The governments of Venezuela and Argentina — two of Latin America’s most populist — have begun 2010 with measures that are sowing disorder among the local populations and foreign investors in the two countries. On the one hand, Argentine president Cristina Fernández de Kirchner decided to sever her connections with Martin Redrado, president of the Argentine central bank (BCRA). Kirchner decreed that Redrado had been dismissed after unsuccessfully demanding that he resign his office. The reason: Redrado had refused to execute a presidential decree that obliged him to transfer US$6.56 billion of the bank’s reserves to the so-called Bicentennial Fund, which was to repay the country’s debts.
A few days later, a judge suspended the presidential decree and Redrado was reinstated because the central bank’s governing charter establishes that Congress must be consulted before any bank governor is dismissed. However, from that point on, the relationship between the government and Redrado became mixed up, leading to some unusual situations, such as the decision by the executive branch to block Redrado’s access to the bank shortly after his return. Finally, the Argentine “soap opera” came to a close, almost a month later, with Redrado’s resignation at a press conference, and the designation on February 3 of Mercedes Marco del Pont, a close ally of Kirchner and her husband, Nestor Kirchner, former President of Argentina, as president of the Bank.
In the middle of this conflict, a judge in the U.S. decreed an embargo on the Argentine central bank’s funds in the U.S. Federal Reserve, in response to a petition by investment fund Elliot and Dart, which has been demanding repayment of unpaid Argentine government bonds since the default by the Argentine government in 2001. Redrado had already expressed his fears that something like this would happen now, because with the new “bicentennial” decree, the BCRA’s funds would now be considered governmental property. Nevertheless, after a meeting between the plaintiffs and the lawyers of the U.S. Fed – who claimed that this move was unnecessary and would interfere with legitimate banking operations – the embargo was officially lifted.
All this has had a negative impact on prices for Argentine bonds and on stock prices there. “[Argentina’s] Country Risk increased from 651 to 727 points, especially after the embargo. The stock exchange [index in Buenos Aires] fell 2.78%. Nevertheless, the [Argentine] monetary authority succeeded in keeping the [U.S.] dollar stable at about 3.83 [pesos to the dollar],” says the latest report published by the Torcuato Di Tella University’s Financial Research Center (CIF) for the Econolatin network. At the present time, Argentina’s courts have continued to block any effort by the country’s central bank to transfer reserves to the government. According to a court decision in March, following the summer recess, the Argentine parliament will have to debate whether to grant authorization for the central bank to transfer its reserves.
The institutional conflict has erupted at the very same time when Argentina is attempting to refinance US$20 billion of bonds that are in default and are in the hands of creditors who rejected the restructuring of the debt agreed upon in 2005. That agreement put an end to the condition of “default” into which the country had entered four years earlier, and from which it needed to emerge in order to access financing at a lower cost. In 2010, Argentina faces payments of US$13 billion on public debt maturities amounting to US$130 billion, which represents 40% of its GDP.
According to the government, the Argentine government grew by only 0.9% during 2009, but independent analysts say that it fell by 4% last year. This economic deceleration has hurt tax revenues and dried up budgetary savings. Since 2004, write the analysts at the CIF, “the tax surplus has been one of the fundamental pillars of government economic policy but it clearly deteriorated in 2009. The main result was that the GDP contracted by 1.3% that year.” In 2010 the outlook continues to show signs of deterioration. “Expectations are for improvement in tax collections because of a 20% inflation as well as economic growth, and spending is not expected to be moderated,” the CIF said.
This is due largely to new child support programs that “increase spending by about US$7.4 billion (0.6% of the GDP).” In addition, “20 of Argentina’s [overall total of 23] provinces are in the red, and their collective deficit could reach 1.2% of the GDP,” says the report.
Felipe Monteiro, a professor of management at Wharton, does not believe that the government’s meddling in the BCRA is as serious a matter as it would be if this had happened in another country in the region such as Brazil, Chile or Mexico. That’s because those governments don’t have such a populist character. In those countries, he says, “a situation of this sort would be a total surprise for foreign investors.” The notion that the Argentine government does not respect any limits is not something surprising for the markets, he adds. “The debate will continue in the courts and in the [Argentine] Congress, and we don’t know a great deal about how things will ultimately turn out…. Nevertheless, something like that fits in with the policies that the government consistently introduces into areas that are not traditionally within its realm.”
