Venezuela: Fatherland, socialism or death… and finance

EVEN TOURISTS CANNOT escape Venezuela’s propaganda barrage. “Get to know Venezuela, where dreams are reborn” is one of the latest slogans from the People’s Power Ministry for Tourism. Dreams or nightmares? With the consumer price index at more than 20%, the Bolivarian republic has one of the world’s highest inflation rates. Access to foreign currency is limited by the state, so in the parallel market dollars normally cost two to three times the official exchange rate.

The “land of contrasts” cliché does not apply in this context. Venezuela is more like a land of parallels. And it is not only in the foreign exchange market (with all the influence that has) where the country is divided. The chasm extends throughout the nation’s economic and political life. Now, as president Hugo Chávez pushes for the revolution to be deepened, divisions seem to be widening even within the government.

The quirks are evident even as you pick up a local newspaper when boarding the plane in Europe. Half the back page celebrates the anniversary of the failed coup Chávez instigated in February 1992. There is a painting of a uniformed and stern-looking Chávez wielding the Venezuelan flag, and the style is reminiscent of Soviet agitprop. Yet on the other half-page, a private-sector bank advertises the names of customers who have won Chevrolet SUVs by using their credit cards.

The plane is packed with Venezuelan tourists returning from splurging their overvalued currency abroad, and, when Euromoney flew, there was a group of migrating Iranian engineers on board.

For now

On arrival, hordes of black-marketeers descend, intent on offloading their increasingly worthless money on to foreigners. On the way down the valley into the capital, Caracas, a huge banner says “FOR NOW…” like a warning, repeating what the President said both in 1992, and after he lost a referendum to change the constitution late last year. The banner is joined with a host of alternative tower-top advertisements from such brands as Pepsi and Nescafé.

Inequality that by some accounts is worse here than in Brazil or South Africa is shown in the contrast between valley-bottom skyscrapers and makeshift barrios creeping up the hills. But some of the newest city-centre buildings now house new state-owned banks.

It is ironic that during the near 10-year rule of a government that has proclaimed itself anti-capitalist, financial services have grown faster than any other industry.

One of the main causes of the boom has been the foreign exchange controls. These prevent capital from leaving the country, while artificially inflating the currency. They also provide an abundance of business opportunities in the gap between the official and parallel exchange rates.

One of the principal actors here is Guillermo Clamens, a Venezuelan who left for New York 14 years ago. Clamens now owns FTC Securities, which is based in the US but has a broker-dealer subsidiary in Venezuela.

FTC completed three private equity deals in Venezuela in 2007 in the telecoms and insurance industries. But the company in Venezuela earns its bread and butter by buying and selling exchange-rate swaps, which are the most common unofficial method of changing Venezuelan currency. “Swaps are the engine that runs the capital market in Venezuela. They are like a conduit to get in and out of Venezuela as you need,” Clamens says.

Venezuelan foreign exchange swaps function by exchanging Venezuela’s dollar-denominated bonds for bonds denominated in bolivares. The method is basic, but price spreads between bid and offer on the swaps are around 5%. Profit margins are so wide that one Caracas-based employee at a global bank estimates that the number of brokerages has trebled since foreign exchange controls were introduced in 2003.

But the swap market is by no means the only way in which money is being made from the gulf between the official and the parallel exchange rate. Until recently, for example, every Venezuelan had an allowance of $3,000 to spend on credit-card purchases abroad via the internet. But most Venezuelans did not possess credit cards. So enterprising countrymen would literally recruit people from the street, offer them a slice of the profit, and use their allowance to gain dollars at the official exchange rate, selling them back into bolivares on the parallel market. With exchange-rate differentials of more than 60%, recruiting just five people a day in this manner could result in a profit of about $30,000.

