Venezuela: Elections Bring Possible Short Term Gain; Prospects however are uncertain

** Chavez v. Capriles** **Budget Worries Remain** This Sunday, October 7th, the much anticipated Venezuelan presidential election will take place to select a President for a six-year term. The two competing choices are the current incumbent, Hugo Chavez, and his rival Henrique Capriles Radonski, aka Capriles. Capriles is considered a market-friendly reformer, intent on weaning Venezuelans off of Chavez’s government interventionist style. Chavez has already governed for twelve years, turning Venezuela into a virtual command economy centered on oil and government largesse. The Venezuelan currency, the Bolivar forte, has a dual rate system. Essential imports such as medical equipment, refined oil and food receive a foreign exchange rate of USD/2.8 Bolivars. Foreign exchange for non essential items is valued at Bs.4.289/4.3 to the USD in a tightly controlled band. US dollars, however, also trade outside of the established rates among local money changers. Venezuela earns the majority of its foreign currency through oil sales conducted through the state- owned oil company PDVSA, Petroleos de Venezuela. Venezuela has established a sovereign wealth fund, known as the Fonden. After accounting for PDVSA’s operating expenses and debt servicing, excess capital is placed within the Fonden. The USD funds are converted into Bolivars which are then distributed to the populace as grants to equalize wealth distribution. The act though generates high inflation with more money chasing after ever scarcer resources. The latest annual inflation rate (September) registered 18.1 percent according to its statistical agency, INE (Instituto Nacional de Venezuela. With a fixed exchange rate and high inflation, the Bolivar after Argentina’s peso, is Latin America’s most overvalued currency. The best way to tap into the Venezuelan currency market is through its hard currency generating vehicle, PDVSA. The massive national oil company has issued international bonds denominated in dollars. As an example, bonds with a maturity of two years yield 8.235 percent and five year bonds yield of approximately of 10.17 percent. PDVSA is rated B+ by Standard and Poor and B2 by Moody’s. According to the Central Bank of Venezuela, as of October 1, international reserves stood at $26 billion. The country’s outstanding debt (both international and national) is in excess $75 billion. More worrisome is the country’s fiscal 2012 budget which was expanded by $25.3 billion to $94.6 billion. The rationale which is likely political is to meet public labor liabilities including pensions and funding gaps among government ministries. Sunday’s election will remove a cloud of uncertainty as either the incumbent or a new president will take control of the presidential palace. In either instance, the euphoria will be short lived as the President must confront a deteriorating economy dominated by income inequality and crime. Investing in Venezuela’s Bolivar through its cash cow, PDVSA, is risky yet so far it has not produced sour milk. John T. Sullivan. Latin America specialist, ForexSpace.com http://www.forexspace.com/forex-insights/1108/venezuelan-election-short-term-opportunity-longer-term-risks e-mail:jtpsullivan@gmail.com Article by: ForexSpace Team

Brazilian Real - