This is an article that was published in AlternativeLatinInvestor.com in 2009
Chavez And The Diminishing Return
Since coming to power in 1992 Hugo Chavez of Venezuela has not only transformed the political landscape of his own country and influenced the populist movement of South America, but he has also dramatically impacted investment and its outlook too. Chavez’s power base has made the prospect of investing (and even preserving) money in Venezuela a complicated affair and unfortunately it is becoming an increasingly difficult riddle.
Investors from outside of Venezuela and particularly those beyond the scope of South America have been forced by Chavez’s actions, which have grown stronger from the populist movement, into a financial proposition that is complex and in many cases not profitable.
A simple statistical truth shows that oil production upon Chavez stepping into power equated to 85% of the GDP and now the oil industry equates into 92% of the economy. Instead of bringing diversification and building new infrastructure for other industries to take hold and grow – Venezuela has become more dependent on exporting oil.
Chavez during the height of the boom in oil prices found himself in a political and cash rich position, able to spend money for pet projects and military rather carelessly. However, because of the global downturn and retracement in oil prices, Venezuela finds itself with a sinking economy that is cash strained. The Bolivar is losing value and its bonds ratings are suffering internationally.
Chavez is widely known as a hawk within OPEC and has called for the oil cartel to try and keep prices as high as possible. While one cannot fault him for wanting his country to profit on the heels of oil’s strength, it does lead him open to criticism considering oils fall and his inability to try and expand Venezuela’s economic base. His one dimensional approach to growing Venezuela’s wealth has left him at a distinct disadvantage.
The question that arises for the private or institutional investor considering a placement of capital within Venezuela is a dynamic one. Because of the political situation it would be foolhardy to try and invest without promises by the leader himself, Chavez, that capital would be welcomed and secure.
But unfortunately his track record does not support that type of consideration, taking into perspective the fact that he has now begun to extort money from corporations by threatening and in some cases taking over facilities of corporations and nationalizing them – or penalizing them with a probation process consisting of different time frames per the government’s whim.
Chavez has not only made it hard to invest into Venezuela but he has made it difficult to get money out of Venezuela, putting limits on amounts of money that can be carried out of the country personally and sent by wire transfer. Leaving the people who have earned good incomes in Venezuela to formulate alternative methods to try and safe guard their wealth and this has not been easy considering the precipitous fall in the value of the Bolivar.
There is a theory in economics called diminishing return. In most cases this is used to point out that the more an entity receives for investment in order to create new industry that eventually the money that follows the previous investments will not match the percentage of profit made before. Too much money often makes the money that follows less valuable and thus less profitable in many cases. Unfortunately for Venezuela (though it certainly is not being overrun by investment from corporations and individuals currently) even if a person wants to invest in the country, one would be taking a huge gamble on the man in power. Unless one has an ability to know firsthand that their money was secure and that the investment was protected by the nation, it begs to ask why anyone would consider such a move. Chavez has helped reformulate a new law of diminishing returns.
In the past year alone, Chavez has not only set his sights on the continuing confiscation of oil based corporate assets but has also gone after other companies like Cargill, the commodity giant. Because of Venezuela’s clear lack of disregard for basic economic theory, Chavez has created inflation by trying to implement price controls on basic food stuffs and caused scarcity as well.
Having increased Venezuela’s dependence economically on the oil industry, Chavez was able to enjoy a robust return of GDP during the boom oil years and the end of the calendar year 2008 was even able to achieve a 4.8% gain. However with the downturn caused by the financial crisis within the United States, Europe, and Asia, Chavez has seen a reversal in not only demand for his black gold but unstable growth as well.
S&P now rates Venezuela’s bonds with a mere BB rating, which means that the country’s economic conditions lack clarity. And there are now doubts and severe questions regarding Venezuela’s ability to cover its debt obligations. With a global economic outlook that continues to be cautious, Venezuela’s circumstances will remain challenging in this environment as long as the oil industry remains the main engine for the Venezuelan machine.
Investors in Venezuela must play a strong and subtle game of political networking at this time to make sure they can maintain production and allow financial assets in the country to perform regularly. A pragmatic approach must be taken by the people within the country who are citizens to essentially safe guard their assets from becoming nationalized or seized ‘for the good of the people’. How to do this without raising the ire of the Chavez government is the one million Bolivar question. The specter of corruption growing in a country that has a ‘populist’ leader is often a grim reality and one that has stood the test of political and economic history as governments try to make money in the ‘utopian’ lands they try to control.