Venezuela's Beginning of the End: The Solution

www.veninvestor.com Dr. Jose Maria Barrionuevo, Director of Emerging Markets Strategy, Barclays Capital

For investors it’s all about cash flow. For Venezuelans it’s all about democracy. Venezuela has had one of the strongest cash flows in emerging markets. Venezuela has also one of the oldest Latin American democracies. Oil prices used to be all investors cared about. That has changed now. Venezuela’s sharp cash flows and its democracy no longer follow separate ways. With sizable revenues in dollars and spending in local currency, cash flow mismatches were easily resolved. Venezuela’s public debt stock was low as well, further contributing to a manageable cash flow. Large oil exports gave Venezuela sizable dollar inflows and fiscal revenues. When the government spent more Bolívares than it earned, all it took to correct the imbalance was to devalue the currency enough to match Bolívar revenues with those spent. Not surprisingly, oil prices were the leading driver of Venezuela’s financial performance. Higher oil prices improved creditworthiness as credit expanded and growth strengthened. Low oil prices, however, contracted credit, weakened growth and led to fiscal imbalances. Devaluation would then close the imbalance. Venezuela’s oil richness created a steady reliance on imports of foreign goods and open trade. Most of the oil dollars were eventually exchanged for foreign goods and, during good times, used to build the country’s dollar reserves position. Some 70% of Venezuela’s basic basket is indeed imported. Not surprisingly, a relatively low content of nontradable goods meant that Venezuela didn’t need the severe economic adjustments that traditional Dutch disease countries experience. Hugo Chávez changed this picture dramatically. Despite presiding over an era of record-high oil prices and one of the sharpest devaluation that should’ve improved cash flows, Mr. Chávez has pushed Venezuela into one of the greatest economic devastations witnessed in Latin America. Cash flows in fact collapsed, risking debt default this year. By the time controls were introduced just over a week ago, the Bolívar had plummeted from Bs750 in early 2002 to a low of Bs1,925 in the official market and Bs2,500 in the black market. The economy is collapsing by over 25% during the first quarter, an economic devastation only seen during the US Great Depression, but in three years! The previous years of the Chávez era were not much better. The recession was -7% in 2002, after modest growth in his first three years. Despite the recession, inflation continues to climb from the 12% low achieved in 2001 to 33% in 2002 and to a likely 49% this year. While price controls will obscure this for the world, Venezuelans will undoubtedly feel it. Venezuela’s once 26% of GDP public debt is now about 40% and will rise to 46% this year, due to the massive devaluation and the severe recession. Still, Venezuela’s fundamentally strong position can be seen in how quickly the country could turn around, should the political crisis be resolved prior to complete economic annihilation. Public debt would fall to 34% of GDP next year should the Bolívar appreciate to Bs1,750, inflation fall to 21.0% and growth rebound to 7.9%. This won’t be easily achieved because a solution of the crisis involves the departure of Mr. Chávez. Despite recently improved oil production, oil exports will level off at half of where they were before a successful oil strike, crippling the ability of the Chávez regime to survive. Recently introduced foreign exchange controls are building a new dynamics that would undoubtedly exacerbate economic and social pressures, as inflation pressures and scarcity of basic goods cripple the country as well. Given all this, there are three possible endings to Venezuela’s worst political crisis. The first and only peaceful ending requires that the international community as represented by the Six Amigos (six friendly nations) persuade Mr. Chávez that a revocatory referendum on August 19th, as suggested by former US President Carter, is the best way out of the crisis. The proposal would make August 19th an irrevocable date, but it would allow Mr. Chávez to run for the presidency a month later. The August 19th revocatory referendum is contemplated by the constitution, as Mr. Chávez has recognized. Mr. Carter also proposed an alternative solution that involves reducing the presidential term to four years from six for both the president and congress, followed by elections thereafter. This would involve major changes to the constitution and, hence, turn into an uncertain, lengthy process. But August is too far away for the millions of Venezuelans that struggle every day to survive the Chávez regime, especially now that the economic debacle is unsustainable. The best solution for Venezuela’s political crisis is therefore that the international community on behalf of the Venezuelan people set a timetable for elections to be held soon. This won’t happen, though, because the Six Amigos believe that a constitutional order is in place in Venezuela. It isn’t. And it would serve well the international community to recognize that there is no constitutional order in Venezuela today. Mr. Chávez has changed the judicial and legislative powers to respond to his demands and this is why Venezuelans need help in restoring democracy. He wants