Potential Future Consequences for Venezuelan Spending Spree

Sources:

Bloomberg: P&G Bracing for ‘Large’ Venezuela Devaluation After Election

Reuters: Venezuela Inflation Slows in July for Seventh Month

WSJ: Venezuela Faces Economic Hangover

Over the past year, Venezuelan President Hugo Chávez increased spending in various social programs, including free government housing and cash stipends for the elderly and pregnant women. According to government officials, these spending tactics contribute to the nation’s forecasted 5% gross domestic product (GDP) for 2012—generally, government spending boosts economic activity because when the government spends, it purchases good and services, which raises the demand for such goods and services. To meet this demand, companies create more jobs, which leads to more income for consumers, and thus, more economic activity. President Chavez encourages spending for social programs in hopes of rallying support for his campaign before the country’s October election. However, analysts such as Boris Segura—of the international financial consulting firm Nomura—are skeptical of the future repercussions that this spending spree could have on Venezuela’s economy.

Analysts like Segura are concerned that President Chávez’s spending spree will affect the country’s debt as well as currency valuation. Although the exact allocation of government spending is unknown due to a lack of transparency in the government, analysts recognize that the recent spending spree increased Venezuela’s debt. Analysts expect the debt-to-GDP ratio to reach 52% by the end of the year, which is almost double the 23% debt-to-GDP ratio from 2008. Even though Venezuela never defaulted on its debt obligations under President Chávez’s leadership, the growing debt harms Venezuela’s credit rating—credit ratings affect how much an entity must pay in interest on their issued debt—because an entity with a large amount of accumulated debt is generally less able to repay that debt. According to both Standard & Poor’s and Fitch,—credit rating agencies—Venezuela’s current investment grade is a B+, meaning that adverse circumstances such as poor economic conditions could affect the country’s ability to meet debt obligations. Due to the country’s recent spending spree and increased debt, Fitch put Venezuela’s rating on review for a potential downgrade. A lower credit rating would hurt the country’s ability to obtain more money (debt) because investors would consider Venezuela to be a riskier investment and the country would have to offer investors higher interest rates (pay more money to investors) to be able to continue borrowing.

Due to this growing debt, Venezuela may need to devalue its currency—lower the value of the currency—to help the country service its debt; that is repay the interest and principal of a debt, . According to a group of fourteen analysts surveyed by Bloomberg, Venezuela will devalue its currency in January 2013 from 4.3 bolivars per dollar to 6.2 bolivars per dollar. By devaluing its currency, Venezuela will earn more bolivars for its exports (instead of selling its goods and services for 4.3 bolivars per dollar, the country now sells its goods and services for 6.2 bolivars per dollar). With more bolivars, Venezuela will improve its ability to pay its debt obligations. However, devaluing the currency will also likely increase inflation— a general rise in the price levels of goods and services. This is because imports become more expensive—more bolivars are needed to purchase the same quantity of dollar-denominated goods and services (instead of paying 4.3 bolivars per dollar of goods and services, the country now pays 6.2 bolivars per dollar of goods and services). Since Venezuela imports about 75% of its consumption, devaluing the currency would likely raise the country’s inflation rate.

Based on Venezuela’s growing debt and likely devaluation of its currency, some analysts suggest that Venezuela will experience a lower GDP in 2013. Normura’s analyst Boris Segura predicts a 1% GDP loss for the country, while Bank of America Merrill Lynch expects a 3.5% GDP loss. Other analysts like Russell M. Dallen Jr., managing partner at a local brokerage and research firm named Caracas Capital Markets, do not provide a GDP prediction as the country’s spending tactics could change after the October election. Nonetheless, most analysts will agree that the current spending tactics are not sustainable because of the potential lasting effects on the country’s debt obligations and inflation rate.