Fear grips banking customers in Venezuela

The march towards nationalization continues unabated. Over the past year the oil, telecommunications, electric, and steel-making sectors have been impacted in President Chávez’s ceaseless drive towards a socialist paradise.

Now the crisis has spilled over to the financial sector as the government seized control of a large Spanish-owned bank, Banco de Venezuela. Nervous depositors lined up seeking reassurance, and many fear a run on the bank in the coming week. Not helping matters, the central Venezuelan bank has been vague in attempting to reassure depositors that the banking system was solid.

Nearly all the companies seized by the government have been run into the ground over a short period of time; productivity has dropped and the feeble earnings have not been reinvested back into the companies.

Venezuelan bonds fell Friday for a second day reflecting “fears over the possible collapse of several banks because of rules forcing them to sell $5 billion of complex securities called structured notes. Banks bought the notes last year at values tied to high black-market rates of the dollar, exposing some of them to huge losses after the local currency, the bolívar, strengthened this year.”

Attempts of individual banks to negotiate their way out of the crisis has not paid returns as the IMF and World Bank have effectively shut off the spigot after being threatened with expulsion by Mr. Chávez.

Even the high price of oil can not cover the cost of large scale programs in Venezuela beyond the next couple of years. Any significant drop in the price of oil will cause an immediate fiscal crisis. At 32%, Venezuela also is experiencing the highest inflation in Latin America. Food-based inflation is above 52%, a crushing level for most of the population. The fiscal crisis and high inflation levels can be directly linked to government policies. This has left the poorest portion of the population, which Chavez claimed would be helped by the government’s policies, in even greater despair.

Venezuela: The slide continues

Hugo Chavez is still running amok in Venezuela. Despite voters rejecting a referendum giving the president sweeping power over the economy a mere few months ago, Chavez has taken steps over the past weeks to seize more businesses.

Chavez is driving the take-over of Sidor, a large, Argentine-controlled steel maker; cement companies owned by Mexican, Swiss and French investors; more than 30 sugar plantations; a large dairy products company; and a sprawling cattle estate on the southern plains…and these firms are just a component of overall list.

As expected these moves have spooked foreign investors and infuriated neighboring countries (whose public companies own many of the assets). The compensation offered by the Venezuelan for these companies is under 20 cents on the dollar. Foreign investment in Venezuela has hit record lows, with only $500 million investing in 2007 as Chavez nationalized electric, telephone, and oil companies.

All this socialist exploitation has tanked the Venezuelan economy, which is now beset with foot shortages, building supply problems, and a lack of many other staples. At a time where many other South American economies are booming, the Venezuelan bolivar currency is in free-fall with the black-market rate climbing over 20% in the past couple of months to 3.4 per dollar. The government moves to prop up the currency have failed miserably. One can only expect that the name-sake of the currency, Simon Bolivar would have been shocked at government policies that are so destructive to the people, if he was alive today.

Only high oil prices are propping up the centralized economy of the nation. Of course this is only a short-term situation because oil production is drastically declining at the oil wells seized by the government. The entire government house of cards will fold as oil prices or production fall, further illuminating the reality of why centralized economies do not work. It is one thing to have social programs in countries that aid the poor, homeless, aged, and disadvantaged; it is another thing entirely to seize companies that your entire productive economy is built upon.

Looking ahead one can only expect further unrest and economic turmoil in Venezuela. This situation is unfortunate since the country is rich in natural resources and formerly endowed with a rising economy prior Mr. Chavez’s administration.

Chávez Seizes Greater Economic Power

Venezuela Introduces New Currency in Plan to Halt Inflation

Venezuela endures the highest inflation rate in South America. The official inflation rate is over 20%, the unofficial rate is over 100% when taking in account the underground economy and realistic exchange rate to other currencies.

The middle class is pressed as more wealth is transferred to social programs with no associated economic benefit. Businesses are under increasing pressure as the government continues to seize resources, placing productive employment in jeopardy. Business growth has declined rather then risen over the last 12 months, while inflationary pressure strains the Venezuelan economy.

While the government has pushed the new currency as the “strong bolivar”; most of the nation has dubbed it the “weak bolivar”. It is generally helpful to lob off three zeros on currency note from a mass psychological perspective, after all who wants to pay 2000 of a currency unit for a loaf of bread. However attempting to sell a new currency as a cure for inflation and a stimulant for economic growth is far-fetched, if not absurd. Sloganeering with "A strong economy, a strong bolivar, a strong country" will not alter reality that the currency change is nothing more than window dressing.

For the government, Chavez's introduction of a new currency is merely an attempt to conceal the extent of the inflationary problem from the people of Venezuela, a traditional national problem that is difficult to hide. Unfortunately this solution will not really resolve the issue, and the second half of 2008 is likely to see stagflation in the local economy as Chavez continues to push fiscally-irresponsible social policies.

