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Skip Navigation LinksHome :: Back Issues :: Chávez devalues under pressure

March 2002

Chávez devalues under pressure


VENEZUELA




       
Chávez: living on borrowed time
Hugo Chávez is very good at alienating people. The Venezuelan president's revolutionary rhetoric and public friendship with Fidel Castro have long since made him an enemy of the US State Department; his authoritarian ways rub the domestic media up the wrong way; his pronouncements have set the Catholic church against him; his populism has enraged the middle classes; his refusal to respect the old divisions of power has meant frequent clashes with the unions; his unpredictability has resulted in increasingly high-profile members of the military demanding his resignation. Now his decision to devalue the bolivar seems set to lose him the backing of the one sector of the population that still supported him: the poor.
In truth, he had little choice. Capital flight had reached unsustainable levels and the Treasury was spending billions it could ill afford in a futile attempt to prop up a currency peg that no-one any longer believed in. "The decision to float the bolivar was not really a decision made freely by the Chávez government but was rather a choice forced by the inability to continue to sustain large foreign exchange reserve losses," says Jose Cerritelli, Venezuela analyst at Bear Stearns.
Even so, the decision to float, announced on the evening of February 12, came as something of a surprise to the markets. "The measures regarding the exchange rate were extremely orthodox," says Vincent Truglia, co-head of sovereign ratings at Moody's. That's unusual: Chávez is not well known for cleaving to economic orthodoxy. In fact he was at pains to point out, later in the week, that he was in no way a liberal.
The consensus in the market was that Chávez would attempt to implement strict exchange controls rather than float the bolivar. The reasoning was political: his power base lies with the poorest sectors of society, who are worst hit by the inflation that the currency peg was designed to prevent.
High inflation, of the order of 50% or so annually, is now almost inevitable in Venezuela, which, typically for an economy based mainly on oil exports, produces very little domestically and relies heavily on imports. Although the devaluation will benefit state oil company PDVSA, it will be of no use at all - quite the opposite, in fact - to most of the population.
By the time Venezuela's devaluation has passed through into inflation, say in the summer, pretty much everybody in the country will be calling for Chávez's resignation, and it will only be a matter of time before he is somehow forced out. He is unlikely to go willingly or quietly, however, and the political turmoil surrounding his removal could be intense.
Financial markets aren't too worried, at least for the time being. Venezuelan debt soared 7% on the day after the announcement of the devaluation: the government's dollars can now be used to pay debt amortizations, rather than to support the bolivar. And although it's anybody's guess who will replace Chávez, there's virtually zero chance that it will be a turn for the worse.
All the same, financial markets hate uncertainty, and Venezuela has demonstrated many times over the past 20 years that making external debt payments is not at the top of its priorities. "One of the best predictors of creditworthiness is how well people have met their past financial obligations," says Moody's Truglia, "and it's somewhat similar regarding countries."
And Moody's changed Venezuela's rating outlook to negative following the devaluation, saying that "the government's recent shift to a floating exchange rate regime has so far failed to stem the loss of reserves, capital flight and high local interest rates."
Moody's action comes despite the fact that Venezuela's B2 rating is already at rock bottom: among sovereigns only Argentina, Ecuador, Pakistan, Cuba, Indonesia and Moldova are rated lower.
If Venezuela descends into political chaos, it's entirely possible that it could become the third Latin American country in as many years to default on its foreign debt. And though institutional investors could probably weather the financial blow, that could have grave knock-on effects for the asset class as a whole.






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