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Takeaway: We see heightened risk of a material devaluation of the Venezuelan bolivar (VEF) over the intermediate term.

CONCLUSIONS:

  1. All told, we see heightened risk of a material devaluation of the Venezuelan bolivar (VEF) over the intermediate term. This is actually not our first rodeo here; recall that we correctly predicted the eventual devaluation in FEB '13 of -32% in our OCT '12 note titled: "IS CHAVEZ POISED TO DO MORE IN VENEZUELA?".
  2. In normal times, that catalyst might come-and-go without any meaningful degree of broad capital markets impact. In today’s increasingly scrutinized emerging market investment landscape, however, we can’t see how another gap down in an EM currency bodes well for broader sentiment towards EM assets and a reversal of #EmergingOutflows.
  3. Looking to actual conditions on the ground in Venezuela, credit investors have been increasingly worried of late. 5Y CDS has ramped +271bps in the YTD to 1,419bps wide. The move on the 1Y tenor has been even more dramatic since then (+316bps to 1,486bps wide – i.e. wider than the longer 5Y tenor).
  4. Moreover, Venezuela’s benchmark 10Y USD bonds have dropped -8.72 points in the YTD to 66 cents on the dollar and are now yielding a world-beating 16.12%.
  5. Perhaps creditors are anticipating that President Maduro does something equally as dramatic over the intermediate term (i.e. yet another material devaluation of the VEF – or worse). Bloomberg Consensus currently anticipates a VEF devaluation from the current official rate of 6.3 per USD to 10.3 per USD (-39%) by the end of 1Q14.

In the wake of Argentina’s currency devaluation last week, we’ve gotten a couple of questions from subscribers asking, “who’s next?”.

While it’s tough to get inside the head of foreign (or domestic) policymakers with regard to timing, we think Venezuela is definitely on what appears to be a growing list for prospective material currency debasement. Please note that we don’t care if it’s an intentional devaluation or unintentional debasement; monetary and fiscal policymakers always have a choice with respect to protecting the purchasing power of their citizenry from both internal and external forces.

Venezuela remains the certified gong show we’ve identified it as in our published work over the years – most recently in our proprietary EM Crisis Risk Model, which shows that Venezuela is overly exposed to BoP/Currency Crisis risk (i.e. Pillar I) and Political & Regulatory (i.e. Pillar IV) risk:

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This, of course, comes as a surprise to no one, given the country’s history of devaluations, expropriations etc. (CLICK HERE for our most recent work on these topics). It’s fitting that the country is rated B-, Caa1 and B+ by S&P, Moody’s and Fitch, respectively, and all three agencies maintain a negative outlook on their ratings.

Looking to actual conditions on the ground, credit investors have been increasingly worried of late. 5Y CDS has ramped +271bps in the YTD to 1,419bps wide. The move on the 1Y tenor has been even more dramatic since then (+316bps to 1,486bps wide – i.e. wider than the longer 5Y tenor).

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That is worrisome. Perhaps creditors are anticipating that President Maduro does something equally as dramatic over the intermediate term (i.e. yet another material devaluation of the VEF – or worse). Bloomberg Consensus currently anticipates a VEF devaluation from the current official rate of 6.3 per USD to 10.3 per USD (-39%) by the end of 1Q14.

Maduro’s recent activity (as well as the recent activities of his gov’t) would certainly support that view:

  • Devaluing the official exchange rate for oil investments and tourist dollars in mid-DEC;
  • Forcing international airlines to keep their revenues locked in the country at the official exchange rate;
  • Stepping up the military enforcement of broad price controls that have been negatively impacting over 1,000 businesses operating in Venezuela – both domestic and foreign; and
  • The central bank delayed the release of its DEC CPI report for 20 days; a preliminary report on public spending, etc. that was scheduled to be released on DEC 31st has also yet to be released.

Meanwhile, here are five key macroeconomic statistics that are currently pressuring Venezuelan policymakers to act:

  1. The VEF has lost ~75% of its value in the black market over the TTM, with one USD fetching as much as 64 VEF in Caracas;
  2. Reported inflation ripped to +56.2% YoY in 2013 from 21.3% in 2012 as producers have hoarded goods and/or reduced production in anticipation of another devaluation and further price increases;
  3. The country’s scarcity index, which measures the percentage of goods that are out of stock and has been conspicuously absent since its OCT ’13 publication, hit 22.4% in OCT – the highest ratio since JAN ’08;
  4. Real GDP growth slowed dramatically to +1.6% YoY in 2013 from +5.6% in 2012; and
  5. At $21.2B as of JAN 24th, central bank FX reserves have declined -40% from their peak in DEC ’09.

IS VENEZUELA NEXT? - 3

IS VENEZUELA NEXT? - 4

The first statistic is supportive of a devaluation in the context of President Maduro’s recent promise to “create a unified exchange system next year which will provide foreign currency at a fair price for the functioning of the economy.” Under the current regime the government provides ~95% of the USD in the economy to selected companies and individuals at 6.3 VEF per USD. The remaining 5% is sold through weekly auctions at a higher floating rate, which currently stands at 11.3 VEF per USD.

The last statistic supports a currency devaluation because the country may seek a devaluation to shore up its illusion of creditworthiness (via artificially inflating FX reserves like Argentina does). The timing of which is anyone’s guess, but we’re guessing last week’s move in the ARS has investors pulling forward expectations, at the margins.

In spite of the aggressive price controls, we can’t see how another devaluation does not promote further rampant inflation – which we’d argue has played a critical role in perpetuating the well-documented social unrest in the country in the wake of Chavez’s death.

Net-net-net-net-net, the bond market’s got this one right, folks; Venezuela’s benchmark 10Y USD bonds have dropped -8.72 points in the YTD to 66 cents on the dollar and are now yielding a world-beating 16.12%. Remember, a weaker currency makes it harder to service USD debt (in the absence of pillaging central bank FX reserves, of course).

IS VENEZUELA NEXT? - 5

All told, we see heightened risk of a material devaluation of the Venezuelan bolivar (VEF) over the intermediate term. In normal times, that catalyst might come-and-go without any meaningful degree of broad capital markets impact. In today’s increasingly scrutinized emerging market investment landscape, however, we can’t see how another gap down in an EM currency bodes well for broader sentiment towards EM assets and a reversal of #EmergingOutflows.

Aye, aye, aye…

DD

Darius Dale

Associate: Macro Team