Venezuela Business Forecast Report Q3 2009

A Crude Awakening

President Hugo Chvez's victory in the constitutional referendum to allow indefinite presidential re-election will further strengthen his extremely tight grip on power. Moreover, efforts to eliminate key opposition figures from the political scene will make it increasingly difficult for the opposition to gain a foothold even if support for Chvez wanes, as we believe it will. In the near term we expect the deteriorating economic picture to lead to a rise in public unrest. We are expecting to see a sharp contraction in Venezuelan economic activity this year as private sector investment collapses and the government's fiscal constraints reduce public-sector economic output, due to the total collapse of oil revenue. While inflationary pressures have subsided slightly, inflation expectations remain entrenched and the risk of hyperinflation cannot be discounted. On the external front, the country's overarching reliance on imports will keep the threat of a balance of payments crisis elevated.

Venezuela's real GDP growth expanded by 3.2% year-on-year (y-o-y) in Q408, taking the fullyear figure in line with our 4.8% estimate. The contraction in investment and slowdown in private consumption support our view that the economy will contract by 5.6% in 2009 and 1.7% in 2010.

Moreover, the country's heavy reliance on imports suggests that the risks of hyperinflation and a balance of payments crisis are growing. With the government still refusing to devalue the official exchange rate, choosing rather to restrict the allocation of dollars to local businesses in response to foreign reserve depletion, local companies have increasingly turned to the black market to meet their foreign currency needs. Given its importance, we have begun to track the parallel exchange rate (VEF*) and will provide regular forecasts going forward. The rate currently stands at VEF*6.2000/US$ and we see further depreciation to VEF*8.0000/US$ by end-2009 as it bears the brunt of Venezuela's external economic imbalances.

On February 15 the Venezuelan electorate voted in favour of the constitutional amendment that allows the indefinite re-election of all elected government officials. Crucially, the vote enables President Hugo Chvez to run in the 2012 presidential election, and beyond, providing him with a mandate to accelerate his socialist revolution, which he believes will take until at least 2019. With unlimited presidential re-election established, and with the government in control of every state institution, we believe that Venezuela's political climate will continue to deteriorate, particularly as the economic environment sours. The clampdown on the opposition indicates that Venezuela's political climate is turning increasingly hostile, and we cannot rule out a rise in violent clashes between the government and opposition supporters over the coming months. Longer term, there is an increasing likelihood that Chvez will remain in power for decades, leading to a further erosion of the country's economic competitiveness.

Venezuela's business environment continues to worsen as a result of rising political uncertainty and a weakening economy. Since winning the constitutional referendum, Chvez has signalled that his socialist drive will continue apace and we expect to see a further marginalisation of private sector enterprise. With the country's international reserves coming under attack from lower oil revenues, local companies are finding it increasingly difficult to attain dollars for daily operations, which, if it continues, will likely cause a sharp reduction in investment.