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Barclays Capital

The Emerging Call
Emerging Markets Strategy – Americas December 18, 2002
The President’s Freefall Begins

Venezuela’s economic miracle: the economic collapse single-handedly brought about by Mr. Chavez has no parallel in the modern history of Latin America. Mr. Chavez’s legacy will be that he has accomplished the swift disintegration of the Venezuelan economy in less than four years. The country faces a staggering unemployment rate of over 20%, only five points below that of the United States during the great depression, which implies that an additional one million plus Venezuelans are now out of work. Thousands of businesses are bankrupt, and inflation for 2002 looks to reach over three to four times the single-digit rate it had achieved at the start of the administration. Public finances are about to push the government to saturate the Central Bank with unwanted bonds to avoid bankruptcy. The miracle is that this is being achieved at a time of record high oil prices and one of the sharpest devaluations in the history of Venezuela, suggesting that the public finances and indeed the country should’ve been in precisely the opposite position. Today, the freefall of
Mr. Chavez begins, and today we know that the resolution of millions of Venezuelans to restore democracy will endure.

The President’s Freefall Begins

The freefall starts with the sharp depletion of dollar reserves and the possible default of domestic debt, or, more likely, its forced restructuring later this month. This could lead to even more desertions, but now at the Central Bank. Monetary financing, combined with sharply falling supply, will boost inflation substantially, thereby ending the remaining enchantment of the few poor that still like Mr. Chavez. What is critical is that Venezuela’s public finances are about to collapse. Having spent the “dividends” of the Central Bank, the federal government is running out of cash (Bolivares), given the sharp drop of both oil and non-oil revenues. With at least 70% of the country on strike, economic activity is collapsing quickly and tax evasion is rising fast. As a result, non-oil revenues are also plummeting. Oil production has plummeted to about 400,000 barrels per day, from 2.3 million barrels per day, representing only 17.4% of its previous daily production levels.

Accordingly, Venezuela will stop receiving some $1.25 billion per month, which in turn suggests that PDVSA will have only about $325mn to make payments to its creditors first and then to the government. This month’s debt obligations alone exceed $1bn, suggesting that the oil contingency fund (FIEM) will be draw down markedly. Not surprisingly as well, PDVSA will run out of funds in the FIEM by the end of January, after making payments to creditors and transferring resources to the federal government. On a cash basis, the government will count with less than $25 million in January to make payments and import food and gasoline, suggesting that the FIEM and indeed dollar reserves will fall markedly.

Mr. Chavez may, of course, choose to default because he is finally cornered, pushed against the wall built by the fall of Venezuela’s democratic order. We don’t think he will default because the gain, an additional $300mn, is outweighed by the cost of default itself: alienating the international community and thus finally forcing him to allow democracy to be restored in Venezuela. He most likely will deplete international reserves by exhausting the oil contingency fund, which stands at some $3.3bn. The problem is that the FIEM is all that the Central Bank would be willing to give him, and because external debt service this month is $1.5bn for the federal government, the FIEM will only have $750mn left after debt service payments of the government and PDVSA. Because the government would need to import basic goods, gasoline, etc., the FIEM could be further depleted to about $250mn in January. After he exhausts it, dollar reserves would stand at $12.25bn, a critical support level for the Central Bank. This is when Mr. Chavez will have to change personnel at the Central Bank, as most directors feel strongly that reserves can’t be allowed to fall below $12bn. The reason is that this number ensures debt service payments of the government and PDVSA of $3.7bn in 2003, private debt payments and basic transactions of $4.5bn, and about $4.0bn for imports of basic goods for less than three months.

With PDVSA and federal debt service in January as well as further imports of food and energy, dollar reserves could fall as low as $10bn. By mid-January, generalized food shortages and widespread hunger will increase the resolution of a desperate people to restore democracy. A determined Venezuelan is not a force to be reckoned with. This is when the risk of widespread bloodshed and repression will be the greatest. But it won’t last. The strength of freedom is much greater than oppression and the country’s resolve will ensure that Mr. Chavez leaves, despite the “bystander” behaviour of the international community. It is no surprise that those Latin countries that are as “democratic” as Venezuela is today don’t want the international community to interfere in Venezuela.

However, it is remarkable that the United States has not yet provided the leadership role that has characterized the country for so long. Still, history will place the US in the position of leadership that former Presidents Reagan and Clinton upheld so highly. High, and even higher oil prices well above $32 in coming days, will suggest even to the US government that the international community faces a problem in Venezuela and that it is in our “interest” to restore democracy.

Mr. Chavez won’t hold for too long. The Venezuelan government lacks two basic qualities of a successful leader: courage and competence. The first well discussed by Winston Churchill means that, as already occurred once on April 11, Mr. Chavez may not stay if the going gets tough. The second quality means that the Venezuelan government can’t run most of the companies that are not operating today, including PDVSA, even if it continues to rely on former guerrilla members to do so. They just don’t know how.

The weak reply of the Organization of American States (OAS) is understandable: Many of its members don’t run democracies and thus fear suffering Mr. Chavez’s fate. It is not understandable, however, why the United States doesn’t provide the leadership in the OAS that it provides in the world. Other priorities such as a trade agreement with Brazil will not suffer from such resolution. It is righteous to say, as the OAS did, that institutions and the institutionality of the Constitution need to be upheld. The problem is that Venezuela no longer has them. There is no constitutional regime in Venezuela today because Mr. Chavez has destroyed the institutions and violated the human and civil rights of Venezuelans, including its most basic one: the right to live in a democracy.

Mr. Chavez’s game of speaking to the Marxist struggle of the classes, something which the liberal US press loves to write about, is romantic but false. A recent poll (December 13) by Consultores 21 showed that 80% of Venezuelans is regarded as poor, and more than 40% of them want Mr. Chavez out of office. Only 30% out of the 80% poor or 24% of the population want him to stay, but the figure is falling quickly. The other 20% of the population is the middle class and the rich, of which there are few left in Venezuela, thanks to Mr. Chavez’s policies. Almost 90% of them want Mr. Chavez out. Mr. Chavez’ policies are indeed establishing a new world in Venezuela, but not one with only a middle class, as Mr. Chavez boasts, but rather a one-class world: everyone poor. This is not surprising, as this is what Mr. Castro produced in Cuba and every other experiment with totalitarian, communist practices. It is time that the United States stands up for the Venezuelan people if only for one reason: to uphold the values of liberty and democracy that Venezuelans seek to restore today.

José M. Barrionuevo
Head of Emerging Markets Strategy
Barclays Capital


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