22 June 2012

Venezuela Weekly Report

N 02 - 22 June 2012
Hernn Yellati Head of Research & Strategy hyellati@banctrust.com Andrs Trujillo Senior Analyst atrujillo@banctrust.com

Who said money growth is neutral?

The short-term is all that matters

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+58 212 903 8417

Fresh polls confirm President Chavez at the helm Local debt soared and liquidity too A dangerous trade-off is in the making

The first post-nominations poll came from Hinterlaces consultancy confirming a comfortable lead from President Chavez over runner-up Henrique Capriles Radonski. Comparing these results with the ones obtained from the previous Hinterlaces poll in April, we see a slight 2 percentage points decline to 17% from 19% lead of Chavez over Capriles with 51% support against 34% of the votes respectively. Arguably, the gap reduction is within the limits of the statistically relevant difference, not to mention the impossibility to call such dynamic a trend. A particularly interesting result from the same poll is the fact that 47% of surveyed people believe that Chavez would guarantee peace and stability if he comes out victorious on 7-O (7 October) while 34% thinks that Capriles is the most suitable candidate to achieve such goals. This confirms our view that, despite Chavezs apparent eroded and repetitive speech, his charisma combined with the so called Chavez or chaos strategy is proving to be effective. Of course, there is another factor behind a bullet-proof popularity. In this weekly report we explore a possible success formula that has become a pattern over the more than 12-year Chavezs presidency.

The (not so) secret weapon

The increase in government expenditure in an election year is not something that we can attribute exclusively to President Chavez. The political cycle is a behavior easily generalized among elections, where the incumbent government has a clear advantage over the challenger in terms of capacity to spend while campaigning. That said, we find a particularly excessive increase in the monetary aggregate M2 over the past twelve years whenever a presidential election or presidential referendum approaches (see chart 1). This report must be read with its respective disclosure and disclaimer on page 3
1

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Chart 1: Monetary Supply Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: BCV

M2 (VEF) 16.623.762 16.995.890 19.638.250 30.993.636 45.839.682 69.858.369 118.806.066 152.916.545 191.217.844 233.704.118 294.492.006 444.975.948

Var(%) 2,24 15,55 57,82 47,90 52,40 70,07 28,71 25,05 22,22 26,01 51,10

Yet, the composition between internal and external debt has completely changed. While last year sovereign issuance was mainly external (USD denominated), so far this year it has been almost exclusively internal (chart 2). The logic is simple: 1) VEF denominated debt can be easily diluted with inflation and; 2) issuance of local debt does not need the pre-approval from the National Assembly.

Chart 2: Variation of Sovereing Debt (millions USD) Var Debt 2011 2012 first quarter
Source: ONCP

Local 1.104 7.082

External 6.416 128

Total 7.520 7.210

Key Events

* Exchange rate VEF 4,3 per dollar

2004: Presidential Referendum (increase of 47.9%) 2006: Presidential Elections (increase of 70%) 2012: Presidential Elections

In the end...money will be neutral

Believe it or not, there is a flip side to such an immaculate story of unbounded expenditure, indebtedness and success. Eventually, the government could face a tradeoff between the shortterm income effect of money creation and inflation. So far, the Law of Fair Coasts and Prices has been effective in keeping inflation at bay. However, we believe that, as the trade-off takes effect, the need for either an increase in dollar supply of an adjustment of the real exchange rate will become more and more urgent. Regarding the former, a possible government reaction could be to resume USD-denominated debt issuance. However, the government accumulation of external assets in extra fiscal funds like FONDEN could easily replace USD debt supply in the coming months. As far as the increasing need for a devaluation of the exchange rate is concerned, the adjustment should only come in 1Q13, in our view. No matter who wins the 7-O elections, it will be politically too costly to engineer a weaker USD/VEF prior to the regional elections in December 2012.

The average M2 increase in the two years preceding a presidential election or presidential referendum more than doubles the rest of the period. So far this year (data until April), the pattern is confirmed with a c50% increase in M2 with respect to the same period last year. Even though short-term, the effect in the real economy of such an increase in money supply is something we believe Chavez understands well, at least empirically. With virtually full control of the countrys resources (i.e. oil exports to the U.S.), the president managed to visibly boost the sentiment of wellness via cash transfers, home building programs (mision vivienda) and less scarcity of essential goods.

A new financing strategy

Part of the expenditure is, however, financed with new government debt. Impressively, in 1Q12 the sovereign has issued almost the same amount of debt as in 2011.

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This publication has been prepared by the Strategy and Research division of BancTrust Servicios Financieros Sucursal Venezuela, C.A. BancTrust & Co (BT & Co.) is the marketing name of a group of regulated and non-regulated companies located worldwide. This report is informative only. Published rates are for reference only. BT & Co. does not recommend or request to buy or sell any Financial Instrument. The information contained in this report has been obtained from sources that BT & Co. considered reliable but does not guarantee its veracity. The views are of BT & Co. and are subject to change without notice. BT & Co. is not required to update their opinions or information contained in the report. Neither BT & Co. or its affiliates, nor any of their respective officers, directors, partners and/or employees accept responsibility for any direct or consequential loss resulting from any use of this publication or its content. The values in this publication may not be suitable for all investor. BT & Co. recommends and advices that investors independently evaluate and apply their own judgment to each issuer, security or instrument discussed in this publication. Copyright BancTrust & Co. All rights reserved. No part of this report can be published or reproduced in any manner without the prior written permission of BancTrust & Co. or any of its affiliates.