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Venezuela: No Vuvuzela for Chavez

The Venezuelan economy is spiralling out of control and President Chavez's political future looks bleak.


With oil prices inching higher and emerging market bond spreads squeezing tighter; it's no surprise that some investors are taking another look at Venezuela. An EMBI+ spread of more than 1,100 bps makes the oil producing giant appear extremely cheap. Venezuela was recently left in the dust by Argentina, after it completed its debt exchange and rehabilitated its relationship with the international financial community. Indeed, some Wall Street analysts are recommending the purchase of Venezuelan bonds. The sovereign's debt servicing requirements is relatively low-amounting to slightly more than $3 billion this year. Most of the debt issued during the last few years had low coupons. It was mainly used as vehicles to allow Venezuelans to evade the capital controls. Yet, the government has clamped down on the parallel market in a ludicrous attempt to stem the inflation rate.

Despite the allure of Venezuelan bond spreads, the truth is that the economy is spiralling out of control and President Hugo Chavez is becoming desperate. The Venezuelan economy shrank 5.8% y/y during the first quarter of this year. Manufacturing activity plunged 10% y/y, on the back of power shortages and electricity rationing. The Venezuelan economy is poised to contract by a similar amount during the second quarter. This makes it the worst performing economy in Latin America--and the entire emerging markets asset class. There is no relief in sight. Although the consensus expects the Venezuelan economy to shrink about 3.3 percent y/y in 2010, we believe that the contraction will be more than 5 percent y/y. At the same time, the inflation rate is running at more than 30 percent --increasing the country's misery rate. Therefore, Venezuela's debt servicing capacity and bond spreads may be appealing, but the country's trajectory is certain to bring it to an ignominious end.

President Chavez's popularity is falling, and the Venezuelan leader is becoming desperate. A recent poll published by Caracas-based Hinterlaces found that his popularity had declined to 41 percent  from 52 percent two years ago. This is very bad news for the Bolivarian leader, who faces mid-term elections in exactly two months. The polls show that Chavez's allies are not going to have an easy time. The contested congressional seats were swept up by pro-government candidates in 2005, when the opposition decided to boycott the elections. However, they are staying in the race this time around. A poll by Datanalisis showed that the opposition should win half of the 167 seats that are up for grabs. This will still allow Chavez to retain control of the congress, but the rout will be a major chink in his armor. It also marks a dangerous precedent for the upcoming presidential elections in 2012. Chavez is looking to extend his mandate into 2021. However, another poll by Hinterlaces revealed that only 24 percent of the population would like to see him stay in power.

This helps explain some of his desperate actions, such as breaking off diplomatic relations with Colombia. Last week, President Chavez made the announcement after Colombia's ambassador to the OAS, Luis Hoyos, accused Caracas of tolerating and abetting the presence of FARC guerrillas on Venezuelan soil. Chavez immediately shot back by accusing Colombia of conspiring with the U.S. to assassinate him and topple his government. While there are surely elements of truth on both sides, Chavez's actions make great political theater and they are designed to help boost his standings in the polls. Unfortunately, this is not the type of behaviour that endears foreign investment.

There is a good reason why Venezuelan bonds are the highest yielding sovereigns in the asset class. It is because it is the riskiest country. Some people take heart from its current account situation. The surplus was an impressive $7.1 billion during the first quarter. However, it is also important to look at the entire balance of payments picture. The capital account showed an outflow of $11.5 billion during the first quarter, resulting in a decline of more than $6 billion in international reserves. The Venezuelan economy is spiralling out of control and President Chavez's political future looks bleak. Of course, the demise of the Chavez Administration would be a welcomed event. However, he is a desperate and irrational individual. Therefore, the transition of power will be anything but smooth. In addition to breaking off relations with his largest trading partner, which only exacerbated the country's economic woes, Chavez jailed some of his closest political allies. The arbitrary incarceration of the local bankers who helped Venezuela meet its financial obligations highlights the fact that he will do anything to further his own political cause. Therefore, ignore the Vuvuzela calls for Chavez. Instead, he deserves nothing more than a Bronx cheer.

Walter Molano is head of research at BCP Securities.


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