Impacts of Politics on Capital Markets in Venezuela
Past research has shown that both capital markets are normally sensitive to the political environment that is prevailing in a particular geographical area or jurisdiction. This is normally the case since most of the politicians are known to enact policies which will basically address their needs without paying attention to the economic impacts of the same. Consequently, this leads to a decline in the market returns or an increase in the market returns depending with the policies that they choose to adhere to (Darlene, 2004).
Typical case of the relationship between economic performance and politics is the 2002 Brazilian presidential election as well as the capital market in Venezuela. First, it is important to understand that Venezuela is headed by President Hugo Rafael Chavez who is a socialist and advocates for democracy. On the other hand, the Venezuelan President is on the frontline in the battle against neo-liberalism and foreign policies as advocated by the United States. He became President in 1998 and was reelected back in office in the elections held in 2000 and 2006 (Michael, 2003).
He enjoys a better geopolitical profile due to the fact that he always comes up with different economic development methods which contradict what the Washington Consensus supports. At this point, it is worth noting that during the election of Chavez as president, the dollar exchange rate was at a high of 575 Bolivars and the oil prices were also high considering that a barrel was trading for $10. By this time, the Venezuelan government had actually increased nominal spending to an all-time high 90. 5% (Com, 2009).
In light of the above, it is now important that we evaluate the impact that his reelection has had on the capital markets in Venezuela. However, it is important to get an understanding of capital market. The term capital market is used in economics to refer to both stock and bond markets where governments and corporate participate in the buying and selling of securities as a way of raising the long term funds which may be needed to finance their operations. In different jurisdictions, some regulatory authorities are normally in charge of the capital markets (Mark, 2001).
Now, the paper will focus o the impacts that politics has had on the capital markets. Currently, it is evident that the capital markets in Venezuela are highly concentrated. Worth noting is the fact that immediately after Chavez assumed office, the president came to the limelight when he expressed concern that the country is facing economic difficulties and it thus left with no alternative other than to limit expenditures and increase the taxes levied on the foreigners as well as the Venezuelan citizens (Gerald, 2006).
This came into force in the year 2001 after the president made an approval of some certain decree laws which were to address the ailing economic status of the country. This saw the reshuffling of the cabinet and the abandonment of the some exchange band system which had been established by the previous government. Eventually, Chavez allowed for the dirty float exchange system which was definitely a surprise to those who were aware of the market mechanisms that should be put in place to restore an already ailing economy.
Due to this, massive campaigns which advocated for the presidents resignation were launched by PDVSA. The campaign was not without fruits since it led to a change in the economic policy which sought for price controls as well as the exchange rate controls. The transition also led to the protection of the international reserves from the negative effects arising from the oil strike which was prevalent in the country (West, 2006). This saw the dollar exchange rate being set at 1,600 Bolivars (Jorge, 2006).
For four consecutive years, the dollar exchange rate had actually increased by over 178 %. However, the appreciation of the Bolivar was only short lived thanks to the hostile political climate that was prevalent (Hans, 2008). Internal public spending whose main source of finance was from oil resulted to an increased monetary base but at the same time led to an increase in the prices of goods and services. These factors also had intense pressure on the capital markets within Venezuela due to the fact that the performance of the exchange rates was rather unpredictable.
The key player in the capital markets business within Venezuela is the Caracas Stock Exchange which is a product of a merger with one of its competitors back in 1974. Prior to the election of Hugo Chavez in 1998, the Caracas Stock Exchange IBC index recorded a remarkable decline due to the fact that it was still unpredictable over the outcomes of the general elections which were to be held later in 1998. At the same time, the effects of the Asian Financial crisis on the capital markets cannot be understated due to the fact that they resulted to a sharp decline in the international oil prices (Caplan, 2006).
Worth noting is the fact that the prevailing government has failed to address the need to lower the high interest rates. Consequently, most of the investors have preferred to avoid the equities and they have opted to invest in the fixed income market which is rather promising. Despite the fact that President Hugo Chavez has on numerous occasions been against the foreign policies especially from the United States, his jurisdiction have laws which seek to address the needs of foreign financial institutions. A typical example of such laws is the 1994 banking law permits U.
S financial institutions to participate indirectly in the full range of capital markets activities through the securities firms under their control (Gayot. com, 2009). Upon approval by the Comision Nacional de Valores (CNV), foreign firms are under no restriction to issue bonds and commercial papers in the Venezuelan domestic market. The capital markets are however biased due to the fact that it prohibits residents of Venezuela from accessing off shore securities for investment purposes but allows non residents to access off shore securities for investment purpose (The Devil’s Excrement, 2010).
Remarkably, Venezuelan capital markets are known due to the fact that they have barriers which limit the foreign entities that can access their market. Basically, the Venezuelan capital market normally considers the prevailing economic and financial conditions but there has been no reported case of a foreign entity being denied entry in to the Venezuelan market. President Hugo Chavez has appeared on the media where his critics argue that he always has some trivial things to address. Early this year was not an exception.
In that, he went on the media to announce that he would devalue the existing currency. This implies that over 44% of the imported goods would definitely have a 20% increase in price. Similarly, 54% of the imports would have a 100% increase in price. His administration is also known to have formulated faulty economic policies which had negative impacts on the capital markets (James, 2003). For instance, the government announced that the Central Bank would facilitate the transfer of US$ 7 billion of the international reserves to the Development Fund Fonden.
This would definitely lead to a decline in the monetary liquidity. A good perspective to look at the above is to take an example of year 2005 when the currency was first devalued and the monetary liquidity stood at Bs. 46 billion. Since then, there has been a sharp decline in the monetary liquidity to an all time low of Bs. 2. 6. To the economic experts, such monetary liquidity is completely unsustainable since it is normally impractical to increase monetary liquidity holding international reserves constants and at the same time expecting the inflationary levels to go down (George, 2008).
