VENEZUELA
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The future of Venezuela is indeed uncertain over the political direction with the democratic election victory in December 1998 of a populist/socialist, President Hugo Chavez and his promise to carry out a “Bolivarian revolution”. President Chavez swiftly implemented many new economic, judicial & political reforms, and a new consititution that was overwhelmingly approved by the people. President Chavez’s vision is government based on a strong presidency as he believes that representative democracy is not good for Venezuela and its population of 24.3 million. The new constitution supports for an increase in the government’s role in managing the economy, critics even suggest at dangerously authoritarian levels. President Chavez promised to take action to clean house and remove elements of corruption from many areas of Venezuelan society that persisted from decades of same party rule. However, much of this corruption is rooted in Venezuelan society and is difficult to achieve. Unfortunately for President Chavez, the vast majority of the poor who support him are somewhat disillusioned and bewildered after 4 years of his rule. Many of the 18 million Venezuelans who are poor are worse off today than they were when President Chavez took power. Today, 67 percent of Venezuelans earn less than $2 US-dollars per day, 50 percent of the population live in extreme/critical poverty. Although the economy is tremendously rich in oil and natural gas reserves, Venezuela was blatantly mismanaged for years from previous corrupt governments.

POLITICS: oldest democracy in South America and independence for Venezuela was achieved in year 1811 from Spain. Hugo Chavez was elected President in 1998, took office in February 1999 and has a political mandate to govern until year 2006. His government follows that of a left leaning socialist populist view which has further to polarize this oil rich nation. At present, both traditional opposition political parties are in trouble - Democratic Action (AD) and COPEI. Chavez has near dictatorial powers. President Chavez replaced the constitution and the Supreme Court, the judiciary has tightened controls over the military. President Chavez has accused previous governments of corruption and mismanagement of the oil wealth for many of the problems that exist in Venezuela today. Today, President Chavez has a slim majority for his government.

Many believe President Chavez is weakening this democracy with his actions, his failure to install responsible managers as loyalty is winning over competence. Corruption has remained entrenched for the most part with opposition critics accusing President Chavez for an autocratic rule and a fear that he will turn to a Cuban communism style of government. The land reform bill being proposed by the Chavez government (‘Bolivarian government’) is being blamed for upwards of $1 billion USD/month leaving Venezuela since he took power, scaring both domestic & foreign investors away and the following brain drain of some of Venezuela’s most productive citizens. Currently, 60 percent of the farmland is owned by less than 1 percent of the people, 80 percent live below the poverty line, 30 percent are undernourished, 14 percent are homeless. Chavez has recently increased the minimum wage and provide for social housing in an attempt to help address the poverty issue.

Political risk
Continued threats of more coup attempts against President Chavez as he accuses many generals in the military of being ‘coup happy’. On April 11, 2002, a coup attempt by rebel military officers ousted President Chavez for only 48 hours until he was re-instated as President after mass demonstrations for both his support and removal. Unfortunately, over 60 people were killed and many more injured in the violence that followed. Again in October 2002, another coup attempt against President Chavez was foiled. There is tension and a history of mistrust between President Chavez and the military. The military itself is now divided with several high level resignations having taken place over the last year or so voicing protests against President Chavez’s government. The three key pillar’s to Chavez’s realm on power consist of public support, continued high oil prices and loyalty from the military. Generally, the poor which represent the majority support Chavez although public confidence in President Chavez’s government is dropping to a low 30 percent approval rating with many of his ardent supporters losing faith in his leadership. It is only the high oil price that is clinging President Chavez to power.

If the economy does indeed take a nose dive to the worse, the military is most likely to takeover and run the country as the traditional political parties are technically bankrupt. There is also the possibility of a political coup from opposition groups including wealthy industrialists.

Social Risk

High unemployment and violent crime, the overall situation is volatile. Labour protests in oil, backlash from union supporters, the steel sector and amongst teachers to name a few.

