January 3, 2006
Venezuela: still on a roll

(BMI Daily Financial Alert) - "The stimulatory impact of President Hugo Chávez's expansionary macroeconomic policy is well evident from year-end data for 2005. With government spending skyrocketing thanks to the windfall revenues from high oil prices, the economy was bound to experience a significant upsurge. And so the catalogue of year-end achievements confirms this picture: tax collection exceeded its target by 40% to come in at VEB38.4trn (US$17.9bn), the unemployment rate fell two full percentage points from November, to 8.9% in December according to the National Statistics Institute, and the real economy grew by 9.4% y-o-y.

Despite the rampant expansion, inflation continued to drop, closing the year at 14.4%, down from 19.2% at the end of 2004, largely as a result of price and currency controls. In December, CPI fell to 0.8% y-o-y, from 1.1% in November, and 1.6% in December 2004. The Central Bank attributed the disinflation to 'monetary policy, increased production, currency and price controls and mechanisms for distributing basic goods at low cost'.

The expansion is set to continue into 2006, with a 25% bigger budget for the year, of US$40.6bn. The government expects real GDP growth of around 5.0%, which is roughly in line with our own expectations. Oil revenues should continue to support the domestic Bolivarian revolution, for this year at least.

The budget factors in a price for the Venezuelan oil basket of US$26/bbl, a fairly conservative estimate which should compensate for what is widely seen as a unrealistic production forecast of 3.4mn bpd. The budget also assumes that the exchange rate will remain unchanged at VEB2,150.00/US$. Indeed, we think that the possibility of a currency devaluation towards year-end due to an oil-price slump is a pretty remote one, and in fact we expect prices to remain fairly solid throughout the year.

In keeping with the government's efforts to move away from the US sphere of influence, the central bank has now turned its attention to the eurozone, and will conduct its currency transactions in euros as well as dollars.

The move will not imply a fixed rate for VEB/EUR, with the cross-rate instead being determined by the VEB/US$ and US$/EUR rates at the time of transaction. It follows the decision earlier in 2005 to diversify central bank reserves away from dollar assets. Whilst the central bank denied that this diversification was politically motivated, it certainly chimes well with Chávez's antagonism towards the US and his goal of loosening the two nations' economic ties.

Against this firm macro picture, the US$ Global 27 bond closed 2005 at a record high of 118.50, no mean achievement given the litany of concerns over the political and economic direction of the country throughout the course of the year. Of course, the primary driver has been the year's record high oil prices, but the bond's price action noticeably diverged from that of oil towards the end of the year, particularly in October, as the dynamism of the economy became increasingly evident.

Although we have many serious reservations about the longer-term macroeconomic picture in Venezuela, based mainly on its excessive dependence on high oil prices and the urgent need for further investment in the sector, the short term outlook for debt remains solid. Its creditworthiness is still-improving; although the government, somewhat imprudently, is eager to purchase other nations' debt rather than pay off its own, we see little risk of default and expect the external debt burden to continue to decline this year, with rumours of multilateral debt prepayment this year reaffirming our view"..