Published by Emerging Markets

Bonds have always rallied with bad news of Hugo Chavez’s health over the two years the self-styled socialist has suffered from cancer. Investors have been keen for more market-friendly policies from the world’s most oil-rich nation.

However on March 5 when Nicolás Maduro, the vice president and Chavez’s chosen heir revealed the news of the president’s death, bond yields shot up.

“The initial reaction was kneejerk,” says Kathryn Rooney Vera, senior macroeconomic strategist and partner at Bulltick Capital Markets in Miami. “The president’s gone, what will the transition be like?”

Elections will be held on April 14. Standing against Maduro will be Henrique Capriles Radonski, the opposition leader who lost to Chávez in October’s presidential election by 11 percentage points.

While that may seem a large margin, it is the closest a usually fragmented opposition has come to unseating Chávez. Since then, however, the opposition has broken apart with party heavyweights calling for a new leader.

Coupled with that is the Midas touch which Maduro has received from Chávez. Just before leaving for Havana early December, Chávez appointed Maduro his heir should his fourth cancer operation not go well.

“Capriles has no chance against Maduro,” says Walter Molano, managing partner and head of research at BCP Securities in Miami.

Rooney Vera agrees. “It’s pretty clear that Maduro is going to be the next president,” she says. “From there, the question will be how much of a pragmatic route will he take towards economic policy.”

Maduro spent six years as Chavez’s foreign minister, executing his boss’ vitriol against Washington in friendships with some unlikely allies such as Iran, Libya and Syria, but also building ties across Latin America.

This had brought hope that Maduro might be more diplomatic than Chávez, whose modus operandi was based on strict military instruction.

There are two routes that Maduro could take: a softer tone than his former boss or a more hard-line one, keen to emulate Chávez to convince voters that he is made of the same stuff.

“April 14 is the day of [Chavez’s] resurrection,” Maduro said earlier this month. “Our father is Hugo Chávez.”

Maduro’s rhetoric and actions — expelling two US diplomats hours before he announced Chavez’s death, for example — are a clear indication that he will be taking the second, firmer, route.

“The near-term objective is to show [voters] that Maduro has the same DNA as Chávez,” says Alberto Ramos, head of Latin America economics at Goldman Sachs in New York. “Maduro has to prove that he has the same revolutionary credentials. This is not the time for him to innovate and forge his own political identity.”
Capriles is doing his utmost to convince voters that they will not be voting for Chávez in the election, rather a poor imitation.

Caracas pollster Luis Vicente Leon, who correctly predicted the outcome of October’s election, wrote on his blog: “[Capriles] has to show the electorate that Maduro isn’t Chávez and ensure they don’t get tangled up with the idea that a vote for Maduro is a vote for Chávez.”

In a fiery speech to kick off his own campaign, the state governor said: “This is an election between Maduro and Capriles,” attacking his opponent: “Nicolás, you are using the body of Chávez for political campaigning.”

“Beating a ghost is hard to do, but that said, Maduro is no Chávez,” wrote Russ Dallen, head trader at Caracas' BBO Financial Services, in a note to investors. “He lacks Chavez’s charisma and street-smarts. He is a dull speaker and seems to have few interesting things bouncing around in his head, which is what helped Chávez connect with so many people.”

Chavez’s ability to connect with the people is key to understanding his success over his 14-year tenure. “Chávez was a unique entity in that the sense that he ruled over more than a decade of economic decay, degradation of institutions, of personal property rights and he came out really smelling of roses, legitimately winning elections,” says Rooney Vera. “Maduro is not that.”

Rooney Vera believes that taking a hard line route would not work for Maduro. “He could either choose the pragmatic route or the ideological route. I think the latter will be a failure,” she says.

Ramos, disagrees, expecting more nationalizations, a cornerstone of Chavez’s economic policy and antagonism towards multinational companies.

"Maduro will have to show that he is powerful and he may do this through highly symbolic moves such as nationalizations,” says Ramos. “The projection of government power may become more raw than it was under Chávez."

David Rees of Capital Economics in London sums it up. “Maduro looks set to stick to the key pillars of Chavismo — loose monetary and fiscal policy, nationalizations and a heavy reliance on imports.”

