Venezuelan Politics – Too Early to Get Bullish

Angel Falls,  Venezuela

The opposition victory in Venezuelan congressional elections this past weekend could eventually herald a new post-Chavez order. However, it’s way too early to celebrate. Severe economic challenges and adjustments lie ahead no matter what, made worse by the continued slide in oil prices.

POLITICAL OUTLOOK

Opposition leaders claim to have won a super-majority (two thirds) in congress, winning 112 of the 167 total seats. Official tallies have not been released yet, but if this is true, it is a potential game-changer. A super-majority would by law allow congress to fire ministers, change the constitution, and reshape the judiciary. Even if it falls short of a super-majority, the opposition could still exert control over the budget process.

The ruling Socialist Party has dealt with a compliant congress since 1998, when Chavez was first elected. President Maduro will be in the unfamiliar position of having to contend with the opposition-controlled congress until the end of his 6-year term in 2019 (assuming that the opposition doesn’t manage to somehow end his term early).

Opposition leader Julio Borges pledged to quickly pass much-needed economic reforms. He also said that congress would work to free political prisoners. Relations with the US and neighboring Colombia could improve at the margin, but President Maduro is still likely to maintain a frosty stance.

 

ECONOMIC OUTLOOK

Decades of policy mismanagement coupled with low oil prices have left the economy in tatters. This finally took a toll on the ruling party, similar to what happened recently in Argentina. GDP is expected to contract -10% this year, and follows a -3% drop in 2014. For 2016 and 2017, the IMF forecasts -6% and -2.5% contractions, respectively.

Despite the contraction in output, inflation remains sky high. Indeed, the government stopped publishing CPI data after December 2014, when it was reported at 68.5% y/y. The IMF forecasts inflation for 2015 and 2016 at 159% and 204%, respectively.

Plunging oil prices moved the current account into deficit this year and probably next year as well. The recent OPEC decision to scrap its quota system is very negative for Venezuela, which is one of the leading hawks in OPEC due to its need for higher oil prices to fund government spending.

The budget gap is widening sharply, as spending has not yet been adjusted to reflect lower oil revenues. A bolivar devaluation would help narrow the budget gap (at least temporarily), as USD-denominated oil revenues are converted into VEB-denominated domestic spending at a more favorable rate. Despite many giveaways to the poor, poverty has gotten worse under Chavez and Maduro, not better.

Foreign reserves have fallen sharply. Venezuela stopped reporting foreign reserve data to the IMF in September 2014. At that point, gold accounted for about 70% of total foreign reserves, but since then, total reserves have fallen from $21.35 bln to $14.64 bln in early December. We suspect gold (which is very illiquid) now makes up an even greater share of total reserves now.

 

INVESTMENT OUTLOOK

Venezuelan bonds have rallied in the wake of the surprise opposition victory. However, we think the rally is overdone in light of still-plunging oil prices. With reserves at multi-year lows and still sinking, the risk of default is not insignificant. Moody’s said it sees increased risks in Venezuela after the election, and that it sees few, if any, economic adjustments ahead.

The official bolivar rate of VEF6.3 per USD is unsustainable. A new rate more in line with the black market rate of 909 currently needs to be put in place. Within the three-tiered system that was last tweaked in early 2015, the SICAD (currently around VEB13.5 for priority sectors) rate and SIMADI rate (currently around VEF200 for non-priority sectors) are also too strong. Any serious effort at FX reforms would have to see a unification of all the rates closer to the black market rate.