The government caught on to this ploy and lowered credit-card allowances to $400 at the end of 2007. But there are still many cunning methods of using some of the official-rate $165 million granted on an average day by Cadavi, the state foreign exchange administrator. Invoicing over the required amount for imports, and using a black market in gambling chips from offshore casinos are among the wiles. For those with sufficient capital, one scheme could be to ask Cadavi for permission to import a $50 million boat, sell it through an SPV in Panama, and if necessary resell the dollars back on the parallel market. You could make about $100 million by doing this, and then start a similar process again. Fortunes are being made.

The banks are having fun too. Total assets managed by banks have roughly quadrupled in the past four years. “It’s unbelievable. I’ve never seen anything like it before,” says a banker who used to work in Europe.

Venezuelan oil production, which makes up about a third of GDP, is today more or less at the same level as it was just before Chávez came to power in 1998: about 2.5 million to 3 million barrels a day. But prices for Venezuelan crude have risen from about $13 10 years ago to $65 last year. At the same time, government spending has risen from about 21% of GDP in the 1990s to 26% now. So annual GDP growth has shot up to between 8% and 10%, and unemployment is about 8%, compared with about 15% 10 years ago.

Thanks to the inflation and currency controls, Venezuelans are spending quickly before their money depreciates. Roughly twice as many cars are being sold today as in 2004. Nevertheless, some funds have to be left in the bank, and more and more people are taking advantage of negative real interest rates through consumer loans, which have grown by more than five times in the last four years.

The bad news for depositors is that current accounts pay 1% to 2% interest. The government has imposed a 10% minimum payment on savings accounts, and an 11% floor on time deposits. But inflation is more than 20%.

Things are better for borrowers, with the government placing an interest rate cap of 28% on loans. But for those international banks such as BBVA and Santander whose subsidiaries control a large part of the Venezuelan banking market, the ability to repatriate dividends at the official exchange rate is a significant boon. Furthermore, with only 35% of the population having a formal banking relationship and 47% depending on the informal economy, the sector still has great growth potential.

Nevertheless, banking in Venezuela is not for the light-hearted. Juan Carlos Dao, executive president of Bancaribe, a medium-sized bank, says: “The key is to be prepared for every eventuality. You need to be ready to exploit the opportunities, or press on the brakes when the problems come.” He should know: his family founded the bank 53 years ago. He has spent his life in Venezuelan banking. One constant burden the system has to bear is what are known as gavetas, to which roughly a third of banks’ loan books now have to be devoted. These are products that the government wants to promote, with agricultural microfinance being the most important, followed by low-cost mortgages, other microfinance programmes, and tourism investments.

More worryingly, the administration sometimes shows signs of misunderstanding the financial system. For example, according to an analyst at Fitch, it was Chávez himself who, perhaps in a bid to curb inflation, ordered the central bank to stop repo lending last September. This temporarily pushed overnight rates from 11% to 120% as small banks turned to larger banks for help. After some explanation, the measure was rescinded. But then in October the inter-bank market was similarly under pressure when the government said it would introduce a 2% transaction tax on every debit from a business account. With the average credit card purchase, for example, requiring numerous account transfers, many banking operations would have become unviable. Again, after negotiation between the banks and the government, exemptions to the transaction tax were apparently granted, and a crisis was avoided.

However, there is a more existential threat to the banking sector. State deposits make up about a quarter of the banking system’s total deposits. They are some banks’ lifeblood. But the government has begun transferring these deposits away from the private sector and into state-owned banks, whose number under Chávez has risen to 11.

Among the 39 private-sector banks, it is the smaller institutions that stand to lose most. “The transfer of government deposits to state banks caused a liquidity crisis in the second half of 2007. This meant we could go to the inter-bank market and lend to other banks,” says Alejandro Gonzales, executive president of the holding company for the country’s largest bank, Mercantil.

But even Mercantil might not be safe: some talk of one the larger state-owned banks getting ready to take over a large or medium-sized private-sector bank.

Heading towards a crisis?

It is difficult to know how the administration could be so badly informed about the workings of the banking system. In fact, if it is hard to obtain a correctly valued exchange rate between dollars and bolivares; it is even harder to get a truly balanced opinion on the Venezuelan economy.

