International Finance: Venezuela - Essay Example

International Finance: Venezuela Introduction Venezuela captured the attention of international investors when it became one of the best performing equities markets in the world in the early half of this decade. The company registered 8% economic growth, mainly on the back of its petroleum exports at a time when international prices of crude were at all-time highs. It is now the task of this brief inquiry to determine the viability of Venezuela as a venue for investment. Overview of the Economy Towards the end of 2006, Business Monitor International (BMI) came out with its analysis of the Venezuelan situation. The analysis identified a “triple threat” attributable to three aspects of macroeconomic mismanagement. Firstly, the level of liquidity has increased dramatically, by as much as 45.1% in less than a year, as a result of capital controls and government splurging during preparations for elections in December of that year. Secondly, the level on net international reserves, which should have been much higher due to the high price of the country’s oil exports, dwindled at an increase of only 14.2%. This is because the government “raids the central bank when reserves exceed US$29 billion, and no longer requires state oil fir PDVSA’s dollar receipts to be transferred directly to the central bank.” (BMI, 2006) Thirdly, the conditions brought about by the first two situations caused the Bolivar to progressively weaken in the parallel market; investors who had wanted out of the Bolivar had difficulty changing their local currency into foreign currency, because only US$1billion worth was available in the legal exchange. They just turned to the parallel (or black) market, forcing the exchange rate lower in this market. This caused a further crisis of confidence in the Venezuelan economy. (BMI, 2006) Because of the conditions described above, the Economist Intelligence Unit (EIU) in 2007 forecasted the possibility of continued inflation (already at 20%) and a devaluation of the fixed official exchange rate (the Bolivar was already overvalued, with the parallel market rate at a premium of 125% to the official rate), and export growth is expected to slow down faster than import growth. In November 2008, the EIU adjusted its forecasts lower, in light of the escalation of the global financial crisis. Oil price has treaded lower, placing Venezuela’s oil exports in a precarious position. It is believed that Chavez will not abandon his expansionary fiscal policy but will instead devalue the fixed exchange rate of the Bolivar. This may cause inflationary pressures and possible food shortages. It is unfortunate that the government has not saved much of their windfall oil revenue when the price of crude was high; despite its being relative cash strapped, the government may move towards nationalising vital industries in the guise of blaming private industries for its economic debacle. (EIU 2008) In May 2009, the BMI brought out its first advisory that there is a possibility Venezuelan economy may turn bearish (it commented that it abandoned its bullish view of the country and assumed a neutral stance in April 2008), due to short-term weakness in the price of Brent Crude and the announcement of President Chavez of the decision of the Venezuelan government to take over oil servicing companies operating in the country. In the preceding table, the forecasted macroeconomic figures for Venezuela are given, as prepared by the Economist Intelligence Unite Ltd in its November 2008 report, including forecasts for 2009 and 2010. Real GDP growth is expected to