VENEZUELA AND PERU: Following (completely) different paths
Recent concerns about the impact on Peru’s economy of the latest weakness in copper prices are overdone. However, the imbalances within Venezuela are such that a further devaluation in coming months appears highly likely.
One of the key developments since early April has been a widespread downward revision of economic growth forecasts, for the global economy as well as for Latin America, by the International Monetary Fund (IMF) and other commentators. Meanwhile, many indicators from developed countries, and from China, have pointed to a slowing of momentum in recent weeks.
In relation to Peru, a development which has received widespread comment has been the slippage in the price of copper, which has dropped by around 10% since late March. Given Peru’s well-known importance as a producer and exporter of the metal, this is seen as being a problem. However, what is not widely acknowledged is that, even after the fall, the price of copper remains elevated in terms of where it has been in the last six years. The price was between US$7,000 and US$8,000 per tonne for much of the time between the beginning of 2007 and late 2008. In the depths of the global financial crisis, the price plummeted to about US$3,000 per tonne.
The pessimists also ignore the small size of the mining and energy sector in the overall context of Peru’s economy. As the chart shows, the sector accounted for about 5% of GDP in 2011, according to the latest figures published by the Banco Central de Reserva del Perú (BCRP). By far the largest component of the economy is ‘other services’. Transportation and communications alone account for about 8% of GDP; indirect taxes, for about 10%; miscellaneous services, for 11%. Manufacturing and commerce each account for about 14%-15% of GDP.
In other words, growth in Peru has for some time been driven by domestic demand, rather than by the external sector. The overall economy expanded by 6.3% in calendar 2012, according to the BCRP. Thanks in part to a contraction in the mining sector, GDP growth slowed a little in the early weeks of this year. Even so, activity in January and February was 5.6% higher than it had been in the previous corresponding period. The deceleration would have been greater but for the boom in construction, where activity continues to grow at double-digit rates. Most sectors are still expanding at a respectable 5-6%.
The BCRP’s latest Weekly Economic Report (No. 16 of April 19, 2013) provides a number of indications that investors are relaxed about Peru’s economic and financial situation. The corporate prime rate stands at 4.38% in Soles and 3.84% in US dollars and has been falling over recent months. Although the currency has softened slightly since the beginning of 2013, it has appreciated by around 10% versus the US dollar since early 2010. The country’s net international reserves have risen from just under US$64bn at the end of last year to US$69.4bn in mid-April 2013. By way of contrast, reserves in Argentina have fallen to a six year low of just under US$39.5bn since early 2013, while in Venezuela they were at just US$26bn in early May.
Bond spreads (relative to US Treasuries) are broadly unchanged relative to September last year and are lower than they were prior to that time. The Lima Stock Exchange General Index is at the lower edge of a 17,500-23,000 band within which it has moved since early 2011.
Meanwhile, the latest data for Venezuela remains grim. As we discuss below, the country remains beset by high inflation at a time that the IMF is looking for a budget deficit of around 13% of GDP. As a result of policies that were hostile to foreign business and investment, and under-investment in the company’s infrastructure, the daily output of state owned energy giant Petróleos de Venezuela (Pdvsa) has fallen by around one fifth since 2003, to an estimated 2.4m barrels per day (b/d), on estimates by the Organization of Oil Exporting Countries [OPEC], of which Venezuela is a member. Pdvsa itself puts output at about 2.9m b/d, but external analysts are not all that confident it its reported figures. Either way, the Chávez administration allowed its cash cow to become smaller over time and the government became very dependent on ever higher international oil prices to fund the Bolivarian Revolution.
In spite of his replacement of Jorge Giordani as finance minister with Nelson Merentes, formerly head of the Banco Central de Venezuela (BCV), the newly elected President Nicolás Maduro has given little indication that his administration will amend the Bolivarian policies of the Chávez years.
In the short term, the challenges are that the 33% devaluation of the unfortunately-named Bolívar Fuerte in February, and the introduction of a new system (the Sicad) for the auction of foreign currency (i.e. US dollars) to complement the main government-controlled FX agency (Cadivi) have benefited few ordinary Venezuelans. The central bank’s scarcity index (a measure of shortages in shops of staple goods) is at or near the record highs set in 2008. Reports indicate that the black market value of the Bolívar is around 20 to the US dollar - as opposed to the official rate of 6.3.
