Credit Negative Spending by Venezuela Likely After Strong Opposition Performance

Credit Negative Spending by Venezuela Likely After Strong Opposition Performance

On 12 February, Henrique Capriles, a 39-year-old state governor, won the Venezuelan opposition’s presidential primary with nearly two-thirds of the vote. Turnout was stronger than expected, with roughly 3 million votes cast, indicating significant support for the opposition Coalition for Democratic Unity candidate. While Mr. Capriles’s platform promises to rectify many of the economic distortions and macroeconomic imbalances introduced in the past 13 years of President Hugo Chavez’s rule, we nevertheless believe that the primary results are credit negative for Venezuela (long-term foreign currency bonds B2 stable, long-term domestic currency bonds B1 stable) given President Chavez’s likely reaction.

Mr. Chavez and his supporters have already begun to disparage Mr. Capriles, and have called the legitimacy of the primaries into question. If Mr. Chavez determines that an opposition victory is a credible threat in the October 2012 election, we would expect the president to open the spigot on government spending even wider than already anticipated in order to boost support for his government. This is exactly what happened during the last election cycle in 2006 when government spending increased by more than 25% in real terms, or 4% of GDP. A spending surge would hasten deterioration of the government’s finances and exacerbate already rampant inflation and the overvalued exchange rate, making it more difficult to address them once the elections are over, regardless of who wins.

Prior to the primary, we forecast that government spending would increase by “just” 10% in real terms in 2012, equal to 1.5% of GDP, thanks largely to the administration’s ability to rely on various extra-budgetary funds to supplement spending. This would have caused the central government deficit to jump to more than 7% of GDP from an estimated 4% in 2011, which in turn would have caused domestic government debt levels to rise by 40% in nominal terms and external debt to increase by $7 billion, or 16%. If, as we now anticipate, President Chavez further increases government spending ahead of the October election, those figures will be considerably larger, which we expect will result in a rise in the government’s financing costs.

In the longer term, the picture is less clear. If Mr. Capriles were to win and successfully implement his platform, it would clearly be a credit positive. But that’s a big if. First, the elections would have to be free and fair. Second, the military and hard line Chavistas would have to countenance a Capriles presidency. Third, Capriles would have to gain approval for his proposals in a Congress that will remain dominated by Chavez supporters. While the opposition actually won the popular vote in the 2010 congressional elections, it was awarded just 67 of 165 seats.
However, the Chavistas are a somewhat fractious coalition comprising a number of disparate interest groups, some of which could be peeled away under certain circumstances. This is what Mr. Capriles reportedly did as governor of Miranda state, where he had a reputation as more of a pragmatist than a partisan. Furthermore, Mr. Capriles himself defeated one of President Chavez’s key allies, Diosdado Cabello, in the election for Governor of the State of Miranda in 2008. Finally, although Mr. Chavez retains significant support and led the polls prior to the recent primary, his health could still prove to be an issue. Though the president alleges the cancer he was diagnosed with last year has been fully cured, there is lingering uncertainty about this. Should his health fail him again, it could at the least prevent him from campaigning as vigorously as he otherwise might.