slow down drastically, from 8% positive growth in 2007 to negative 5.4% in 2010, with recession being seen in 2009. Agriculture growth will dwindle, unemployment will almost double, and average inflation will skyrocket to a projected 40.6% for this year (year-end it is seen at 45.9%). The lending interest rate will be dismal at 30% next year, and government balance will be a negative percentage of GDP for three years in a row. Although exports and imports are seen to fall steadily from 2008 onwards, exports will still exceed imports by twice the amount imported. Finally, the government will be forced to give up its fixed exchange rate, and the Bolivar will be devalued, although the official rate will still be overvalued, maintaining its premium to the parallel rate. (EIU, 2008; Andean Group Monitor, 2008) Political Environment Despite strong warning signs developing in the macroeconomy, Hugo Chavez won a strong mandate in the national election of December 2006. On his third term, he took it as his stand to pursue a “21st-century socialism”. In late 2007, EIU was of the opinion that Chavez’s political concerns would be complicated not only by the weakness and politicisation of institutions at the time, but also the slow but steady reduction in fiscal revenues and the decline in private investment. It was about this time that a proposed constitutional reform was initiated, which sought to eliminate presidential term limits, weaken private property rights, politicise the military and establish a new form of local government. The initiative was thought unpopoular particularly in the prospect of unlimited chances for presidential re-election, but since the proposed measure also pushed for a six-hour workday, there was a chance that it would succeed. Contrary to expectation, the referendum, held in December 2007, had narrowly defeated Chavez’s reform package, largely due to campaigns by student groups, traditional opposition leaders, and even some former Chavez allies, against the package. This was the first electoral defeat of Chavez since assuming office, and taken by many to be a public rebuke of his apparent intention to propagate himself in power. (US State, 2008) And finally in the political commentary, the BMI report for December 2008 underscored Venezuela’s short- and long-term political risk, giving them high-risk scores of 71.7 and 60.0 respectively. The advisory also cautions that further uncertainty and a deterioration of the political situation is in the future for Venezuela, as President Chavez adopts an increasingly authoritarian stance in ascertaining that his party maintains control over key positions – according to BMI, “a key risk to democracy”. Lower oil prices will tend to dry up revenues from oil exports, and the government will be hard put to raise the funding for social programmes, which in turn could compromise Chavez’ popularity and political influence. Commentary on comparative advantage In benchmarking Venezuela against other countries, the Financial Standards Foundation (FSF) has scored it a 7.5/100 in the Standards Compliance Index, indicating that the country has achieved very low overall compliance with international standards and codes. The country’s regulatory environment “remains extremely weak”; seven out of twelve standards were gauged at “insufficient information” level, meaning that there is a serious lack of publicly available data. This reflects a serious lack of transparency in its economic, financial and political practices. Furthermore, the country “appears to suffer from rampant corruption, politicization of economic processes, centralization