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WorldMay 1 2014

Is a post-Chávez Venezuela embracing the free market?

Politicians claim that 2014 is going to be a key year of economic development for Venezuela, with a new foreign exchange system driven by supply and demand. How will banks respond?
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Is a post-Chávez Venezuela embracing the free market?

Street protests, students hurling rocks, barricades manned by radical government opponents and rows of armed police are an almost daily spectacle in Venezuela at the moment. So there is a lot riding on talks between president Nicolás Maduro and opposition leader Henrique Capriles, which started in April.

A peaceful solution is badly needed. The protests, which have been going on since early February, have resulted in 40 deaths, and convey an image of unpredictability and uncertainty. This, say analysts, is incomprehensible in a country as rich as Venezuela – with the world’s largest reserves of crude oil, according to the Organisation of the Petroleum Exporting Countries.

Joe Kogan, chief market strategist for emerging markets at Canada’s Scotiabank, says: “According to our data, Venezuelan oil production is not going down. In fact, since 2011 it has increased." This rise has gone from 2.4 million barrels a day in 2011 to 2.8 million today, according to the ministry of finance and PDVSA, the state oil company. With crude oil prices fluctuating at about $100 a barrel, this represents a boon for Venezuela’s economy.

The protests may have been confined to middle-class neighbourhoods and a few cities so far, but many of the frustrations voiced by the students, including high levels of crime, inflation of 57% and shortages of basic consumer goods, affect all Venezuelans.

On top of that, based on Mr Maduro’s very narrow victory in presidential elections last year following the death of Hugo Chávez, the country is now almost equally divided between supporters of Mr Capriles, who are mainly middle class, and the government’s largely working class and low-income electoral base.

FX challenge

Rafael Ramirez, the country’s oil minister and top economic adviser to Mr Maduro, said during an interview with Venevisión, the country’s state TV, earlier this year: “This is going to be the year of new economic development… We must establish economic balances. And, among the issues, the most important will be finding a new way to administer foreign exchange.”

Not long after, on March 27, in a bid to bring down Venezuela’s soaring black market rate for the dollar, which is the main cause of imbalances in the economy, the authorities launched a foreign exchange system where the price of the dollar is set by supply and demand; a standard free-market move.

Francisco Rodríguez, senior economist for the Andean region at Bank of America Merrill Lynch, sees the move as a radical departure from socialist policy and an admission that the currency controls enacted by Mr Chávez more than a decade ago, which pegged the bolívar to the US dollar and limited exchange, have failed.

“It is really the first time in more than a decade that we’ve seen this government react by trying to fix a problem by reducing regulation and by liberalisation. That is effectively a sea change in terms of policy in Venezuela,” says Mr Rodríguez.

Venezuela’s economy certainly has its problems, with low productivity and 1% negative growth forecast this year, according to the World Bank. Yet economists do not think it has major macroeconomic problems or anything resembling a balance-of-payments crisis.

Venezuela had an external public debt-to-gross domestic product (GDP) ratio of 27.6% at the end of 2013 and in the third quarter the current account balance improved by 1.9% of GDP. Combining the liquid and near-liquid assets of the central bank, PDVSA and other government holdings, the government’s foreign reserves amount to more than $50bn, a healthy level relative to Venezuela’s imports, according to a March 21 Bank of America report on Venezuela, which bases its data on the Venezuelan central bank, PDVSA and the ministry of finance.

Most profitable

The country’s banking sector, according to bankers and regulators, is not only one of the best performing in Latin America, it is also the most profitable. Take the comments of Miguel Ángel Marcano, chief executive of Banesco Banco Universal, the largest of 24 private sector banks in a country that has seen a sharp rise over the past decade in the number of government-owned banks. He says: “There were multiple challenges last year. But the banks concluded the year with an average return-on-assets ratio of 4.52% and an average return on equity of 57.56%, significantly more than the average recorded for Latin American banks.”

In fact, the region’s average return on assets is 2.4%, according to the International Monetary Fund’s Global Financial Stability report published in October. “[Banks in] Venezuela have the highest profit rate in the region, as well as the lowest non-performing loan rate [0.6%, according to Sudeban, Venezuela’s bank regulator],” it said.