As president, Chávez had a number of advantages which are patently not available to Maduro. For much of the time, the growth of the world economy meant that the price of oil, the key export, was high and/or rising. Devaluations, which often brought disruption to the economy, would typically be announced just after elections. Chávez’s personal charisma within Venezuela, and his prestige elsewhere in the region, usually meant that he could keep sufficient numbers of supporters onside on the frequent occasions when the country’s economic situation would have sunk a lesser man.
As we made clear in the introduction, the global economy is not moving in favour of Venezuela under Maduro. The latest devaluation came before the election, which Maduro (appears to have) won by a very narrow margin. Even if Maduro took the (hugely unpopular) step of abandoning fuel subsidies, the estimated 5.5% of GDP that he would save the government would not be sufficient to plug the budget deficit.
Whatever their rhetoric may be, Maduro and Merentes need to move quickly to address the challenges. As we explained in the last edition of LatinAmerican Economy & Business, we think that Argentina’s government can defer hard decisions for at least three months, if not longer. This is not the case for Venezuela’s government. Inaction on the part of the new Maduro administration could quickly result in major unrest, not least as a result of the shortages of basic goods on shop shelves.
There are few policy options. Any attempt to return the budget to balance will require decisions that, for the short term at least, are very unpopular. The government’s access to global financial markets is limited. The amounts of money required are enormous – even by the standards of non-traditional financial supporters such as the government of China. As noted above, the general trend in output from Pdvsa has been downwards, and will not easily be reversed.
Neither OPEC as a bloc nor Venezuela as a single producer of oil have much sway over the oil price at a time that the global economy is slowing. It appears that another devaluation of the Bolívar is inevitable, and possibly within weeks rather than months.
So how does Venezuela really compare?
Trends and developments in Venezuela’s economy are often considered in the context of the rest of Latin America. This is problematic, because, with the arguable exception of Argentina, most of the other governments in the region are not following policies remotely resembling the Bolivarian mix pursued by the administrations led by Hugo Chávez or (for now) Nicolás Maduro.
As in Venezuela, the government of Argentina is over-reliant on tax revenues that are levied on a globally competitive export sector. Argentina’s government also uses revenues to reward its supporters through a well-established system of patronage. Like its counterpart in Venezuela, the Argentine government has monetised spending and, in doing so, has contributed to an inflationary problem that exacerbates its own costs and which crimps the real incomes of many of its own supporters.
However, the differences are important. It was only in the final quarter of last year that the current expenses of Argentina’s government pulled ahead of its current revenues. As the chart indicates, the budget was broadly in balance last year – in very stark contrast to that of the Venezuelan government. In last month’s edition of LatinAmerican Economy & Business, we explained that the administration led by President Cristina Fernández may face a budgetary problem (because of the impact of inflation that is two-to-three times the official rate noted in the chart): however, such an outcome is unlikely in the next two-to-three months. Another scenario, which is also unlikely to materialise in the short term, is that households and businesses shun peso deposits in order to avoid the impact of inflation. The money would most probably be spent on (ideally non-perishable) goods and/or invested in real assets with Argentina (because of the effective capital controls). This could cause problems for the banks.
The data in the chart, which is based on forecasts sourced from the International Monetary Fund (IMF)’s World Economic Outlook, also shows how Venezuela’s budgetary situation appears far worse than that of Iran, the other major country in the world where the economy has been distorted by the size of the energy sector, isolation from global capital markets and monetisation of budget deficits by a compliant central bank. This is true even if one assumes that spending by central government in Iran substantially understates the actual size of the public sector.
By contrast, Saudi Arabia, the third of the substantial energy based economies featured in the chart, appears to be a paragon of monetary and fiscal virtue. A budget that is balanced – or, as is the case this year, in surplus – is the norm. Because of the pace of growth in Saudi Arabia, and the logistical challenges involved with sourcing goods (e.g. building materials) from overseas there are episodes in which the prices for particular items rise rapidly. Nevertheless, the rate of inflation is, as economic theory would suggest, usually similar to that of the US – thanks to the operation of the currency peg that links the riyal with the US dollar. Venezuela’s current situation looks dire if the economy is contrasted with peers that are similarly structured and/or similarly run.