of control by the presidential government, inadequate powers in financial sector regulators, and a serious lack of accountability.” (FSF, 2009) In short, in comparison with international standards and best practices as far as financial systems, business activity and investment potential is concerned, Venezuela ranks in the lowest 10% prospects. From a closer perspective, Venezuela’s key advantage over many other countries is that it is an oil producing, oil exporting country. However, it is telling that in 2008, Venezuela was hit by three large-scale power blackouts, affecting at least an entire one-third of the country, including the capital city, Caracas. The outages are more than just coincidental; they are symptomatic of the country’s outdated and quickly deteriorating power infrastructure. Even as President Chavez nationalised the power sector in the previous year and vowed to infuse investment into the system, analysts are pessimistic that Venezuela will be able to afford a major upgrade in their power infrastructure, particularly with oil prices falling. Venezuela’s major export is oil, from which it realized windfall revenues that fuelled the country’s bullish performance prior to 2007, due to the record highs of oil prices. Since the present financial crisis has eroded productive activity worldwide and the demand for power and, thus, fossil fuels is but a fraction of what it had been, there is little chance that Venezuela will see the same kind of oil export revenues that it did in the past. (BMI Andean, 2008) During good times, the country’s leadership did little to shore up its resources and to make the most of its advantage over oil-importing countries. Furthermore, with the poor condition of its power generation and delivery system, Venezuela loses whatever advantages it may offer as a venue for direct investments. With the present economic challenge worldwide, and with no meaningful reforms in sight, there is little hope for the country’s turnaround at this point in time. As to requirements for entry of multinational enterprises and provisions for foreign direct investments in Venezuela, it is worthwhile to note that Venezuela poses no particularly difficult requirements or restrictions to entry of foreign productive capacity. In fact, in the 1990s, direct foreign investment was the largest single source of external finance for Venezuela as well as other developing countries, accounting for nearly half of all capital flows. In fact, restrictions on incoming foreign investments were eased by policymakers in third world countries, and even offered special subsidies as incentives to foreign enterprise. Such incentive include lower tax rates, tax holidays, import duty exemption, and subsidies for infrastructure. (Aitken & Harrison, 1999). While in general Venezuela welcomes foreign direct investment, there are certain restrictions. According to the Superintendency of Foreign Investments (SIEX, 2009), Decree 2095, Article 26, states that there are certain economic sectors that are reserved for national companies, as defined by the Andean Pact Policy: television and radio, Spanish-language newspapers, and Professional services which are regulated by national laws. For these companies, national investors must be holders of at least 80% of the stock. Other such industries with similar ownership requirements are the oil industry, which was nationalized in 1975; companies dedicated to air transportation ; and domestic navigation in general, including cabotage. (SIEX, 2009) Key Industries (major companies and descriptions) Among the key industries on which the backbone Venezuelan