Crystallex International

By Andres Schipani and Robin Wigglesworth
Financial Times, London
Thursday, October 17, 2013

Beauty pageants are to Venezuela what football is to Argentina or baseball to Cuba -- a spectacle that allows people to forget their everyday woes. Yet at the Miss Venezuela competition last week, even the contestant from the capital Caracas had a gritty message for the audience, saying she wanted her country "to fight in the face of adversity."

Not even under the lights could the brunette model dodge the reality that Venezuelans are battling an economic crisis that threatens the legacy of Hugo Chavez and his "Bolivarian revolution" and which is coming to the boil as the overvalued exchange rate drains foreign reserves.

"The big warning sign for Venezuela is its plummeting foreign exchange reserves," says Michael Riddell, a bond fund manager at M&G Investments in London.

The OPEC nation's $95 billion of annual oil revenues mean default on its more than $45 billion of foreign debt remains improbable. Nonetheless, analysts say the country could face financing issues, as only a small percentage of its foreign reserves are liquid.

Headline foreign reserves have fallen to $21 billion from $30 billion at the start of the year; furthermore, because of large gold holdings, only some $2 billion of that is fully liquid.

Still, after including off-budget funds, such as a development fund that is partially Chinese financed and the foreign currency account of PDVSA, the state oil company, total available reserves are approximately $48 billion, analysts estimate.

"Venezuela is not broke," says Efrain Velazquez, president of the National Economic Council, a government watchdog. Instead, the country "has had inappropriate international reserves management."

That mismanagement is now flaring up, however, ahead of municipal elections on December 8 -- a poll widely seen as a referendum on the popularity of Nicolas Maduro, the president. Central to the economic problems he faces is the exchange rate, officially fixed at 6.3 bolivars to the US dollar but trading on the black market at close to 50 bolivars.

That widening gap has led to a flourishing arbitrage by insiders who have access to dollars at the official rate and can then sell them at the street rate, pocketing the difference. Currency restrictions have also exacerbated shortages of essential goods, fuelling inflation running at almost 50 per cent a year. Toyota announced that it will this month shut its Venezuelan plant for two weeks because of delays in getting dollars needed to buy materials.

Investors outside the country have been watching worriedly. The yield on Venezuela's benchmark 2027 dollar bond has risen to more than 12 per cent from under 9 per cent at the start of the year. The annual cost of insuring $10 million of Venezuelan debt against default for five years, as measured by credit default swaps, has also risen to $983,000 versus $600,000 in January.

Nonetheless, Francisco Rodrguez, Venezuela economist at Bank of America Merrill Lynch, shrugs off the market concerns, saying total foreign reserves of $48 billion can cover some 10 months of imports and four years of debt service.

"The excessive focus on the country's short-term liquidity situation runs the risk of missing the forest for the trees," he wrote in a recent note to investors. While $2 billion cash reserves might seem little, "this is not an abnormal number by Venezuelan standards -- it is near the average for the past four years -- making it hard to understand recent concerns with liquidity levels."

One reason for that concern is lack of action by Mr Maduro's administration to face up to problems. Behind the scenes, his ruling Socialist party faces internecine fights between radical ideologues and pragmatists, a tug of war that has led to a stalemate which has only worsened the economic situation.

A devaluation, for example, would boost the local currency value of Venezuela's dollar oil receipts -- the country's time-honoured solution to closing a fiscal deficit -- and remove the need for currency restrictions.

But doing so before the December 8 elections would damage Mr Maduro, who has to decide whether his administration "wants to be politically popular or economically sustainable," as Stratfor, the risk consultancy, puts it.

"We see little scope for President Maduro to re-engineer a new path for the economy of Venezuela," says Paolo Batori, Morgan Stanley's global head of sovereign strategy. He has "little flexibility for any diversion from the populist oil-financed government spending policies of his predecessor."

Nonetheless, analysts agree a large devaluation seems all but inevitable at some point. Indeed, planning minister Jorge Giordani recently said Mr Maduro would outline changes to macroeconomic policy at "an appropriate moment."

In the meantime, or at least until after the election, Mr Maduro has taken to blaming Venezuela's problems on corruption, sabotage, speculation, and hoarding, and has asked lawmakers for decree powers to fight graft and an "economic war."

Co-incidentally, when his mentor Chvez presided over maxi-devaluations in 2002 and 2010, the government also claimed that the country's foreign exchange and broader economic problems were due to economic sabotage.