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Sunday, 21 September 2014

IMF/World Bank 2007: Filling the void

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With many Latin American countries paying down IMF debt to free themselves of the conditionality imposed by that institution, Venezuela has been moving in to fill the void as it uses it oil wealth to advance its foreign policy goals. But is President Hugo Chavez’s spending spree sustainable and would he be willing to act as a lender of last resort? Paul Kilby reports.

The Venezuelan president has dismissed the notion that he wishes to fill the boots of the IMF. But many observers think otherwise as Chavez routinely tours the region and other parts of the globe, offering various types of aid. In that sense, Venezuela is pushing historical precedents in Latin America.

"I can't remember any Latin American government spreading influence and wealth around the region like this one," said Arturo Porzecanski, professor of international finance at American University in Washington DC, and a Wall Street veteran. "Chile and Peru have excess dollars, but you don't see them buying goodwill and influence."

According to Fitch, Venezuela has recently provided cash financing to 12 Latin American and Caribbean countries, and the largest recipients of its investments, grants and military spending have been Brazil and Argentina. Uruguay, Bolivia, Ecuador and the Dominican Republic are next in line, but all with smaller amounts.

Interestingly, as Fitch pointed out earlier this year, the main beneficiaries have been countries that also made the largest net repayments to the IMF between 2005 and 2006. This list includes Brazil, Argentina and Uruguay. These are also Mercosur countries, a trading block Chavez is interested in joining.

Late last year Uruguay announced it would cancel its current standby agreement with the IMF and repay early all of its outstanding obligations. Just a year before that, Brazil also made a similar move, announcing it would repay the equivalent of US$15.46bn to the agency.

Argentina ended its long and ignominious relationship with the IMF in December 2005 when it used US$10bn in reserves to pay what it still owed the Fund. Vilified in Buenos Aires at the time, the IMF accepted some blame for the sovereign's debacle, but cutting links with the Fund also drew criticism.

Critics thought Argentina's IMF payback meant there would be a lower probability of the holdouts getting paid and that such a move further isolated the country from the international financial community. In some ways, such critics were proven right.

The holdout problem is still hanging over the country and hence Argentinean issuance has been confined to local law, domestic bonds to raise capital for fear of attachment risk. The other option of course has been selling bonds to Venezuela, which has gladly come to the rescue.

Since the beginning of 2006, Venezuela has bought roughly US$4.5bn worth of bonds from Argentine. This has come in handy for the government of President Nestor Kirschner, especially when demand has waned locally or when the cost of funding exceeds the government's ideal limits.

Indeed, Argentina is perhaps the best example of where Venezuela is playing an IMF role. In most other cases such as some Caribbean and Central America countries, it has acted more as an aid agency, while in Brazil it has been involved more in energy projects and defence spending.

"Much of Chavez's spending is more like USAID, spending on medical care and subsidising oil imports. It is more development related," said Porzecanski. "In the case of Argentina you could argue that instead of looking for financial assistance, they went to the Fondo Monetaria Chavista. In this case it is budgetary support, bonds that Argentina would like to sell internationally, but out of attachment fears did not."

Nevertheless, some analysts question the notion that Chavez, or at least his economic team, is ignoring market realities and blindly throwing money at countries just to gain influence. Others wonder whether Venezuela would ultimately act like the IMF and become lender of last resort and support countries that face severe crises.

"Whenever the Venezuelan economic team has extended credit, it has done so for political reasons but also ones that are economically sound," says Maya Hernandez, country analyst at HSBC. "Even in Cuba, the intangibles Chavez is getting justify the cost of what he is giving in oil. He gets doctors and the Cubans are running all his presidential campaigns, which have been extremely effective."

This argument may be particularly applicable in Argentina. The Venezuelan government has simply repackaged the Argentine bonds along with local Venezuela debt and resold them as so-called Bonds of the South in the local market, where demand for hard currency assets has been strong thanks to capital controls.

Not only have the Bonos del Sur helped absorb local liquidity as the government tried to contain inflation and strengthen the parallel exchange rate, but Venezuela is thought to have made a decent return on such trades.

"They may be indirectly buying Argentine debt, but they sold it at a profit," said an analyst at a rating agency. "They are not just being willy-nilly about it."

Hernandez recalls how Chavez's economic team put the kibosh on a US$400m loan to Ecuador when President Raphael Correa was finance minister and the country needed assistance.

"[The economic team] dismissed it, as it didn't make sense financially," she said. "It would have made sense for Chavez if he wanted to become the new IMF. There is an obvious willingness to become a lender of last resort, but it is only when conditions are appropriate."

Given such thinking Hernandez doubts that Venezuela can be seen as replacing a multilateral such as the IMF that would come to countries help in times of need. Even if that were not the case, analysts question whether Venezuela can sustain its largesse.

With oil prices breaking past the US$80 a barrel mark this summer, it would seem that Venezuela can afford to splash out for some time to come. And investors have drawn comfort from what is still a strong balance sheet.

Even taking oil giant PDVSA out of the equation but including US$26bn in central bank reserves, US dollar assets held by the pubic sector are estimated to be more than US$50bn against external debt of around US$25bn, according to JPMorgan.

However, economic policies combined with the president's increasingly stringent socialist agenda have analysts and investors worried. Notwithstanding Chavez's threat to withdraw from the IMF that triggered default fears earlier this year, the country has other problems on its hands and trouble is brewing on the horizon.

Loose fiscal and monetary policies are fuelling domestic demand, which is outpacing the local supply of products in a country overly reliant on oil exports. Imports are growing at torrid pace, jumping 47% in the first quarter of 2007 alone versus an expansion by 36% in 2006, and inflation is now around 17%, according to JPMorgan. The bank says that the country's current account surplus could turn into a deficit next year if oil prices turn south.

"It is not a sustainable position," said Theresa Paiz Fredel, senior director at Fitch Ratings. "You have a combination of [rising] expenditures and revenues are coming down. There is no intention to change the exchange rate policy and they are running such high inflation. It is going to be difficult. At some point something will have to give."

Meanwhile, the country's parallel exchange rate has been approaching 4,500 bolivars per US dollar versus an official exchange rate of 2,150. Analysts think that the government can starve off a devaluation in the short term. The overvalued currency is pressuring the trade balance, but it is also helping the government contain higher inflation.

Perhaps more important is that PDVSA's production levels are on the decline, though an investment plan is underway to reverse that trend. Discrepancies are also appearing between what PDVSA reports and other official estimates. (See Table.) This comes alongside a steady increase in spending as government raids PDVSA and Central Bank coffers.

"It is interesting to note that even though oil prices are high, there are indications that there has been a deterioration in Venezuela's fiscal position," said Mauro Leos, senior credit officer for Latin America in Moody's sovereign risk unit.

Investments in the public sector jumped to US$11bn during the first half of this year, up from around US$5bn in all of the 2006, according to Barclays Capital. Part of that was close to US$7bn that was transferred from the Central Bank to oil fund Fonden, which according to JPMorgan has been allocating its resources to infrastructure projects, military hardware as well as credit derivatives.

The country's financial account posted an US$11.5bn deficit in the second quarter, up from US$8.3bn in the first quarter, or the equivalent of 11.9% of GDP on a 12-month basis, according to Credit Suisse. The fact that PDVSA tapped the local markets earlier this year with an upsized US$7.5bn three-tranche issue was also seen as evidence that its fiscal contributions to the government have been taking their toll.

"The real problem comes from the fact that the government has been milking PDVSA too much by forcing the company to spend heavily on social projects and hence not allowing the company to invest to expand oil production," said Richard Francis, a sovereign analyst at Standard & Poor's. "PDVSA has an ambitious capital expenditure programme through to 2012. They need to raise oil production. If they don't it will continue to falter and then their prospects don't look so robust."

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