Venezuela Business Forecast Report Q2 2009

A Slippery Slope The Venezuelan economy appears to be falling into recession, which we believe is necessary to bring domestic consumption down towards sustainable levels. The huge fall in oil prices will make the downturn harsh, and the government may attempt to cure the economic ails by printing money. This will substantially increase the risks of a hyperinflationary depression. On the political front, there is also little to be optimistic about. We believe that President Hugo Chvez will not succeed in the referendum to amend the constitution so he can run for indefinite re-election. This would deliver a major blow to his 'Bolivarian revolution' and seriously raise the risks of large-scale politically-motivated violence. Heightened economic and political uncertainty, combined with the government's still-strong nationalisation drive, will also continue to undermine the country's business environment.

It has been a core view of ours over the past year that Chvez would continue to press towards changing the constitution to allow himself to remain in power indefinitely. However, we believed that the December 2007 defeat marked the end to Chvez's chances of democratically changing the constitution. Growing social unrest due to soaring crime levels and rampant inflation, as well as a renewed political opposition, would make a successful vote highly unlikely. With few other options remaining in the event of a defeat at the polls, there is a serious threat of Chvez becoming more totalitarian. In such an event, we do not rule out the use of military force to put down any resistance by opposition to the government. Chvez's moves to reorganise the armed forces into a revolutionary corps, combined with the training and arming of hundreds of thousands of loyal militias, suggest that the president may be prepared for a potential military crackdown.

Our newly revised economic growth forecast for 2009 is a contraction of 5.6%, and we see the recession continuing into 2010 when the economy will shrink by 1.7%. While we are far below consensus with our projections, we believe that there are few supportive factors underpinning the economy and point to previous economic contractions as evidence to suggest that significant pain could be in store. Historical data also support our view that inflation will continue to grind higher despite the collapse in domestic demand, due, in part, to an implicit or explicit currency devaluation.

A major concern of ours is that the cyclical bust is made all the more worse by rising structural damage done to the economy in recent years, such as the nationalisations undertaken by President Hugo Chvez, which could prevent a return to positive growth for a number of years.

The Venezuelan business environment will turn increasingly hostile in 2009 as the deteriorating economy, soaring inflation, and rising political tensions discourage private sector investments. What is more, the government is steadfast in its aim to take over the means of production, particularly in the agricultural sector, which will further raise fears over property rights. We are also likely to see a general reduction in the amount of US dollars allocated to the private sector from the CADIVI foreign exchange board, which will make it difficult for local producers to fund imports. This will force the parallel exchange rate to weaken in the absence of a large currency devaluation.