So one thing is clear: in the short term at least, the Chávez government has created profound divisions within the country.

At the most senior levels, it is difficult to move between the public and private sectors. Opposition supporters sometimes feel little incentive to help the country move forward under Chávez. “This is what happens when you vote a whole class out of power,” concedes Mark Weisbrot, a Washington-based economist who recently wrote a paper defending Venezuela’s prospects.

The reluctance of some individuals to cooperate with the government, says Weisbrot, has created the weaknesses in policing and rubbish collection that are evident as soon as one enters the capital. Chavista catch phrases such as last year’s “fatherland, socialism or death” (patria, socialismo o muerte) hardly help. But confrontations have been most notorious in the oil industry.

Before Chávez came to power, national oil company Petróleos de Venezuela (Pdvsa) had grown accustomed to getting more and more independence from the state. Chávez wanted it under his control and, in December 2002, the company shut itself down in protest. Despite an immediate and acute recession, the president survived to refill the company with his supporters. Some of the most experienced employees left, however.

Pablo Venturino, head of Latin American debt at ABN Amro, is clearly not as concerned as some about the condition of the company and, by extension, the country. ABN Amro was the sole bookrunner for a $7.5 billion bond placement for Pdvsa last April. This was the largest ever debt transaction from Latin America. “Pdvsa’s debt ratios are better than those of BP and Exxon Mobil,” he says.

“The most important factor ensuring that the production targets are met is that international and national energy companies can operate in an atmosphere of legal and regulatory stability” Luis Grisanti, Venezuelan Hydrocarbons Association

Opposition supporters within the country, however, say the industry is in a terrible state. One story recounts how Pdvsa painted piping and machinery red in order to reinforce notions of its ownership by a socialist state. But it was then discovered that the paint was highly flammable, so everything had to be painted white again. Critics say incompetence has caused production to fall well below the official figures of about 3 million barrels a day. But the government’s defenders say that if the Pdvsa’s production is down, it is because it is a price hawk.

Certainly, one of Chávez’s main aims has been to raise the oil price. There is a worldwide shortage of oil engineers. But then many Pdvsa employees stayed after the shutdown, and the company has more or less resurrected its production.

In Plan Siembra Petrolera, Venezuela hopes to “sow the oil”, investing $56 billion between 2005 and 2012 in extraction, exploration, infrastructure, refining and regional energy integration. The private sector is expected to contribute 30% to these investments, with the rest coming from Pdvsa.

Luis Grisanti, president of the Venezuelan Hydrocarbons Association (AVHI), admits that production targets are optimistic. But he says that if his organization’s 24 members work together with Pdvsa, the plan could succeed. “The most important factor ensuring that the production targets are met is that international and national energy companies can operate in an atmosphere of legal and regulatory stability,” he says.

But in Pdvsa, as elsewhere in the economy, one of the government’s priorities is to train its own support base. According to Conapri, an organization that promotes investment in Venezuela, 100 engineers from the military, Pdvsa and the recently nationalized telecoms company are already training in China.

Where the petrodollars go

Chávez’s policies could be blocked if the moderate opposition were to unite with the moderate Chavista elite. Or at least that is the view of a pro-Chávez former economic adviser to the government who spoke to Euromoney. However lamentable it might be, says the former adviser, a bad turnout at regional and municipal elections this November for Chávez’s new mass party, the PSUV, might indeed entail his disempowerment, if not his departure before his term ends in 2013.

In part thanks to the food shortages caused by price controls initiated in a bid to curb inflation, many say Chávez’s popularity is already waning, and that December’s lost referendum proved it. But cutting the price controls would immediately hurt the poor, Chávez’s most loyal support base. In addition, allowing the economy more flexibility by getting rid of the currency controls would be dangerous, as prices for the imports Venezuela depends on would soar. 

