Venezuela Business Forecast Report Q1 2009

Oil Price Fall Poses Major Risks

The Venezuelan economy is in for a rough ride over the coming years. With oil prices falling rapidly and private sector economic activity slowing, the government is likely to find it difficult to maintain the current economic growth rate. Meanwhile, the inflation outlook has deteriorated somewhat and there are growing risks that lower oil revenues, combined with the potential for poor policy choices, could result in a hyperinflationary spiral. We look at the similarities and differences between the Venezuelan and Zimbabwean economies to highlight this potential threat. Meanwhile, as the November regional elections approach, the political outlook continues to sour, with President Hugo Chvez adopting increasingly draconian measures to ensure that his party retains its tight grip on the country. As we have previously stated, the erosion of democracy will continue to lead to a worsening business environment and economic outlook.

Chvez is taking drastic steps to ensure his party retains control of the country following the November 23 regional elections. These measures, which include promising to increase development spending in Chvista-controlled regions, and electing regional presidents to oversee local governors and mayors, are undermining democracy in the country and will continue to cloud the long-term political and economic landscape. The possibility of further declines in oil prices is also increasing, and we highlight the potential impact that a sharp reduction in petro-dollars would have on the Venezuelan political scene. In the short term, we would expect to see a rise in social unrest and a decline in Chvez popularity as social spending would need to be cut. In the longer term, while it would provide a golden opportunity for the dormant opposition parties to mount a challenge to Chvez, it may also lead to the president tightening his already unyielding grip on the country.

The Venezuelan economy expanded by an impressive 7.1% y-o-y in Q208, rebounding from 4.9% in Q108, suggesting that the effects of high inflation and mounting economic distortions are yet to take effect. However, economic growth is almost entirely down to the public sector, with private sector output suffering as a result. We see real GDP growth coming in at 5.8% this year, but falling to 2.5% in 2009. We note though that with oil prices continuing to fall the risks to growth are heavily weighted to the downside. Although economic growth will slow, inflation will remain elevated next year as a weaker exchange rate raises the cost of imports.

We see the decision by Chvez to nationalise Banco de Venezuela, the local unit of Banco Santander, as a worrying development for the countrys business environment for a number of reasons. It suggests to us that more government involvement in the banking sector is to come. Given the current administrations track record at running state enterprises, we are doubtful of their capacity to manage such an important financial entity. The potential for the government to further tighten its grip on the sector, which is already suffering from artificially low lending rates, suggests that investment in the sector may be hurt further. The recent rise in yields on Venezuelas external debt, in part due to the rise in risk aversion globally, will also pose a threat to the Venezuelan government, as companies will find it more difficult to finance operations with dollar-denominated debt.