One immediate concern will be if the chill spreads like the flu to other economies in the region. The Latin American countries are interlinked in both trade and stock market performance. Surprising many pundits the Latin American market (as seen by the ILF ETF) has continued to have a hot run despite the rising regional risk.
http://finance.yahoo.com/q/bc?s=ILF&t=2y&l=on&z=m&q=l&c=


Venezuela Introduces New Currency
Venezuela Launches New Currency As Chavez's Government Seeks to Stem Inflation
http://biz.yahoo.com/ap/080101/venezuela_new_currency.html

Don’t cry for me Argentina

Recent reports from notable sources have accused Argentina with manipulating their economic data in order to reduce the amount of interest that the government must pay on inflation indexed debt. About 40 percent of the nation's $136 billion debt is inflation-based securities; the tampering caused bond holders to miss out on over $250 million in interest payments in the past twelve months. In reaction, ‘Argentina's benchmark inflation-linked bonds have tumbled 24 percent this year, making the country's debt market the worst performer in the world’.

Governments always have a temptation to manipulate economic data for their own political or fiscal agendas. Most governments do toy with the figures by regularly changing the definition of employment or altering the mix of items factored into inflation. The situation in Argentina demonstrates what occurs when a government takes it one step too far.

Argentine Debt Devastated by Data Suspicion, Election
http://www.bloomberg.com/apps/news?pid=20601109&sid=axTqfaTiLf4I&refer=home

Despite the meteoric rise of the Latin American stock indexes over the past years; the situation in Argentina is a prime example of the risk in this region’s markets.

Latin America "nationalization" hitting corporate bottom lines

The nationalization trend in Latin America is starting to show up on Wall Street earnings reports. In the long term, this will have the impact of dragging down the entire market in the region and all the outside business operations associated with it.

The most recent examples include ConocoPhillips net income dropping off 94% due to the confiscatory activities of Hugo Chavez's government in Venezuela. HNR (Harvest Natural Resources) also reported a loss after not being able to recognize equity earnings from Venezuela.

It can only be expected that this trend will get worse moving forward into 2007. Investors should consider slowly moving out of their Latin American investments over time; and take a close look at natural resource stocks they hold which may be significantly impacted by the policies of Hugo Chavez in Venezuela, Evo Morales in Bolivia, and Rafael Correa in Ecuador.

Venezuela charge hits ConocoPhillips earnings
http://biz.yahoo.com/bizj/070725/1496115.html?.v=1

Regional Risk - Latin America

The indexes representing the broader Latin American markets have recently been hitting new highs; however most investors do not understand the increasing political risks relative to their investments in this region. There is a significantly increasing likelihood that the stock markets in these countries will reverse course and decline.

What is the key risk --- nationalization. Many of the governments in the region have leaders who are focused on nationalizing key industries in these countries. Public companies involved in the oil, gas, mining, electric, water, telecommunications, mining, and transport industries are at risk. In the natural resource focused region, these activities represent over 80% of the economy in many countries. Recently presidents Hugo Chavez of Venezuela, Evo Morales of Bolivia, and Rafael Correa of Ecuador have implemented plans to nationalize these industries. Further comments from these leaders have been made recently which make it clear that they do not plan to properly compensate the current owners of these firms at anywhere near market value in their push towards "21st Century socialism".

So there are other countries in the region that are still committed to free markets; why should investors be concerned if just a few countries representing only a portion of the market in Latin America appear to be walking down the path of seizing assets for nationalization.

The answer is cross-ownership; many of the industries in the region are partially owned by public companies in neighboring countries. Despite the rhetoric from some of the leaders about "kicking the Yankees out"; the largest impact of nationalization is on their direct neighbors in the region. Due to the large amount of cross-ownership and joint ventures of the firms in Latin America, continued nationalization is likely to lead to a widespread conflagration and regional market melt-down.

For example, when Bolivia announced plans in 2006 to nationalize its gas and oil industry; this immediately caused a political crisis with Brazil. Brazil, which is heavily dependent on energy from its neighbor, was enraged by Bolivia's decision to nationalize its energy sector, including local operations of Brazilian state energy company Petrobras. An agreement to resolve this flare up over the disposal of energy assets owned by large publicly traded firms is still being worked out.

The U.S. newspapers have focused on the impact on U.S. publicly traded companies. For example the recent announcements in Venezuela regarding nationalization of the telecommunications and electricity sector generated headlines regarding telecom carrier Cantv (NYSE ADR: VNT) and power company EDC. CANTV is controlled by New York-based Verizon Communications Inc., which holds the largest minority share. In April 2006, Verizon agreed to sell its 28.5 percent stake in Compañia Anónima Nacional Teléfonos de Venezuela, or CANTV, to América Móvil and Teléfonos de Mexico, for $676 million; this deal unraveled on the news from Venezuela. Chavez said Sunday that shareholders in CA Nacional Telefonos de Venezuela, or CANTV, will not be compensated at market value when the company is nationalized. Similarly AES Corporation of Arlington, Va., is suddenly facing the potential of hundreds of millions of dollars of losses related to its ownership of EDC in Venezuela. Despite the media focus on the losses to U.S. firms, the real impact will be on other public companies in the region that have ownership stakes in firms that are nationalized.

