Outlook Worsens in Venezuela

What would Bolivar do? In August of this year Fortune reported: Venezuela's real-world bolívar is now worth considerably less than the fantasy currency in the video game World of Warcraft. According to Focus Economics, little has changed and the situation is slated to get worse. Forecasts place unemployment at 20-22% in 2018. 

Outlooks Worsens in Venezuela
President Nicolás Maduro addressed the Russian Energy Week forum on 4 October and affirmed that the nation would meet its debt obligations despite the imposition of a fresh round of sanctions by the U.S. The sanctions restrict the ability of the cash-strapped Venezuelan government to raise new debt from U.S. financial markets, amid increasing worldwide diplomatic isolation. Taking a softer stance, Russia is looking at the prospects of restructuring Venezuela’s bilateral debt payments. 

Maduro’s newly-introduced measures to peg the bolivar to a basket of currencies excluding the U.S. dollar and no longer accept payments in U.S. dollars for oil sales, in a bid to subvert the U.S. sanctions, fail to address the fundamental imbalances that have precipitated a lethal inflation depreciation spiral. Meanwhile, campaigning for regional elections to appoint state governors to be held on 15 October kicked off on 23 September, ramping up tensions between the government and opposition. 

The new U.S. sanctions will weigh heavily on the crippled economy, which together with the authority’s measures failing to address the underlying structural problems wreaking havoc on the economy, indicates that the three-year long recession will continue into next year. FocusEconomics panelists see the economy shrinking 8.3% in 2017. For 2018, the contraction is expected to soften to 3.2%, which is down 0.5 percentage points from last month’s forecast. 

Panelists estimate that inflation rose from 807.0% at the end of Q2 to 871.6% at the end of Q3. The free-fall in the currency, triple-digit increases in the money supply and a number of wage hikes should continue to fuel price pressures through 2017 and 2018. FocusEconomics panelists forecast that inflation will end 2017 at 1,219% and 2018 at 1,707%.

Inflation continues its unchecked ascent 
Due to the shortage of official data for inflation, different indicators from official and non-official sources are used as proxies to measure the evolution of price levels. The turbulent events of the current year and the preceding one suggest that price pressures have ramped up significantly since the last official data from December 2015, which showed that inflation came in at 180.9%. FocusEconomics Consensus Forecast panelists estimate that inflation rose from 807.0% at the end of Q2 to 871.6% at the end of Q3. A sharp increase in the money supply and a free-falling currency in the parallel market have induced a destructive inflation spiral in the economy. The latest Central Bank data shows that the money supply rose by 451.5% year-on-year in August, up from 422.5% in July, and marking the thirteenth consecutive triple-digit increase.  

Since January 2017, the opposition-controlled National Assembly has published its own index and inflation data following the government’s decision to stop releasing price data. Adopting the same methodology, the Central Bank used previously, the legislative body’s data from September showed that consumer prices increased 36.3% month-on-month (August: +33.8% monthon-month). In cumulative year-to-date terms, consumer prices soared from a 366.4% increase in August to a 536.2% rise in September. Panelists participating in the LatinFocus Consensus Forecast project inflation ending 2017 at 1219% and 2018 at 1707%. The panel expects the economy to contract 8.3% this year, which is down 0.7 percentage points from last month’s forecast, and shrink 3.2% in 2018, which is down 0.5 percentage points from last month’s estimate.

On 6 October, the bolivar traded in the parallel market at 26,749 VED per USD. The result marked a 24.5% depreciation from the same day last month. The parallel dollar has shed 88.2% of its value since the start of the year and a massive 96.2% of its value from the same day last year. Against the backdrop of an economy crippled by soaring inflation and a massive debt burden, the bolivar traded in the parallel market has seen an almost uninterrupted depreciation since Q4 2016 due to a drop in the Central Bank’s reserves requirement and an increase in monetary financing to the state-owned oil and natural gas company (PDVSA). This has perpetuated a vicious “inflation-depreciation” spiral as the two trends reinforce each another, whereby higher inflation raises the demand for dollars, and as more dollars are purchased, the black-market price of the dollar rises, increasing the cost of imports and propelling inflation up even further. Panelists participating in the LatinFocus Consensus Forecast see continued pressure on the parallel dollar and project a non-official exchange rate of 39,437 VEF per USD by the end of 2017. In 2018, the panel sees the nonofficial exchange rate trading at 593,927 VEF per USD. 

On the other hand, the Dipro exchange rate—the first tier of the official exchange rate system—remained unchanged at 10.00 VEF per USD on 6 October. According to the government, the Dipro is used exclusively to purchase essential goods, such as medicine and food, and can face devaluations when authorities deem it necessary. The Dicom exchange rate, the second tier of the exchange rate system introduced by the Central Bank, traded at 3,34 VEF per USD on 6 October, virtually stable from the same day last month but a 79.8% depreciation since the start of 2017. The Dicom has lost 80.6% of its value from the same day in 2016. FocusEconomics panelists expect the bolivar at the Dipro exchange rate to end 2017 at 17.2 VEF per USD. The panel sees the exchange rate ending 2018 at 1,641 VEF per USD.
As oil prices continue to ascend, crippling political uncertainty persists Oil prices continued on an upward trajectory in September, rising to the highest level in over two years. The average price of Venezuela’s mix of crude oil traded at USD 47.8 per barrel (pb), which marked a 4.6% increase compared to the previous month (August: USD 45.7 pb).

The sustained month-on-month rise in oil prices was sparked by signs that the global oil glut is gradually receding amid a context of tumultuous domestic political developments at home. Tensions between Venezuela and the United States remain very elevated, with the levy of harsher new sanctions by the U.S. striking a massive blow to the already crippled economy. The financial sanctions prevent the debt-ridden Venezuelan government and the state-owned enterprise, PDVSA, from issuing new debt and equity in U.S. financial markets, and also restricts U.S. entities from dealing in pre-existing Venezuelan government bonds. 

While the new U.S. sanctions have raised the prospect of a sovereign debt default, Russia is looking to offer some respite and help ease the difficulties of financing the debt burden in the short-term as it considers restructuring around USD 1 billion of the bilateral debt owed by Venezuela. A credit default would be a catastrophic climax for the economy that would oust the government from access to international financial markets and see the seizure of foreign assets by creditors. Although the government has made bond payments in a timely manner so far, most of our panelists consider a debt default inevitable in the foreseeable future. Current levels of international reserves fall significantly short of the outstanding short- and medium-term debt levels. The same goes for oil revenues, the source of over 90% of the country’s dollar-denominated earnings, which have been limited by low oil prices and deteriorating production due to a lack of reinvestment in operations. Taking into account conservative price estimates for Venezuelan oil this year and next, oil earnings are anticipated to remain subdued, which will siphon off more of the already depleted international reserves for meeting debt repayments. Furthermore, the bulk of the reserves are in the form of gold and other non-liquid assets that are not readily available. 

Panelists participating in this month’s LatinFocus Consensus Forecast expect the price for Venezuela’s mix of oils to average USD 43.5 per barrel in 2017 and USD 45.7 per barrel in 2018. 

 - FocusEconomics