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November 27, 2013

Investment Hazard: New Venezuelan President Has No Cure For Economic Crisis

Venezuela’s economy is in deep trouble, making it a minefield for investors and citizens alike, and its president has no idea how to fix it—despite oil money that pours in from the world’s largest oil reserve.

So say the opponents of President Nicolas Maduro, who has captured headlines with aggressive actions that the opposition says are designed more to win voters in an early December election than to remedy economic problems only made worse by Maduro himself.

When President Hugo Chavez died of cancer in March, Maduro, then his vice president, was his hand-picked successor. But under Maduro, the country’s economy has spiraled even further out of control, with inflation raging at 54% and a scarcity of affordable goods, including such essentials as food and toilet paper.

Those are not the only problems. Under Maduro, and Chavez before him, there was a lack of infrastructure investment as the government used oil money to focus more on spending to reduce malnutrition, poverty, and inequality—areas in which, according to both the World Bank and the UN, it has made progress. But neglect of the country’s infrastructure has led to power cuts and other issues. In September the largest power outage in five years darkened the streets of Caracas, disabling trains, traffic lights, office buildings and ATMs.

The real headline grabber, though, was Maduro’s seizure of a chain of five electronics shops, which he accused of overcharging customers. Their wares were later put up for sale under “official” prices roughly a quarter of what they had been before the seizure. Other store seizures followed, as did reports of looting in a number of areas.

Maduro also issued a declaration that he would set price controls on all consumer goods, not just electronics, if given the authority by the country’s National Assembly. That body granted him those powers through a new law in late November, and he now can take independent action for a year without consulting the country’s congress.

But will any of this help? Likely not, according to John Blank, chief equity strategist for Zacks, who dismissed Maduro’s widely reported actions as insignificant overall with regard to mending the economy, and pointed to deeper issues at work in the country.

Part of the problem is the fixing of the foreign exchange rate, something Chavez did in 2003 as a means of keeping some consumer staples, such as rice and bread, affordable for the country’s poor. Venezuela’s currency is officially set around 6.3 bolivars to the dollar, with dollars available only through a government currency agency. But there’s a lively black market that runs about six times higher, and that’s led to higher prices, said Blank, as merchants set their prices in an attempt to keep up with inflation.

While Chavez held the country together, Maduro, said Blank, “doesn’t have the horsepower” to do what Chavez was able to do. Maduro “doesn’t pay [the government’s] bills, doesn’t understand the government budget. Despite all the oil money, he’s still running an egregiously inefficient government. He is responsible for the problem he’s trying to address by nationalizing [the electronics] company.”

Besides, the seized chain “is a 5-store, 500-employee outfit selling HD TVs, basically nothing in the overall scheme.” It’s not, as a result, going to have any real effect on the price woes of the country, and it was done for its “drama consequences—drama achieves consequences,” Blank said.

Blank pointed out that the turmoil caused Venezuelan bond prices to plummet more than 10% over the span of three days after the seizure of the electronics chain. The country’s dollar-denominated bonds yield 15%. While Blank said that this was “not as bad as Greece, Cyprus, or Ireland,” and that there wasn’t a selloff in the bond market, he cautioned, “If you’re not already in, don’t go in. Do not invest there. If [money] goes in, it’s not coming back out. Principal is being ratcheted out.”

Other experts are also wary of Maduro’s actions and their aftermath. In a recent research note, J.P. Morgan cautioned that the news about government intervention in retail outlets and reports of looting “seemed like a taste of a much less manageable social and political backdrop.” It has also changed Venezuela’s position in its EMBIG emerging market global bond portfolio to neutral from overweight.

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