This could be dire for Venezuela’s economy. One of the country’s major economic problems is a severe shortage of dollars after currency controls were imposed by the Chávez government in 2003 in order to prevent capital flight.

Five devaluations have taken place since then, the most recent in February pushed the currency down 32% against the greenback, to 6.3 VEF to the dollar. However, thanks to low supply and high demand for dollars, the black market rate is currently around 26 VEF and rising almost daily.

“I would certainly not rule out a devaluation before the end of the year,” says Ramos. “This devaluation came larger than what I was expecting, which probably shows that the fiscal picture is worse than people thought.”

Official exchange through the government’s CADIVI (Commission for the Administration of Currency Exchange) is limited to $3,000 per year for individuals and $50,000 per day for companies.

A bond-mechanized exchange known as SITME (Transaction System for Foreign Currency Denominated Securities), by which bonds are sold in VEF to Venezuelans who will then sell them in foreign currency, existed until last month. It was scrapped at the same time as the devaluation causing an even further shortage of dollars.

Oil Minister Rafael Ramírez told reporters earlier this month that fiscal measures, “approved by Comandante Chávez,” were on the way. “We will create another market for the dollar to combat speculation,” said Ramírez.

Ramos is not impressed. “The root causes of [the currency’s] weakness have not been addressed,” he says. “Inflation will certainly accelerate 30%-plus this year.” Inflation in 2012 was tamed at 20.1%, according to the Central Bank. This was down from 2011’s high of 27.6%.

Michael Henderson, of Capital Economics, does not agree that inflation will rocket so high as most of the damage has already been done. “We don’t think the inflationary impact will be as big as some are suggesting,” he says. “They’ve already seen a ‘de facto’ devaluation in that SITME volumes have been drastically reduced.”

Effectively, says Henderson, the devaluation has already happened and prices have already gone up. “Much of the pass-through from a weaker currency to higher import prices has already occurred,” he says. “This will certainly put upward pressure on inflation, but for those thinking it will sky-rocket above say 30%, I’d tend to disagree.”

Keeping Venezuela’s economy off its knees is its huge oil wealth. Having channelled some of that wealth to the country’s poor, Chávez is seen as their saviour. However, many complain that much has been siphoned off by corruption. With the world’s largest reserves at its disposal, state oil company PDVSA has tremendous power to pump dollars into the market.

Ramírez, who also heads PDVSA, announced a shakeup to Venezuela’s oil windfall tax earlier this year. PDVSA and foreign partners will have to pay the state 95% on income on oil sales of above $110 a barrel, 90% on income on sales between $100 and $110 a barrel, 80% between $80 and $100 a barrel and 20% between $55 and $80 a barrel.

Ramírez says that this will add $3 billion to Central Bank coffers and $1.8 billion to PDVSA’s own, as its contributions to controversial state investment fund Fonden would drop significantly. The International Energy Agency is not expecting great things from Maduro’s oil policy.

“Venezuela's next leader faces a Catch 22 situation: current oil policies — the diversion of oil revenues to fund costly social programmes — cannot continue without putting the oil industry, and the country's entire economy, at considerable risk but neither can they be reversed without the risk of social unrest and political chaos.” a recent report from the body said.

“Maduro’s government and PDVSA’s top priority will remain to be directing funds to the social programmes instead of enhancing the oil industry’s capabilities,” says Carlos Bellorin, oil and gas analyst at Petroleum Economics and Policy Solutions for IHS in London.
“The biggest challenge for the government will be maintaining its massive social spending and trying to increase PDVSA’s production while relying that oil prices remain high.”

Maduro, lacking Chavez’s charisma, may not last more than a couple of years, when the opposition can call for a recall referendum. “With Chávez, people could say, 'The president means well but is surrounded by a cast of individuals that don't allow him to do such a good job.’” says Ramos. “Later on, Maduro will have to defend his own record.”

Ramos also believes factions within Chavismo could stake claims for the leadership, post-election. “Chávez, because of his charisma and dominant position, could keep in check all the different factions within the Chavismo,” says Ramos.

“Chávez was not challenged from below within Chavismo. But now, with Maduro at the helm other senior figures within Chavismo may have their own ideas now and claim their own space.”

Whatever happens, says Rooney Vera, “there’s a light on the horizon for Venezuela.”