ECONOMY: oil-dominated economy. The national strike that began in December 2002 and ended in March 2003 has decimated Venezuela over the short term. The national strike was supported by the economic elite and many in the middle class who fear redistribution, it has cost the government $6 billion in revenues so far.
During year 1999, damage from floods at $2 billion USD and low oil prices negatively impacted the economy as the economy declined by 7 percent reflecting a deep recession year. By year 2000 with the rebound in the oil price, the economy began to rebound even with OPEC productions cuts. These higher revenues helped Chavez politically and dramatically improved the balance of payment and fiscal situation for Venezuela. President Chavez must provide prudent leadership and maintain good relations with the United States, its largest oil customer. The economy’s fortunes are traditionally tied into the price of oil as it generates 80 percent of export revenues and accounts for one third of GDP and 50 pecent of government revenues.

Since President Chavez took power in 1999, thousands of businesses have closed and/or left the country coupled with a massive de-industrialization of the economy. Capital flight has pursued with billions leaving the nation. Immediate challenges include potential debt servicing and fiscal challenges although Venezuela should be able to manage theses pressures with oil now back on stream. As of March 2003, Standard & Poor’s debt rating agency gave Venezuela a CCC+ rating which is still a few notches above default levels. Industries include oil, natural gas, gold, bauxite, hydropower, agricultural and chemicals.

Oil Industry
Venezuela is home to one of the largest oil reserves outside the Middle East. The national strike that ended in March 2003 is slowly seeing Venezuela claw its back to full oil production. Since the strike that started in December 2002, the nation has been in a state of economic chaos as oil output collapsed to only 400,000 b/p/d. Official OPEC output quota for Venezuela is 2.497 million b/p/d although in October 2002, Venezueala was producing well beyond quota at 3.2 million b/p/d. Venezuela is currently the world’s number five oil producer and OPEC’s third largest oil exporter. Crude oil capacity is 3.7 millon b/p/d, the industry is currently worth $45 million USD/day in oil exports.

Economic Statistics
GDP is at $150 billion USD (2002) as measured by purchasing power parity equivalent ot GDP/Capita at $6,000 USD. GDP as measured by market prices at approximately $100 billion USD (2002). GDP growth for QTR1 2003 collapsed by 30 percent due to the national strike and loss of oil revenues. GDP growth contracted 10 percent in 2002, year 2001 grew at 2.7 percent after a miserable 2000 where GDP growth fell 7.2 percent and 650,000 jobs were lost as massive capital flight reigned. GDP growth rates averaged 1.9 percent from 1991 to year 1999. Inflation for 2002 at 30 pecent, 2001 at 14 percent, year 2000 at 20 percent, 1999 at 24 percent. Since 1998, fiscal deficit has shrunk from 4.1 percent of GDP in 1998 to 1.8 percent of GDP in 2000, however, it grew immensely to 10 percent of GDP in 2002. External debt is at $22.4 billion USD (2002) while total sovereign debt is measured at $44 billion USD (2002). In year 2000, Venezuela achieved a large current account surplus due to rising oil prices at the time with a surplus of $13.1 billion USD. Official unemployment is at 15 percent although the actual rate with underemployment is significantly higher. Year 2002 capital flight estimated at $8 billion USD.

POSITIVE: well educated nation, overall debt to GDP is one of the lowest in South America - debt default is less likely. CONCERN: non-oil business is struggling. The oil industry has had a history of boom and bust for many years previously in Venezuela and for many economies worldwide. For example, during year 2000-01 the government has increased spending to its highest real level since 1958 reflecting an increase of 40 percent in year 2000 over 1999 alone. Much of this windfall oil money has been spent on improving the nation’s infrastructure with $225 million USD alone for the nation’s airports.