Generally speaking, he notes, investors are “standing by, in a suspended state, since the [Argentine presidential] elections of the coming year can change the political situation, and the country can go back to having a better investment climate.” At the moment, however, institutional instability once again darkens the horizon of Argentina, which is the region’s third-largest economy.
Elections Force Devaluation in Venezuela
At almost the same time that emergency presidential decrees were removing the institutional foundations of Argentina, Hugo Chávez, President of Venezuela, was announcing a devaluation of the Venezuelan Bolivar of almost 50% relative to the dollar. From now on, in place of one exchange rate of 2.15 Bolivars to the dollar – the official rate since 2005 – there will be a system of three rates: an exchange rate of 2.60 to the dollar for those products that are in greatest need, a second rate of 4.30 for other products, and a market rate.
Although this decision was anticipated, some experts were struck by the change. For Richard Obuchi, professor of public policy at the Institute of Advanced Management Studies in Venezuela, the devaluation of the Bolivar was a surprise. Although he recognizes that this is a move that the government had to carry out sooner or later because of the high cumulative inflation rate after the official exchange rate was established, in his view “the negative effects of this policy on its popularity should have impelled the government to postpone this decision as long as possible.”
Venezuela’s next legislative elections will take place in September 2010 and, at least for now, Chávez has an approval rating of less than 50%, compared with 60% a year ago. This situation is largely a result of the crisis that impelled Venezuela last year to suffer a negative growth rate of 2.9% and an inflation rate of 25%, the highest in the region. Prospects for this year are not much better. Forecasts call for economic growth to decline again by between 2% and 3%. Given the negative views that populations usually have about devaluations, Obuchi notes that the government has been able to move up this change until the start of the year so that it is as far away as possible from the election date. “This lowers the value of the domestic debt, and [Venezuela] faces fewer pressures on the financing so it is able to increase public spending before and during the election campaign.”
Among other things, says Obuchi, “This decision makes me think that the fiscal condition of the government is worse than it looks, and it demonstrates how vulnerable the Venezuelan economy is to external shocks.” The global financial crisis has highlighted the high dependence of Venezuela, the fifth-largest oil exporter in the world, on revenues from ‘black gold’ (oil) and the negative impact that the decline in prices of that commodity has had on the country’s foreign exchange revenues. However, in 2010 Obuchi expects that tax revenues will be higher because of the recovery in crude oil prices, “which will determine the behavior of the government and the players in the economy.”
The Inflationary Impact
The most immediate effect of the devaluation will be “an increase in people’s expectations about prices as well as the rising cost of imports that were once subject to a rate of 2.15 Bolivars [to the U.S. dollar] and will now be exchanged at 2.60 and 4.30 Bolivars [to the dollar],” says Obuchi. In recent years, the country has undergone several devaluation processes that have always been very inflationary during the first few months. He notes, “In January and February 2003, when they changed the exchange system to a fixed rate of 1.6 Bolivars to the dollar, the inter-month inflation rate was at 2.9% [in January] and at 5.5% [in February], and those were the highest rates of the year.” This inflationary impact was also felt in 2004 and 2005, years when the currency was also devalued: It was fixed at 1.9 Bolivars to the dollar in 2004, and 2.15 Bolivars to the dollar in 2005. Some analysts in the country estimate that inflation could shoot up to 50% this year as a result of the coming devaluation.
At the moment, Chávez has acted to protect the country from the speculation that has supposedly impacted the food supply chain after the devaluation. Chávez ordered the nationalization of the Franco-Colombian hypermarket chain called Exito, and the temporary closing of up to 150 businesses. The government also announced that it would resort to massive imports of automobiles and even of school equipment as a means of protecting against price increases.
Despite everything, Obuchi believes that if the government “manages to inject enough cash into the market, it accelerates the input of dollars for imports and manages to significantly lower the value of the ‘parallel dollar’ [whose value results from trading in debt instruments and other financial instruments denominated in foreign currency], and this can have a positive impact on inflation over the medium term.”