But Theresa Paiz-Fredel, Fitch Ratings' Latin American financial institutions director, has reservations. She believes Venezuela’s high inflation rate distorts data for bank profitability, asset quality and GDP growth. “Once adjustments are made for inflation, the profitability of most of the banks… is probably the same or more like other similarly rated banks in the region. But the profits would still be relatively decent,” she says.

No repeat performance?

Few analysts think it will be possible for Venezuela’s banks to repeat 2013’s high profits this year. Fitch, for instance, based on reports on the country’s three largest privately owned banks, in terms of assets – Banesco, BBVA Banco Provincial and Mercantil Banco Universal – as well as a report on the privately owned medium-sized, Bancaribe (in which Scotiabank has a minority 26.59% stake), expects they will all see a decline in profits in 2014 due to weaker demand for credits, higher funding costs, tighter net interest margins and a possible economic shock such as a devaluation, which would be the seventh in a decade.

Mercantil and Provincial, which have a widely noted strong credit risk culture, boosted reserves for impaired loans significantly last year. Provincial’s reserve coverage was 640.34%, the highest in the country, while Mercantil’s was 598%, above the already high average 453% coverage for non-performing loans.

The four banks – which together account for 46% of total assets, 50% of total loans and 44% of total deposits in Venezuela, according to Sudeban – have also been increasing the amount of capital they hold in relation to their risk-weighted assets, with Provincial and Mercantil again the sector’s leaders, followed by Banesco and Bancaribe. All four had a ratio of regulatory capital to risk-weighted assets well above the required 12% minimum at September 30, 2013, according to Sudeban. (The capital that counts as regulatory is less strict in Venezuela than in some other countries, as it includes both Tier 1 and Tier 2 capital.)

Positive thinking

Not all bankers think conditions in 2014 will be worse than in 2013. Some say with the new liberalised foreign exchange market and other economic reforms (see box) the economy should improve during the rest of the year, or even before, according to Banesco’s Mr Marcano. In January and February, bank lending grew 3.9% and bank deposits by 7.1%, both higher than in 2012 and 2013.

The four banks differ in many ways. Banesco, for instance, which accelerated its lending the most last year (58%), is a leader in consumer lending and in loans to medium-sized companies. Bancaribe, on the other hand, has a historic franchise in the small and medium-size business lending market and is reportedly making efforts to increase its penetration in the more profitable, but riskier, consumer/retail market. Through its 89% ownership of Banco de la Gente Emprendedora, a specialised bank, it is also the leading microcredit lender in the country.

Provincial has a strong market share in consumer credits, as well as in loans for multinationals and large Venezuelan companies. It is also the bank that had the highest capitalisation and the lowest non-performing loans in 2013. Mercantil, the most profitable bank in 2013, was number one in credit card loans for the second year in a row, a leader in loans to the manufacturing sector and in savings deposits, with a 20% share.

Structural mismatch

Traditionally, Venezuelan banks have a weakness – a big structural mismatch between deposits, which are nearly all short-term, and longer dated assets.

Ms Paiz-Fredel says that in the medium-term, profitability is likely to depend on whether banks can continue to increase higher interest-earning retail loans (consumer credits, car credits and credit card loans) while keeping costs low. The combination has underpinned banks’ “very high margins”, she says, and mitigates some of the interest rate risk stemming from regulation caps and floors applied to bank interest rates – the same applies to bank commissions.

These controls, averaging 80% of market rates, according to bankers, apply to state-directed credits, which have increased over the past decade. Banks are now obliged to provide credit quotas to farming and agribusiness; mortgages and the construction of first homes; manufacturing; microfinance; and tourism.

The purpose of these quotas is to develop local niche industries, reduce unemployment and complement an array of programmes that Mr Chávez launched when taking power 15 years ago to bring into the main economy that half of the country’s population of 28.9 million living in poverty. But this compulsory lending is onerous for banks. At the end of February, 42% of the total bank lending was earmarked for state-directed credits.