BANKING SYSTEM: banking system is very weak with high inflation & interest rates, remains vulnerable. Interest rates are in the 40 to 50 percent range. Capital account measures were introduced in 2001 to slow down capital flight from taking place within Venezuela. In January 2003, foreign currency trading was suspended. Crisis mode: the Central Bank of Venezuela’s net international reserves at December 2002 were at $15 billion USD, by April 2003 they fell to $12 billion USD. As oil revenues come back on stream, the reserve position should increase.

Currently not a favorable investment climate with Chavez in power. Last figure, over 500 middle class Venezuelan families are leaving each month and taking their money with them. Over $10 billion USD in capital flight since 1998. However, on the whole it should be noted that Venezuela even with its own domestic turmoil has high levels of foreign reserves when compared to other Latin American countries. The Central bank has reduced the ceiling on the bank’s foreign currency holdings and has raised their reserve requirements. It has also banned foreign currency sales to companies domiciled outside of Venezuela.

KNOWLEDGE: current oil reserves are estimated at 175 billion barrels, a fraction of Venezuela’s potential. This figure jumps into the stratosphere when heavy crude oil is researched. The Orinoco heavy belt in eastern Venezuela is 270 miles by 40 mile wide oil field estimated to hold as high as 1.2 trillion barrels of oil. In addition, offshore natural gas fields are prevalent. Venezuela’s natural gas reserves are one of the largest in the world. President Chavez is coming under fire for his political manouvering of taking more control of state-owned oil conglomerate and Latin America’s largest company, Petroles de Venezuela (PDVSA).

However, he can claim success by striking a deal with the United States in September 2002 with a 20 year oil supply agreement to hungry U.S. markets. The U.S. currently imports 1.5 million b/p/d from Venezuela. The U.S. Bush Administration has warned Venezuela’s military that it would not recognize the unconstititional removal of President Chavez. Why? Oil and gas deals that were signed in the run-up to the Iraq War II. Further, President Chavez has also recently opened up its massive natural gas fields for development valued at $4 billion USD, much of it to be exported to the United States forward. The U.S. is securing its future energy supplies, Venezuela is to play an important role in this strategy.

Venezuela also has consdierable natural resource wealth available in mining resources, particularly gold mining wealth. The Las Crisinas gold deposit is Latin America’s largest undeveloped deposit with 11.5 million ounces. However, foreign capital will not return to help develop these deposits unless the socialist economic policies change particularly within the energy sector with new laws that deter foreign investment while royalty taxes have been increased to 30 percent, one of the highest rates in the world.

REGIONAL: Brazil, Colombia

Brazil will be an important export energy market for Venezuela. Close by Colombia is a major drug producer, internal drug use in Venezuela is currently increasing. On the flip side, Colombia is a significant buyer of Venezuelan electrical energy as Venezuela is home to large coal reserves and third largest producer in South America coupled with its large hydropower industry.

Global Outlook
President Chavez is actively pursuing relationships with other controversial world leaders including Cuba and Libya. More recently, the Cuban influence in Venezuela is more active now with participation from Cuban education and medical support in exchange for Venezuela’s oil. With repect to Free Trade for the America’s by year 2005, President Chavez is cautious as he fears large multinational giants taking over and wiping out small business. The fear for President Chavez and his administration is that he is isolating Venezuela from the civilized world. Chavez also supports Third World unity as a counterbalance to the world dominated by the United States. This anti-American feeling is dangerous considering the U.S. is a large key oil customer for Venezuela as it consumes 57 percent of Venezuelan’s oil exports.

CURRENCY: ISO symbol ‘VEB’, Venezuelan bolivar. At time of review on June 7, 2003, the bolivar had an exchange value of 1598 VEB to the US-dollar (‘USD’). The black market rate for the bolivar is as high as 2,500 VEB to the USD. When President Chavez took power in 1999, the exchange rate was then at 575 VEB to the USD. The current fixed exchange rate regime was established in February 2003 where the bolivar is fixed at 1598 VEB to the USD coupled with foreign exchange controls implemented at this time. Previous to the current fixed exchange rate regime, a floating currency rate was installed on February 2002 as Banco Central de Venezuela was forced to float and abolish currency controls due to reserves falling dramatically, capital flight and an overall balance of payments account that turned negative. Declining reserves resulted in its inability to defend the currency. The bolivar fell 22 percent versus the USD in its first day of free trading.