economy is built, are petroleum (a nationalized industry by the Venezuelan government), iron ore mining, construction materials, food processing, textiles, steel aluminium, and motor vehicle assembly. Its key export commodities are petroleum, bauxite and aluminium, steel, chemicals, agricultural products, and basic manufactures. Finally, its main import commodities are raw materials, machinery and equipment, transport equipment, and construction materials. (Davidbarber.org, 2002) Included in this paper as index is the complete list of companies listed in the Bolsas de Valeros de Caracas (Caracas Stock Exchange). Unfortunately, further information on the companies other than this listing is nearly impossible to get for academic purposes, as an investor’s subscription is required. This is but a confirmation of the finding reported by the FSF, that Venezuelan practices do not comply with transparency in reporting, a further discouragement for potential portfolio investments. It is apparent from this exhaustive list that there are only a few companies available to trade in the Caracas exchange. This is not a surprise, nor is it intentional. In 2000, a spate of mergers and acquisitions (M&As) took the best of the most liquid and financially attractive counters at the Caracas exchange and as a consequence, rendered the exchange increasingly illiquid. For instance, La Electricidad de Caracas, a Venezuelan utility, used to account for 40% of all stock market trading. A controlling stake of La Electricidad was acquired by AES Corporation for $1.7 billion, the first hostile takeover in Venezuelan history. This was followed by the takeover by Spain’s Banco Santander Central Hispano of 93% share in Banco Caracas for $316 million, and Kimberly-Clark’s rumoured buy-in into Venezuelan paper producer Manpa, which records annual sales of $210 million. Because of these mergers and acquisitions, the daily value traded, once at $20 million in 1997, has trickled to $2 million. Of only 72 companies listed, a mere 15 or so are traded actively. This has caused a group that comprised 20% of Caracas exchange’s stockholders to announce in February, 2001 their desire to have the exchange dissolved. (Hoag, 2001; Italiani, 2009) Conclusion Venezuela as a venue for investments is replete with foreseen problems. Economically it is facing heightened inflation and monetary devaluation, reduced national revenues and failing power utilities. Politically it is plagued with corruption, lack of transparency, and promises of future political instability as Chavez attempts to extra-constitutionally forestall his exit form the presidency. Benchmarked against other countries, it falls within the last 10% of possible venues for investment. This environmental analysis points to a negative recommendation for Venezuela as a target for investment, at least for now, for either portfolio funds or direct foreign investment, until its economic and political uncertainties are addressed. APPENDIX Publicly Held Companies listed by Economic Activity (Source: Bolsas de Valeros de Caracas) COMMON SHARES CLASSIFIED BY ECONOMIC ACTIVITY Industrial Sector Processed Food Industry Manufacturing Industry Services Sector Electric Utilities, Telecomunications and Natural Gas Transportation, Commerce and Hotels Financial Sector Commercial Banking Mortgage Banking Other Financials Institutions Insurance and Real State INDUSTRIAL SECTOR Processed Food Industry Symbol ISIN Code Nominal Value (Bs.) PRODUCTOS EFE, C.A. EFE VEV00099100 1 10,00 PROAGRO, C.A. PGR VEV00090100 0 100,00 PROTINAL, C.A. PTN VEV00109100 9 100,00 C.A. RON SANTA TERESA, S.A.C.A. RST