Venezuelan president Hugo Chávez has a fanatical following at home as a fiery, anti-US leader, but his outbursts have always been taken with a pinch of salt abroad. After all, the US is the main buyer of Venezuela's oil, its chief export. But Chávez's new posturing as a virulent anti-capitalist has more than a few investors concerned.
A series of financial controls on bank interest rates, currency trading and oil investments, and a contentious land reform programme that is jeopardizing property rights are now backing up what for much of Chávez's six-year rule has been just rhetoric. "Capitalism is worse than Count Dracula, Frankenstein, the Boston Strangler and Jack the Ripper combined," Chávez proclaimed recently, promoting a socialist "revolution" he says is designed to help the country's poor. Bondholders and bankers fear Chávez, who praised Argentina's 2001 debt default, and aims to move Venezuela towards a centrally planned economy inspired by his Cuban ally Fidel Castro that could ultimately implode and throw the country into a deep recession.
On the surface, Venezuela's economy seems to be doing better than ever. Economic growth was Latin America's highest last year at 17% and the government says it will be 10% this year. Foreign reserves are at a record $28 billion, higher than the national external debt that the Chávez government has always serviced on time. Yet economists say growth is skewed by high oil prices and point to minimal expansion in the key crude sector in the first quarter of this year as investment is cut to pay for populist socialist programmes. The oil sector generates 80% of oil revenues and makes up a quarter of GDP – successive governments, including that of Chávez, have been unable to diversify the economy.
Meanwhile, banking profits fell 11% in the first four months of this year, as Chávez imposed a series of lending obligations that could undermine the financial system. Banks must now devote almost one-third of all loans to home mortgages, agricultural credits and small businesses at below the market rate. The government has also set limits to the rates banks can charge on its loans.
"Venezuela's capacity for self-destruction knows few limits," says New York research firm IDEAglobal in a report. "The result: less credit, weaker banks, more distortion in an already distorted economy. Venezuela will keep repelling the capital inflows it needs to develop." In April Chávez increased income taxes for 32 foreign oil-operating contracts and ordered them to be made into joint ventures, giving the state a minimum 51% share. The former army officer, who is also keen to strengthen links with China, has also passed a law that allows the confiscation of land the government deems is not being used by its owners. The UK's cattle farming Vestey Group has already been affected.
The populist policies have not yet closed Venezuela's access to international markets. Venezuela raised €1 billion in 10-year bonds in March, offering a yield of 7.1%. Demand for the offering surpassed €4 billion. Venezuelan lawmakers have approved the issuance of $1.4 billion in new debt as the country faces nearly $7 billion in debt service payments this year. Credit Suisse First Boston expects more dollar-denominated bond deals to be considered in the next few months, possibly involving 20-year paper and the repurchase of Brady bonds. But Chávez's politics come at a cost. Fitch Ratings in May revised its outlook on the debt to negative from stable.
Although the short-term risk of default is low, investment banks also worry that when oil prices come down, Chávez will be reluctant to cut social spending to service debt, raising the spectre of "major disruptive adjustments," according to Merrill Lynch. Private-sector investment has collapsed under Chávez and public finances have deteriorated since 1998, paving the way for another cycle of bust after the oil boom. In real terms, domestic public debt has almost tripled to 15% of GDP today from 6% in 1999 as the country has accumulated debt to finance a widening budget shortfall. Domestic debt accumulation has also saturated the banking system with government debt and is choking already illiquid local financial markets.