Venezuelans to abide by a constitution that he has violated repeatedly. The international community needs to set a binding date for elections soon and, should Mr. Chávez not abide by them, be prepared to stop recognizing the legitimacy of his government and, through a United Nations resolution, intervene to restore democracy in Venezuela. The second ending and, still a probable outcome, is that the new wave of basic goods scarcity and further economic attrition that follows the introduction of foreign exchange and price controls leashes a new wave of repression. The beginning of the end and, indeed, the greatest success of the Venezuelan opposition began when the Chávez regime was forced to adopt foreign exchange control to protect the rapidly depleting dollar reserves. Because the goal was to hit the government’s cash flow irreversibly, the opposition’s strike was no doubt successful. The measure, however, will exacerbate the political crisis as basic goods supply falls and inflation rises. Mr. Chávez is already sending the military to seize the dwindling inventories of food and basic goods and will next force businesses to increase production as well. Venezuela’s private businesses would refuse to comply, exacerbating the repression backlash. The recent success of the government to restore oil production to under one-half of where it was prior to the strike is only based on making “natural flowing”, light oil wells operational again. With oil production likely to level off at 1.5 million barrels per day, cash flows will continue to falter and controls will be kept. The recent bouts of repression could reach new heights when the Venezuelan people, poor and rich alike, continue to unite to demand Mr. Chávez’s resignation, as scarcity worsens and inflation climbs quickly. The critical question is whether the military would follow orders to repress the people, paving the way for an outright dictatorship. It is probable that some factions of the military would open fire against unarmed civilians, as it is suspected happened on April 11, but it’s unlikely that they would engage in the kind of systematic repression that would end in a Castro-like dictatorship. In this outcome, hundreds, possibly thousands, of Venezuelans would die, but Mr. Chávez would have no choice but to leave as the military demands his resignation. The third and final ending, of course, is that Mr. Chávez succeeds in reaching his ultimate goal of installing a de-facto dictatorship. He would then rule over a country of poor, in which limited oil production would be destined to make his regime endure thanks to the support of thousands of men from Havana now serving in Venezuela. Because Venezuela’s democracy has endured many past crises and the international community will oppose the installation of an outright dictatorship, Mr. Chávez’s strategy has been based on a process of economic attrition in which, by devastating the private economy, is forcing thousands of Venezuelans to leave the country. Many foreign multinational companies are leaving as well, including Honda, Microsoft and now Procter and Gamble, which used to handle its entire Latin American business out of Venezuela, and Coca Cola, which is for sale. In an effort to isolate the country, Mr. Chávez is now getting ready to close down television and radio stations as well as to expropriate private schools. He is doing all of this expeditiously while the world’s attention is on Iraq. The clash between dwindling cash flows that would make the Chávez regime collapse and the growing opposition that seeks to restore democracy suggests that Venezuelans, in cooperation with the international community, need to take three actions to bring an end to the crisis. First, they need to focus on one electoral proposal that is workable for the international community in the shortest timeframe. Instead, they’ve been engaged on varying strategies that involve setting either a Constitutional Assembly or having Venezuelans sign petitions to show their will. These are on top of the Carter proposals and of the negotiations conducted by the Organization of American States. Being all over the place, of course, only helps Mr. Chávez. The success of the opposition hinges on the support of the world in setting a binding timetable for elections based on one proposal. Second, they need to register a new political party that represents the twenty million of Venezuelans that oppose the Chávez regime. This would show the real unity and will of the Venezuelan people in pursuing a democratic solution and would focus everyone on the only real solution of the crisis: elections. Third, they need to announce a presidential candidate for the opposition party to rally the many Venezuelans that are already campaigning for change. To hold elections, a candidate is needed to run against Mr. Chávez. A presidential candidate would also provide one voice to lead the millions of courageous Venezuelans that have stood up to the Chávez regime. The Venezuelan opposition has many strong leaders to pick from, including Messrs. Fernández, Mendoza, and Ortega, among others. If Venezuela is to succeed in restoring its democracy, it needs to tell its people and the world who the presidential candidate is and how he or she would unite all Venezuelans to pull out of the crisis.   —     José M. Barrionuevo Director of Strategy Barclays Capital, Inc. (212) 412-3306