VEV00063100 3 100,00 Manufacturing Industry Symbol ISIN Code Nominal Value (Bs.) CERAMICA CARABOBO, S.A.C.A. CCR VEV00020100 5 164,00 CORPORACION GRUPO QUIMICO, S.A.C.A. CGQ VEV00017100 0 100,00 CORPORACION INDUSTRIAL CARABOBO, S.A.C.A. - CLASE A CIC.A VEV0004210A 0 10,00 CORPORACION INDUSTRIAL CARABOBO, S.A.C.A. - CLASE B CIC.B VEV0004210B 8 10,00 CORIMON, S.A.C.A. CLASE A CRM.A VEV0000410A 0 100,00 CORIMON, S.A.C.A. CLASE B - PREFERIDAS CRM.B VEV0000420B 7 100,00 DOMINGUEZ & CIA., S.A. DOM VEV00044100 7 10,00 DOMINGUEZ & CIA., S.A. - PREFERIDAS DOM.P VEV00044200 5 10,00 ENVASES VENEZOLANOS, S.A. ENV VEV00056100 2 10,00 C.A. FABRICA NACIONAL DE CEMENTOS, S.A.C.A. FNC VEV00066100 0 10,00 C.A. FABRICA NACIONAL DE VIDRIO FNV VEV00076100 8 10,00 GRUPO ZULIANO, C.A., S.A.C.A. GZL VEV00050100 8 10,00 INTERNACIONAL BRIQUETTES HOLDING IBH VEV00101100 7   MANUFACTURAS DE PAPEL (MANPA), S.A.C.A. MPA VEV00001100 8 10,00 MANTEX, S.A.C.A. MTX VEV00091100 9 1000,00 SUELOPETROL C.A. - CLASE B SPT.B VEV0010710B 9 100,00 SUDAMTEX DE VENEZUELA, C.A., S.A.C.A. - CLASE A STX.A VEV0012110A 2 20,00 SUDAMTEX DE VENEZUELA, C.A., S.A.C.A. - CLASE B STX.B VEV0012110B 0 20,00 INVERSIONES SELVA, C.A. - CLASE A SV.A VEV0008010A 0 1000,00 INVERSIONES SELVA, C.A. - CLASE B SV.B VEV0008010B 8 1000,00 SIDERURGICA VENEZOLANA (SIVENSA), S.A. SVS VEV00114100 2 20,00 SIVENSA, S.A.C.A. ADR SVSR1 VEV00114601 9 9.060,00 TORNILLOS VENEZOLANOS, S.A.I.C.A. S.A.C.A. TOR VEV00039100 4 20,00 C.A. TELARES DE PALO GRANDE TPG VEV00131100 1 100,00 CEMEX VENEZUELA, S.A.C.A. - TIPO I (antes Vencemos) VCM.1 VEV00136101 4 100,00 CEMEX VENEZUELA, S.A.C.A. - TIPO II (antes Vencemos) VCM.2 VEV00136102 2 100,00 VENEZOLANA DE PRERREDUCIDOS CARONI, C.A. (VENPRECAR) GDS VEN.G VEV00193500 7 100,00 VENEPAL, S.A.C.A. - CLASE A VNP.A VEV0014910A 3 100,00 VENEPAL, S.A.C.A. - CLASE B VNP.B VEV0014910B 1 100,00 VENEPAL, S.A.C.A. - CLASE B GDS VNPBG VEV00149500 2 100,00 VENASETA, C.A. - CLASE A VNS.A VEV0017210A 5 10,00 VENASETA, C.A. - CLASE B VNS.B VEV0017210B 3 10,00 SERVICES SECTOR Electric Utilities, Telecomunications and Natural Gas Symbol ISIN Code Nominal Value (Bs.) CORPORACION INDUSTRIAL DE ENERGIA, C.A S.A.C.A. CIE VEV0019510A 6 10,00 COMTEL, COMUNICACIONES TELEFONICAS, S.A. CTE VEV00031100 2 1,00 C.A. ELECTRICIDAD DE CARACAS, S.A.C.A. EDC VEV00008100 1 100,00 ELECTRICIDAD DE CARACAS "ADS" ELDAY US12477A106 0   VENGAS, S.A. (antes Industrias Ventane) IVE VEV00161100 4 11,70 C.A. TELEFONOS DE VENEZUELA (CANTV) - CLASE D TDV.D VEV0008810D 7 36,90 AMERICAN DEPOSITARY SHARES (ADS) DE CANTV VNT US204421101 7   Transportation, Commerce And Hotels Symbol ISIN Code Nominal Value (Bs.) H.L. BOULTON & Co., S.A.C.A. HLB VEV00160100 5 10,00 HOTEL TAMANACO, C.A. HTM VEV00117100 9 203,16 TORDISCA DISTRIBUIDORA TORVENCA, C.A. TDS VEV00171100 2 20,00 TEMINALES MARACAIBO, C.A. TRM VEV00092100 8 40,00 FINANCIAL SECTOR Commercial Banking Symbol ISIN Code Nominal Value (Bs.) BANCO DEL CARIBE, C.A. BANCO UNIVERSAL - CLASE A ABC.A VEV0021410A 5 1.126,00 BANCO DEL CARIBE, C.A. BANCO UNIVERSAL - CLASE B ABC.B VEV0021410B 3 1.126,00 BANESCO BANCO UNIVERSAL, S.A.C.A BBC VEV00167100 8 100,00 BANCO CANARIAS DE VENEZUELA, BANCO UNIVERSAL, C.A. BCA VEV00234100 7 100,00 BANCO CONFEDERADO, S.A. BANCO UNIVERSAL BCF VEV00043100 8 100,00 BANCO CANARIAS DE VENEZUELA, C.A. BCZ VEV00036100 7 100,00 BANCO EXTERIOR, C.A. BEX VEV00077100 7 500,00 BANCO NACIONAL CREDITO, C.A. BNC VEV00236100 5 1.000,00 BANCO OCCIDENTAL DE DESCUENTO BANCO UNIVERSAL, C.A. BOU VEV00224100 9 100,00 BANCO PROVINCIAL, S.A. BPV VEV00127100 7 100,00 UNIBANCA BANCA UNIVERSAL, S.A. (antes BANCO