Foreign MNCs face trapped assets in Venezuela

Foreign MNCs face trapped assets in Venezuela

Foreign multinational corporations in Venezuela are faced with rapidly decreasing profit margins amidst strict capital controls and mounting inflation. Given incentives to maintain the status quo, the government is unlikely to implement sounder macroeconomic policies anytime soon.

According to the theory of the trilemma, central banks must regulate their currencies by choosing two out of three conditions – maintaining a sovereign monetary policy, free capital flows, and/or a fixed exchange rate – to have a national currency safe from arbitrage risk and speculative attacks.

In the case of Venezuela, however, despite the government’s actions to maintain an equilibrium of a fixed exchange rate and sovereign monetary policy, only the latter is truly enforced. This occurs because the “official” Bolivar fixed exchange rate is exclusively offered by the government and on a very limited and arbitrary basis. This, in turn, has made the widely accessible and highly volatile black market rate the “true” exchange for the Bolivar.

To further comprehend this reality, it is necessary to understand that Venezuela is highly dependent on imported primary materials, food, appliances, and vehicles, as the nation’s productive capacity has been decimated by rampant expropriations and price controls. Furthermore, Venezuela suffers from a lack of diversification due to Dutch disease, as well as limited access to discounted, official rate foreign exchange.

When businesses are not able to import materials through official exchange rate dollars, they must do so at higher black market exchange prices. This creates inflationary pressures as consumption demands increasingly depend more on expensive black-market dollars.

There has been a dramatic increase in the spread between the official and black market exchange rate over the past years, with the current differential standing at approximately 43x, or 43 times more expensive. As of February 12th 2015, there are effectively four different exchange rates for the Venezuelan Bolivar (BsF).

First, there is the official exchange rate, which stands at 6.30BsF. per $1 USD. This rate is awarded exclusively and arbitrarily by the government, and is now reserved for importing only food and medicine.

The second system is called SICAD, which features another government-administered exchange arbitrarily granting dollars for companies and individuals at 12BsF. per $1 for non-essential goods, according to official Central Bank statistics.

Thirdly, the recently created SIMADI allows for a legal exchange of the Bolivar via limited government-sponsored auctions. It currently trades at an alarming 196.71BsF, or approximately at over 3122.38% of the official rate.

Lastly, the black market rate trades at 275.68BsF – a staggering 43 times above the official exchange rate.

In the case of foreign multinational corporations, firms conduct their accounting by reporting earnings to investors based on Bolivares to US Dollars conversions, often using the official exchange rate.

As can be seen in the following February 2015 Reuters graph, many firms convert their assets utilizing the official 6.3 exchange rate as their basis, but in reality, given capital controls, these valuations aren’t reliable.

Without government approval, foreign firms cannot extract their Bolivares freely unless they exchange them via black market rates, therefore submitting themselves to a significant financial haircut. It is worth highlighting that the graph above features a hypothetical 50-to-1 exchange rate projection, whereas the actual one stands at approximately 43-to-1, as previously mentioned.

As a result of this particular macroeconomic climate, MNCs operating in Venezuela have decided to extensively purchase real estate as a way to mitigate domestic profit losses due to capital controls and mounting inflation. The recent asymmetric incentive structures have fueled an exorbitant real estate bubble in Caracas, with MNCs purchasing prime properties and hoping to one day sell these assets in American dollars.

The same report estimates that these firms’ trapped profits range from $8 billion to $12 billion. Firms are faced with the option of either sustaining and surviving heavy losses or losing everything by packing up and leaving, as was the case with Clorox late last year. Its potential exit costs are estimated at $65 million.

Furthermore, the devaluation of the Bolivar at the official exchange rate translates into decreased earnings reports for foreign firms, albeit the last devaluation occurred on February 13th, 2013 from 4.30BsF to the current 6.30BsF. Interestingly enough, MNCs have often compensated for bad quarters by re-adjusting their Bolivares’ earnings conversions across different exchange rates.

The Road Ahead – Why the Situation Won’t Change

Despite the adverse investment climate created by capital controls and inflation, the Venezuelan government is not likely to compensate for it with better macroeconomic policies, given political incentives to maintain the status quo.

Being the sole legal issuers of the heavily discounted official rate, ruling-party PSUV leaders are able to devalue the currency as necessary to adjust fiscal imbalances by getting more Bolivares for the Dollar for their foreign currency revenues.

Furthermore, the power to devalue translates into profligate spending incentives for electoral reasons. After a Supreme Court ruling in June 2008, it was established that there is no constitutional binding on public financing of electoral campaigns. Consequently, as an interesting correlation, the Chavismo has won all six national plebiscites.

In addition to devaluation, the government is able to cater to special interest groups that allow them to stay in power by overriding any institutional opposition. In his 2014 book Chavistas en el Imperio, investigative reporter Casto Ocando highlights several cases of dollarized corruption by renown contemporary Venezuelan politicians.

Most recently, Barack Obama issued an executive order to freeze US assets of several top Venezuelan government officials responsible for human rights abuses. Sanctioned individuals listed include leadership members of the Armed Forces intelligence services, prosecutors, police, among other key institutions.

For foreign MNCs which operate in industries other than hydrocarbons, special treatment that would allow them to recover and repatriate profits is unlikely.

Investors, for now, should stay away from these ventures in Venezuela. There is hope, however, that an upset win by the national opposition movement could bring the gradual change needed to once again attract diverse foreign capital investment.

Categories: Finance, Latin America

About Author

Juan Daniel Goncalves

Juan Daniel was born in Caracas, Venezuela to a family of Portuguese origin. He has experience in private banking and emerging market investment, and is also passionate about hydrocarbons and energy infrastructure. He graduated from Georgetown University with a Bachelor's degree in International Political Economics as well as a Certificate in Latin American Studies. Besides English, Juan Daniel is also fluent in Spanish, Portuguese, and French.