The Fall of Foreign Investment
The financial condition of subsidiaries of foreign companies in the country has also been affected by Chávez’s measure. Automatically, as a result, all of their Venezuelan businesses will wind up being worth half of what they were before; this includes both revenues and profits, when exchanged for euros in the case of Spanish companies. Among these, Telefónica has been the company that suffered the most because it has yet to repatriate millions in dividends from its profits of previous years, estimated at 1.4 billion euros. Other companies that will be harmed include BBVA bank, the insurance company Mapfre, and Repsol, the oil company.
Statistics confirm that foreign companies lack confidence in the Venezuelan government’s policy. In 1998, Foreign Direct Investment (FDI) was some US$6.2 billion, but fell by 72% to US$1.7 billion in 2008. However, this is a general trend in the region, since the results of a study by UNCTAD, the U.N. Conference for Trade and Development, show a drop of 41% in FDI in Latin America in 2009. In that regard, says Monteiro, “Venezuela is isolated from [other] countries. When you talk about investments, the country is in another category; no one puts it in the same portfolio as Brazil and Mexico.”
Monteiro notes that companies consider two different scenarios when it is time to deal with a country like Venezuela. “There is a difference in how they compute the risks and benefits” depending on if they already have investments in that country, as in the case of Telefónica, or if they have to decide whether to get into the country. “You have to realize that in many cases the solution to specific situations is going to involve political negotiation, and this is not something that happens solely in financial terms.” Monteiro adds, “You have to rely on people who know the market well; not just its purely economic aspects but also the political situation, so you can negotiate.”
The Poverty Effect
In addition, as Rafael Pampillón, professor of economy at IE, notes in his blog, devaluation is generally going to have a very strong impact on the redistribution of wealth in the country, because it “hurts those who have debt denominated in dollars, Reales, euros, etc., and who will now have to convert more Bolivars than before the devaluation in order to pay those debts. Meanwhile, it benefits creditors in dollars who now receive more pesos.” He notes that small and midsize companies may be in the most compromised situation because their debts are in dollars and their revenue streams (sales) are tied basically to the domestic market (which is denominated in Bolivars).
For those families who have debts in a foreign currency, adds Pampillón, “the devaluation will increase the debt/revenue ratio, leading to a re-composition in the structure of their expenditures at home, which has a negative impact on consumption. In general terms, devaluation generates a poverty effect on families and small companies.”
Although any currency devaluation implies an overall improvement in the competitiveness of a country’s goods in international markets, for Obuchi “the numerous regulations, attacks on property, attacks on the private sector and other risks, provide a disincentive for investment and production in the country [Venezuela].” He agrees with Pampillón on that issue, and adds that the negatives for the [Venezuelan] economy stem not only from the fact that the Bolivar “without doubt, is overvalued but also, above all, from the fact that [Venezuela] has not undertaken deep fiscal reforms, and has not battled against inefficiency and corruption in its political class.”
Despite everything, however, Pampillón believes that the decision of the Venezuelan president represents a movement in the right direction because it brings [the country] closer to the marketplace. “The wisest thing would be to break with this sort of fixed, controlled exchange rate, and to adopt a floating system. Having fixed exchange rates is like accepting the failure of other economic policy measures in order to control inflation, and it offers little credibility to investors. Beyond that, around the world there has been a clear trend toward abandoning regimes with fixed exchange rates in order to adopt floating rates.”
Obuchi also believes that if the government manages to significantly reduce the value [of the Bolivar] on the parallel market and to control the country’s inflation rate to a certain degree, the negative impact of the devaluation could be reduced. He adds, “The devaluation relieves some of the fiscal pressure on the government, and helps its ability to finance its election campaign.” In such a case, the government will not only take into account the effects of the devaluation but it will evaluate the consequences of the electricity rationing plan that the country will be adopting after the beginning of this year as a result of the rain shortage of last year. Without doubt, this will have a negative impact on the country’s output, its employment levels and its general well-being. However, only time will tell if the strategy adopted by Chávez will produce the anticipated political returns.