This is evident due to the fact that inflationary levels recorded an all time high of 30% at the beginning of this year. This comes at a time when the citizens are already criticizing him of having handed out fake loans (Caracas, 2010). During his tenure, Chavez went ahead to announce that there would be a dual government exchange rate which would be applicable to foodstuffs, machinery and some specific remittances abroad. The effect of this is that the swap rate would be devalued from Bs. 2. 15 per dollar to Bs. 2. 6 per dollar.
Moreover, Chavez is of the opinion that he is to introduce an oil Bolivar which would be going for 4. 3 dollars. To the economists, this is a 100% devaluation of the Venezuelan currency, the Bolivar (Thomas, 2000). This was seen as a move to regulate the foreign currency exchange at a time when the political environment of the country could only be described as volatile. In that, there were plans to oust the democratically elected president after there was a mismanagement of over $20 billion from the country’s reserve (Com, 2009).
Chavez administration saw the rise in the swap rate which the government had initially claimed to have control of. The government had actually planned to regulate any form of imports which are not made in CADIVI dollars. As a result of this, the swap rate firsts recorded an impressive performance but then this was short lived due to the fact that in the short run there would be fewer dollars in the market as compared to the Bolivars in the market (PMB Comments, 2010).
Also, the fact that Chavez accepted the swap rate as a third rate makes it impossible to sustain a productive swap rate. In line with this, a report from the CMA Data division has ranked Venezuela as top in the debt default risk and the most risky autonomous borrowers. The report showed that Venezuela had a 48. 5% default risk for the next five consecutive years (Parsley, Popper, 2005). This led to the stagnation of the capital markets as well as the economic markets. Worth noting is the year 2001 when the real GDP was less than that of the year 1997.
This was the main contributor of the recessionary gap which was a factor of the high unemployment rates witnessed in the country. When politics and the economic markets fail to operate as two separate entities, there is the problem of having to contend with high cost of borrowing (Mark, 2001). There has been a recurrence of the same scenario in Venezuela where the Chavez administration seems to advocate for high interest rates as a means of supporting the exchange rate, control inflation and attract some foreigners who may be interested in investing in the country.
As if devaluation of the currency and having to cope with high inflation levels and unsustainable swap rates is not enough, President Hugo Chavez have added another blow to the potential investors within the country (Marta, 2004). In that, Venezuelans must update their government about how they spend their hard earned cash as well as their exact location whenever they travel abroad. This has had negative impacts on the capital markets since both international local investors do not have confidence with the current state of affairs (Peeler, 2000).
The Venezuelans are under an obligation to provide prove of their spending habits. CADIVI which is the government agency has come up with limits which are restricting the amount of hard currency that one is supposed to spend depending with the destination that one wish to travel. This new development comes only a year after Chavez had minimized the travel allowances allowable to the Venezuelan citizens by over 50 %. This has had an impact on the capital markets since there has been a decline in the strength of the Venezuelan currency against the U.
S dollar. This went hand in hand with the decline in the demand within the travel industry. Remarkably, the demand for plane tickets had fallen by over 30 % and speculations were high that the decline would hit an all time high of 40% (Walter, Cancel, 2010). However, economists are optimistic with this new development since they have expressed an opinion that this is measure to preserve the international reserve as well as prevent any further devaluation of the Bolivar.
The economists have expressed concern that any further devaluation of the Bolivar would result higher inflationary levels bearing in mind that the country had the highest inflation levels in the hemisphere (Travelvice. com, 2010). In addition, this is an important factor which will strengthen the foreign exchange controls. This will definitely go a long way in ensuring that capital flight is minimized and in the long run the Bolivar will have to stand strong against the dollar. Chavez came on the limelight due to the fact that he seems to have an oil strategy which may lead to liberation of the disenfranchised Venezuelan citizens.
The President lately announced that he was actually embarking on the project about the 21st century Socialism which will seek to drive its economic and social agenda for the better (Deloitte. com, 2010). However, this move has attracted sharp criticism from critics who are of the opinion that this revolution is in no way a representation of a break from imperialism and will in no way lead to societal transformation. This fact has had some radical impacts on the exchange rate (Saritz, 2010).
In that, the Venezuelan currency has weakened against the dollar due to unhealthy ties between the Venezuelan government and that of the United States. Recent reports indicate that Hugo Chavez have signed a law against the U. S dollar exchanges. This was in a bid to curb to illegal exchange of the U. S dollars in a parallel market within the country. Chavez is of the opinion that any speculations about the dollar exchange market should be a thing of the past and they should be in no way be used as a measure in the ordinary market since they lack basis (Barrell, et al, 2005).
The speculations have raised concern since January this year due to the fact that they have lead to an increase in the consumer prices as well as the decline in the prediction levels of the exchange rates. At this point, it is worth concluding from the essay that though Chavez assumed office at a time when the dollar exchange rates were favorable, his tenure has been frequented by numerous incidences of unpredictable exchange rates. However, recent developments which limits consumer spending will soon address the problem of unpredictable exchange rates.
In the long run, inflation will be at manageable levels and the capital markets will soon be performing as per their capacity. References Barrell, R. et al, (2005). The Sterling Effective Exchange Rate and Other Measures of UK Competitiveness, National Institute Economic Review, pp. 23-35 Caplan, J. (2006). Calculating Risk in Venezuela. Global Finance, Vol. 14, December Caracas Gringo (2010). Hugo Hurls Venezuela into the Void. Retrieved on 18th May 2010 from, http://caracasgringo. wordpress. com/ Corn, D. (2009). Our Gang in Venezuela?
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