28th Jan.

2014

LATIN AMERICA
ECONOMICS UPDATE

Venezuela is unlikely to follow Argentinas lead

The parallels between the current economic situations in Argentina and Venezuela only go so far. While
both economies have been ravaged by rampant inflation in recent years and haven depleted their foreign
exchange reserves in order to defend overvalued exchange rates, the Argentine government has shown
more willingness to alter its policy mix in order to stave off a crisis.

One question that has repeatedly cropped up during the past few days is how similar is the situation in
Argentina to that in Venezuela? Moreover, do the Argentine governments recent actions set a precedent
for a similar shift in exchange rate policy in Venezuela?

There are undoubtedly some striking similarities between Argentina and Venezuela. Most notably, several
years of extremely poor economic policymaking, including the monetisation of populist government
spending, have manifested themselves in rampant inflation. Our estimates, based on regional data and
independent food price figures, show that Argentine inflation has been in the range of 25-30% since 2010.
Venezuelan inflation has been in double-digits since the 1990s. (See Chart 1.)

In turn, rampant inflation has been the driving force behind real exchange rate appreciation. And with
both regimes imposing capital controls and managing their exchange rates, the respective economies have
suffered from dollar droughts, creating shortages of many goods and feeding back into higher inflation.
Whats more, foreign exchange reserves have been depleted in order to defend overvalued exchange rates.

In addition, both governments have recently devalued their exchange rates in some form. Last week, the
Argentine government allowed the official peso exchange rate to depreciate by around 12% against the
dollar. And while the Venezuelan authorities have been careful to avoid an embarrassing devaluation of
their official exchange rate, they have instead introduced a range of new exchange rate tiers, all of which
trade at a discount to the official exchange rate.

But that is about as far as the parallels run. Recent actions suggest that the Argentine government has a
more pragmatic streak than its Venezuelan counterpart. Perhaps motivated by an inability to borrow
large quantities of foreign currency in the bond market, the Argentine government appears more willing to
accept a weaker currency in order to preserve the current level of their foreign exchange reserves.

By contrast, Venezuelas institutions are in extremely poor shape and the country is currently being run by
decree by President Maduro. Moreover, Mr. Maduro has been extremely dogmatic with regards to
economic policymaking, dashing hopes that he would be more pragmatic than his predecessor, Hugo
Chavez. As such, it seems that the government will continue to defend its overvalued exchange rate at the
expense of FX reserve depletion, a worsening dollar drought, higher inflation and economic stagnation.

This perhaps also explains why the yields on the foreign currency debt of the respective governments have
been heading in opposite directions. (See Chart 2.) The market demands a double-digit yield from both
regimes. But with Venezuelas debt dynamics worsening by the day, FX bond yields have climbed
towards 15% and look set to remain higher than in Argentina for the foreseeable future.
David Rees Emerging Markets Economist (+44 (0)20 7811 3907, david.rees@capitaleconomics.com)
Chart 1: Consumer Prices (% y/y)

Chart 2: EMBI+ Bond Yields (%)

60

60

50

50

Argentina
Venezuela

40

40

30

30

20

20

10
0
2003

10
0
2005

2007

2009

2011

Sources Thomson Datastream, Capital Economics

2013

23

23
21

Argentina

21

19

Venezuela

19

17

17

15

15

13

13

11

11

5
2006

5
2007

2008

2009

2010

2011

2012

2013

2014

Source Thomson Datastream

Latin America Economics Update