Venezuela: Rising Risks Of A Bolivar Devaluation In 2014
We are growing increasingly pessimistic about the trajectory of the Venezuelan bolívar, as the ongoing sell-off across emerging market assets significantly increases the government’s cost of sustaining an overvalued fixed exchange rate.
Indeed, given Venezuela’s weak export outlook, as its oil sector (which accounts for 95% of total outbound shipments) continues to slip, the government relies heavily on the issuance of dollar-denominated debt to inject foreign currency into the economy. However, because of ongoing capital outflows from emerging markets, a trend that our Global Research team expects to continue as the US recovery gains momentum, Venezuela’s cost of issuing debt will increase further. Therefore, while we currently forecast that the next devaluation of the bolívar will not occur until 2015, we now acknowledge that it could happen as early as 2014, as the Maduro administration seeks to increase the amount of local currency it receives from each dollar-denominated oil export sale to continue financing its politically crucial social agenda.
Exchange Rate Imbalances Will Continue To Widen
A clear indication that Venezuela’s exchange rate is becoming increasingly unsustainable at the current VEF6.300/US$ level is the black market exchange rate, which continues to weaken. Indeed, the lack of foreign currency available for importers through the official exchange rate window has fuelled a large black market, where the rate at which US dollars can be bought has risen from 4.5x the official rate just before the 46.6% February devaluation, to 5.0x currently, an all-time high.
The weakening of the black market exchange rate has contributed to 30%+ consumer price inflation, which has taken its toll on the already struggling popularity of new President Nicolás Maduro’s administration. While the government will likely issue additional US dollar-denominated debt in the coming months to inject foreign currency into the economy and ease rising price pressures, higher borrowing costs will either reduce the size of the issuance or delay it. Indeed, the yield on the government’s benchmark US$ 2027 global bond has already risen from its 8.7% low in February to 12.3% at the time of writing, and borrowing costs are likely to head higher over a multi-month period. This means that the currency imbalances will continue to build significantly over the coming months, increasing the likelihood that the next devaluation will occur before our current 2015 forecast.
Political Factors Will Be Key To Determining The Timing Of The Next Devaluation
Currency devaluations in Venezuela have always been closely tied to the administration’s political agenda, and we do not expect the next exchange rate adjustment to be different. Indeed, amid an elevated fiscal deficit, which we estimate at 11.8% of GDP, a devaluation of the bolívar would help narrow the government’s budgetary shortfall by generating more local currency per dollar-denominated oil exports. We have long highlighted that Maduro’s administration will seek to retain much of his late mentor President Hugo Chávez’s political agenda, which is based on high levels of social spending to ensure strong popular support.
Therefore, we believe that in order for the Venezuelan government to continue financing social spending at its elevated levels, in an environment with a constrained ability to issue debt, it will have to implement another one-off exchange rate adjustment. While it is highly unlikely that the next devaluation will occur this year, given the importance of the December 2013 local elections – Maduro’s first political test since he was elected in April – it could occur as soon as early next year.
A poor performance by the ruling Partido Socialista Unido de Venezuela (PSUV) would increase the likelihood of a devaluation occurring in 2014, as the PSUV would likely seek to raise social spending well of the next legislative election, which is scheduled to take place in the autumn of 2015. Given these factors, we will be monitoring political, economic, and global conditions closely, and may revisit our bolívar exchange rate forecast accordingly over the coming months.