Compulsory lending

Meanwhile, most banks rely on a high proportion of non-interest-bearing current account deposits for their funding. These deposits are almost entirely taken in local currency. Loans are all in the domestic currency. So even with high inflation and devaluation, it does not really matter if bank interest rates for loans and deposits are negative. As long as the spread is positive, they continue to make money.

Another reason for banks’ high profits is that about 30% of their assets are invested in different types of mainly local currency-denominated government debt, such as T-bills and bonds. These are tax free and have a decent return as well. The high concentration of investments exposes banks to sovereign risks, but it reflects a lack of any alternative liquid interest-yielding investments, as well as Venezuela’s underdeveloped local capital market and foreign exchange controls.

Commenting on the relationship between Venezuela’s bankers and the government, Fitch’s Ms Paiz-Fredel says: “The private sector banks have learnt how to manage around the regulations and requirements… There isn’t outright antagonism; it’s more along the lines of co-existence. But all the bankers are aware of the need to keep track of the regulatory requirements and stay on top of that.”

Ironing out Venezuela's imbalances 

During the first week of operations on Venezuela’s foreign exchange market, which launched at the end of March, traders stood aghast while the dollar sold for an average of between 51 and 52 bolívares; a huge depreciation of the local currency. The official peg for almost all the dollars the government makes available – to importers of priority goods, such as food and medicine – is 6.3 bolívares per dollar.

Opinions vary as to how much of a change the new market represents in terms of Venezuelan economic policy. Erich Arispe, a Fitch Ratings senior director, thinks it is not clear how many dollars will be made available to the new market or whether it can be sustained without fiscal and monetary policy changes. He says: “It would seem the government is moving in a different policy direction. But we have to see how the [change] is implemented and how much political support it has [in the ruling coalition] over time.”

Barbara Kotschwar from the Washington, DC-based Peterson Institute for International Economics, is also sceptical: “This is a stop-gap measure to attempt to alleviate some of the [country’s] economic problems. But I don’t see any robust turn towards the market.”

But the new market has already spurred positive change and has greater potential in the long term. Inflation seems to have stabilised, for example, thanks to the halt in the upward rise of the past year-and-a-half of the dollar on Venezuela’s black market.

Letting the value of the bolívar slide could also bolster the government’s dollar income from oil exports, which are now at about $90bn a year, according to Scotiabank. In turn, that could reduce the fiscal deficit estimated at 13.2% of gross domestic product at the end of 2013, according to Venezuela’s central bank.

A falling bolívar could also ease widespread shortages of basic goods by allowing more businesses access to dollars that can be used to import goods. A lack of hard currency has been a principal factor behind the shortages as nearly three-quarters of what Venezuelans consume is imported.

Meanwhile, the government has simultaneously told importers and businessmen that they can pass on the higher price for the dollars that they buy on the new foreign exchange market to consumers up to a maximum 30% profit. A retail network of state shops for low-income Venezuelans, Mercal, has also significantly adjusted its controlled prices. A kilo of sugar that previously cost 6.3 bolívares now costs three times as much.

The government has also launched a programme distributing electronic cards to consumers in low-income neighbourhoods as part of a transition away from a system of indirect subsidies for the poor to direct subsidies. So, instead of controlled prices in state shops that resulted in smuggling of goods over the border to Colombia where shop owners can charge more, the price in the Venezuelan grocery will now be higher, but poorer Venezuelans, using the electronic card, will be able to get a discount.

Even if government changes look timid so far, they may expand relatively quickly. For instance, a new foreign exchange system will apply to only about 8% of total foreign exchange transactions in 2014. But according to Francisco Rodríguez, senior economist for the Andean region at Bank of America Merrill Lynch: “By the end of this year, or early in 2015, we are likely to have 50% of total transactions on this new foreign exchange system. At least if the government is able to carry out what appears to be their current policy plan. We actually think… the government does seem to be carrying out enough of [these policy changes] to bring the situation under control.”

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Read more about:  Americas , Americas , Venezuela