combined with a debt stock of USD $110.6 billion, and declining oil production, not to mention high inflation and poor infrastructure, has led Morgan Stanley analysts to conclude that if changes aren’t made, we can see negative credit events on Venezuela sovereign bonds starting in the latter half of 2013, when USD $4.3 billion in external debt payments will come due.

The likelihood of changes to fiscal policy and government spending in Venezuela decrease with a Chavez victory in October, but even Capriles would need to continue much of the spending on programs set up by Chavez during his 14 years in power, in order to preserve social stability. However, the market believes that under Capriles, expenditure would at the very least not grow as quickly or aggressively as it has in the past, while the productive sectors in Venezuela could return to the role they once played in the economy and help create the economic growth necessary to meet its obligations going forward.

Any investors holding Venezuelan credit risk is thus advised that they could be in for a period of considerable volatility and a possible crash. Nevertheless, there could also be some longer term buying opportunities for investors who are willing to be patient and vigilant. Additionally, using momentum-based technical strategies, investors can profit from some of that volatility. Firstline is equipped to assist with investments from both fundamental and technical points of view. For more information and insight, please contact us at workingtogether@nullfirstlinesecurities.com

Michael J Cooper
Trading / Investment Strategist
Firstline Securities Limited

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