Before this float, the Central Bank has maintained a managed float ‘dirty float’ since 1997 when it was implemented. In this currency set up, a crawling peg exchange rate policy allowed the bolivar to float in a trading range of 7.5 percent on either side of parity exchange rate. This policy did help to bring inflation its lowest level in 14 years in year 2001 although it led to an overvalued bolivar. This currency regime was left in place too long as an overvalued USD during this time led to great difficulties in Venezuela. On January 22, 2003, USD purchases were suspended with currency controls in place. By February 2003, the government fixed the exchange rate at 1598 VEB to the USD to help replenish reserves with exchange controls to help pay the national debt. Under this currency regime, both the government and central bank can change the currency rate when required. The fear with the current fixed rate currency regime is that during the 1980’s, the government during this time had a similar preferred exchange rates whereby capital flight estimated upwards of $60 billion USD left Venezuela - biggest theft of the century.

CURRENCY HISTORY: the bolivar fell 60 percent to the declining USD in year 2002 and as much as 30 percent more recently during the national strike from March 2002 to March 2003. Historical valuations include: March 2003 at 1598 VEB to 1 USD, February 5, 2003 at 1849.5 to the USD, January 16, 2003 at 1609, January 10, 2003 at 1507, September 2002 at 1455, January 2002 at 899, September 6, 2001 at 743.76, January 2001 at 699, January 2000 at 652, August 1999 at 617.98, January 1999 at 569, May 1998 at 536, 1997 at 488, September 1996 at 474, January 1996 at 289, 1995 at 176.85, 1994 at 148.5, 1993 at 91. Historical currency crisis dates have included December 1986, March 1989, October 1992, May 1994, December 95.

CURRENCY OUTLOOK: the present level of government debt is increasing from President Chavez’s social spending and fiscal deficit challenges, capital flight remains a problem coupled with the continuing political instability. The resulting devaluation of the bolivar over the last 2 years and year 2003’s fiscal deficit shortfall may have inflation reach 50 percent in 2003. When looking at purchasing power parity, the bolivar is currently 10 to 15 percent undervalued in relation to the USD suggesting that the bolivar has bottomed out. Our forecast is for the bolivar to settle out at these current exchange levels. Capital inflows are an important measure, unattractive tax laws in energy may continue to discourage foreign investment particularly on marginal deposits, the oil industry receives the majority of investment. On par, Venezuela has had a history of surpluses due to oil industry, unqualified management is responsible for its unpredictable position today.

Venezuela is now in a more vulnerable position with an increase in domestic debt and and a more than likely lower oil price in the months ahead with Iraqi oil production to soon start feeding the world markets. This event will continue to bring currency exchange pressures to the bolivar. Venezuela’s difficult social polarization with many of the educated and their capital have already left Venezuela under Chavez’s tenure. It is ironic with Venezeula’s tremendous oil wealth, it should be a nation in theory as rich as Norway with a currency that should be an exchange value several multiples stonger. The upside appreciation risk is for a new leader to take power if President Chavez loses his binding referendum on his rule in a confidence vote that is open this August 2003. Recent polls suggest that President Chavez will lose this referendum. Political stability over time with prudent policies will reverse the capital inflows. In this scenario, the bolivar may reverse course and quickly move back towards 1000 VEB to the falling USD. On May 30, 2003, an agreement was signed with the opposition formally ending the general strike and any future coup attempts. Is the worst behind for Venezuela’s political crisis and crashing bolivar? Most likely unless civil war breaks out which is a low probability as the military would quickly take control. UPDATED: June 7, 2003





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