UNION) BUN VEV00132100 0 100,00 VENEZOLANO DE CREDITO, S.A. BANCO UNIVERSAL (antes Banco Venezolano de Crédito) BVE VEV00003100 6 500,00 BANCO DE VENEZUELA, S.A.C.A., BANCO UNIVERSAL BVL VEV00057100 1 100,00 CORP BANCA, C.A. CBN VEV00021100 4 100,00 EUROBANCO BANCO COMERCIAL, C.A. EUR VEV00165100 0 1.893,12 ORGANIZACION ITALCAMBIO, C.A. ITLC VEV00230100 1 26.082,00 MERCANTIL SERVICIOS FINANCIEROS C.A. - CLASE A MVZ.A VEV0019410A 9 150,00 MERCANTIL SERVICIOS FINANCIEROS C.A. - CLASE B MVZ.B VEV0019410B 7 150,00 Mortgage Banking Symbol ISIN Code Nominal Value (Bs.) BANCO HIPOTECARIO ACTIVO, C.A. (antes Banesco Banco Hipotecario, C.A.) BBH VEV00119100 7 100,00 C.A. CENTRAL BANCO UNIVERSAL (antes Banco Hipotecario Venezolano) BHN VEV00068100 8 250,00 Other Financial Institutions Symbol ISIN Code Nominal Value (Bs.) BBO FINANCIAL SERVICES, INC. BBO VEV0005910A 4 100,00 BOLSA DE VALORES DE CARACAS, C.A. BVCC VEV00037100 6 8.300.000,00 ECONOINVEST CAPITAL S.A. - CLASE A ECO.A VEV0024510A 6 740,00 ECONOINVEST CAPITAL S.A. - CLASE B ECO.B VEV0024510B 7 740,00 INVERSIONES TACOA, C.A - CLASE A ITC.A VEV0001510A 6 100,00 INVERSIONES TACOA, C.A - CLASE B ITC.B VEV0001510B 4 20,00 Insurance and Real State Symbol ISIN Code Nominal Value (Bs.) F.V.I. FONDO DE VALORES INMOBILIARIOS, S.A.C.A. - CLASE A FVI.A VEV0018810A 1 10,00 F.V.I. FONDO DE VALORES INMOBILIARIOS, S.A.C.A. - CLASE B FVI.B VEV0018810B 9 10,00 INMUEBLES B. DE V. 1985, C.A. IBV VEV00058100 0 10,00 INVERSIONES DIVERSAS, C.A. (INVERDICA) INV VEV00094100 6 5,00 C.A. DE INMUEBLES Y VALORES CARACAS IVC VEV00051100 7 70,00 ORIENTE ENTIDAD DE INVERSION COLECTIVA INMOBILIARIA, C.A. OCE VEV00252100 4 1.00,00 OCCIDENTE ENTIDAD DE INVERSION COLECTIVA INMOBILIARIA TURISTICA, C.A. OEI VEV00243100 6 1.000,00 C.N.A. SEGUROS LA PREVISORA SLP VEV00027100 8 400,00 SEGUROS LA SEGURIDAD, C.A. SLS VEV00229100 4 2,00 SEGUROS PANAMERICAN, C.A. SPA VEV00186100 5 50,00 VENCRED, S.A. VCR VEV00038100 5 66,65 REFERENCES Aitken, Brian J. & Harrison, Ann E., “ Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela”, The American Economic Review, vol. 89 no. 3, pp. 605-618, June 1999. Bolsa de Valores de Caracas Business Monitor International (BMI), “Venezuela: Boom Turning to Bust” Andean Group Monitor, December 2008. Business Monitor International (BMI), “Venezuela: The Problems Mount”, Emerging Market Monitor, 27 November 2006, 3 July 2009, Business Monitor International (BMI), “Venezuela: Turning Bearish Debt”, Emerging Market Monitor, 18 May 2009, 5 July 2009, CountryWatch, “Venezuela Review 2007”, Economic Overview, pp. 113-89, 2007 Davidbarber.org, Venezuela power point presentation, 2002, 3 July 2009. Financial Standards Foundation (FSF), “Venezuela”, eStandards Forum, February 2009, 5 July 2009, < http://www.estandardsforum.org/jhtml/country/Venezuela/gc/186/> Hoag, Christina. “Bye-Bye Bolsa? Deal fever could spell the end of Venezuela’s exchange”, Businessweek, 5 March 2001, 5 July 2009, Italiani, Fulvio, “Venezuela Mergers and Acquisitions”, Latinlawyer, 2009, 5 July 2009, Institute for International Economics, “Globalization, Foreign Direct Investment and Labor”, Fighting the Wrong Enemy, 5 July 2009, < http://www.iie.com/publications/chapters_preview /91/4iie2725.pdf> Superintendency of Foreign Investments (SIEX), Foreign Investment, 2009, 3 July 2009, The Economist Intelligence Unit (EIU). Edited by Mackie, Fiona, “Venezuela at a glance: 2008-2009”, Country Report, 10 September 2007, 4 July 2009, The Economist Intelligence Unit (EIU). “Venezuela”, Economic Policy Outlook Monthly Report, Nov. 2008, 4 July 2009, US State Political Environment Read More