With 2008 yet another election year, it will be difficult to restrain public spending, which is one of the quickest ways inflation could be tamed. “Demand needs to grow more slowly,” says Efrain Velazquez, president of the National Economic Council, an independent organization that advises the government. “There need to be more incentives for private-sector investment, so that the supply-side can keep up.”

For their part, the ratings agencies are worried that any decrease in spending will be complicated by the activities of off-budget petrodollar funds and the so-called misiones that the government has introduced to improve access to health care and education among the poor. The misiones are sometimes financed by these funds, and cutting funding would mean Chávez might lose support.

“Too often, we mix politics with economics,” says Arnoldo Cardenas, head of treasury at Banco del Tesoro, the largest state-owned bank.

Indeed, patronage has been a dominant characteristic of Venezuelan political life for longer than most people can remember.

Cardenas’s bank is itself receiving a lot of help from the government, and its headquarters is full of posters of Chávez. Yet its lending, which is mostly in small, low-cost mortgages and microfinance, is not nearly as large as its deposits. This is because 80% of its deposits are trusts (fideicomisos) for government institutions. “We manage almost all the funds of the government,” says Cardenas.

The five-year-old institution’s most important customer is Fonden, the biggest off-budget fund. Roughly equivalent to sovereign wealth funds among other Opec members, Fonden, which was created in 2005, is the biggest of the pots into which Venezuela pours its windfalls from the commodities boom. Its lack of transparency makes Fonden similar to other sovereign funds. Up-to-date and detailed information about its investments are hard to obtain. But it differs from other such funds in that its main objective is to invest in the home country’s infrastructure.

Efrain Velazquez is writing a paper comparing Fonden with Norway’s sovereign wealth fund. He estimates that some $29 billion has been transferred from the central bank and Pdvsa to the fund in the past three years. Perhaps $7 billion is held in US dollar cash. Another $6.5 billion, he says, is being held in other financial instruments, including government bonds from such states as Brazil, Ecuador, Argentina, and Bolivia. Approximately $15.5 billion has already helped finance projects. These include subway systems in the provincial cities of Valencia and Maracaibo, two new subway lines in Caracas, a railway, and a bridge in Bolivar, Venezuela’s largest state.

Some observers are worried that the fund is fuelling inflation and weakening the currency by taking the central bank’s reserves. They have doubts about the quality of the bonds the fund holds, and say the bigger infrastructure projects would be difficult to wind down if oil revenues were suddenly to fall. A culture of honouring debt is lacking, claims one ratings agency. But others say the government has plenty of cash, and note that the Chávez government has always been punctual in meeting its international debt payments.

Whether or not Fonden and the other off-budget funds end badly, Venezuela’s history in sovereign wealth funds has not always been happy. The Venezuelan Investment Fund was set up during the first Opec oil boom, about the same time as the Abu Dhabi Investment Authority. There is an anecdote that the Venezuelan fund was offered a 50% stake in a US company called Walt Disney.

Political pressures forced the fund to focus on infrastructure at home, whereas it was originally intended for investments abroad as well. Some schemes it financed, such as the Guri dam hydroelectric station, were a success. But by the 1990s, the fund had become little more than a holding company for struggling state enterprises to which it had lent money.

It was about this time that Luis Grisanti was deputy minister of finance and, as such, the managing director of the Venezuelan Investment Fund. “There is no big difference between Fonden and the Venezuelan Investment Fund,” says Grisanti. “The main challenge now, as then, is whether the investments will be well chosen, well managed, and not too ambitious.”

Among the activities of these off-budget funds, however, are signs of the kind of ambition Hugo Chávez has revived even in the most depressed sections of Venezuelan society.

After losing his latest referendum, Chávez pledged a more realist approach, indicating that he would be more accommodating to the middle classes. Some food-price controls have been relaxed. But his stated readiness for economic warfare over a legal battle with Exxon Mobil showed that he could still be uncompromising.

It remains to be seen, then, how long Chávez’s government – and the oil price – are capable of keeping alive Venezuela’s reborn socialist dreams.