There are strong investment ownership links in the Latin American region that bind public companies across national boundaries; which explains why the Latin American stocks fell to their lowest levels in a month as Venezuela's plan to nationalize of telephone and electric companies was announced recently. Markets in countries that support a free market system such as Colombia, Mexico, and Brazil fell 1.9 percent or more after Venezuelan President Hugo Chavez stated he would nationalize these industries. Individual stocks of firms such as Petrobras in Brazil, which owns significant assets in other countries in the region, continue to drop with each negative news item from the nation’s neighbors. The world’s second largest mining company Cia. Vale do Rio Doce in Brazil also has many regional binds and the stock price drops each time Bolivia or another country indicates plans to seize mines. The valuation stock price in the Mexican market of both America Movil and Telefonos de Mexico has been impacted by the inability to purchase the CANTV minority stake from Verizon. There are a continuous string of cross-ownership relationships that can be cited in the markets in the Latin American region. No single country is an island; all are bound together in a common regional market and economy.

There is also strong potential that owners of Venezuelan steel, banking, cement and hotel companies will be impacted by the nationalization trend. One media report even stated that the cable car operator that takes tourists to the top of the Ávila mountain could be affected by the push toward nationalization. A few press outlets have focused on the impact to smaller private firms that nationalization threatens. The increasing gloom relative to political risk regarding investing in the region, whether demonstrated by large publicly traded firms or smaller private enterprises, should be a huge stop sign to investors.

There is also concern that more countries in the region could jump on the nationalization bandwagon; this would increase the investment risk. One recent article quoted Horacio A. Valeiras, who oversees $14 billion as chief investment officer of Nicholas- Applegate Capital stating “He'll nationalize everything he can. We've been avoiding Latin America because of the nationalization issues in almost every country south of Mexico.'' This demonstrates the investment communities concerns over regional conflagration.

In the recent Davos summit, Mexico's Calderon urged the region to reject turn to it’s failed past. He warned that Latin America is splitting into two economic camps, one embracing a failed past of state control, the other seeking growth with foreign investment. Only time will tell if voices such as Calderon’s will be persuasive in stopping the slide of the market economy in the region.

Clearly the Latin American stock markets have climbed significantly during the past several years. The high returns have driven many investors to jump on the band-wagon and purchase mutual funds and index ETFs (such as ILF) which focus on Latin America. What should these investors do now in view of the increased political risk in these markets? The answer is to sell your holdings and invest this component of your portfolio in other emerging markets. Should you sell all of your holdings in one transaction? No, if your investments in ILF or a Latin American fund are sizeable then I would urge that you sell it over the course of several months in portions. This reduces the market timing risk, and demonstrates that regional investment risk is not an immediate crisis but a problem that will materialize over a longer period of time as particular governments nationalize industries.


Back-up material and articles:
ILF - ISHARES S&P LAT AM40 : Two Year Chart
http://finance.yahoo.com/q/bc?s=ILF&t=2y&l=on&z=m&q=l&c=

Latin Stocks Fall on Venezuela Nationalization Concerns, Oil
http://www.bloomberg.com/apps/news?pid=20601086&sid=aWMgAjf6tT20

Venezuelan plan alarms investors
http://www.iht.com/articles/2007/01/10/america/venezuela.php

Chavez to nationalize electric, telecom firms
http://www.usatoday.com/news/world/2007-01-08-chavez-socialism_x.htm?csp=34

VENEZUELAN PLAN SHAKES INVESTORS
http://select.nytimes.com/gst/abstract.html?res=F40F11FC39540C738DDDA80894DF404482

Some Venezuelans fret about Chavez plans
http://www.sharewatch.com/story.php?storynumber=300572

Free trade no longer star of Latin summit
http://www.cnn.com/2007/WORLD/americas/01/18/trade.summit.ap/index.html?section=cnn_latest

Govt looking at Entel nationalization – Bolivia
http://www.bnamericas.com/story.jsp?sector=2&noticia=380153&idioma=I

Morales says Bolivia to nationalize mining sector
http://news.yahoo.com/s/nm/20070119/wl_nm/bolivia_mining_nationalization_dc_1

Mexico's Calderon Urges Region to Reject Turn to Failed Past
http://quote.bloomberg.com/apps/news?pid=20601170&sid=asSWAccIrVJo

Chavez to Get Powers to Remake Venezuela
http://apnews.excite.com/article/20070131/D8N0BMOO0.html

Analysis: The negative impact of Cantv nationalization
http://www.cellular-news.com/story/21320.php

Bolivia's populism steps on Brazil
http://www.csmonitor.com/2006/0508/p07s02-woam.html

Tensions ease in Brazil-Bolivia energy dispute
http://www.boston.com/news/world/europe/articles/2006/05/13/tensions_ease_in_brazil_bolivia_energy_dispute/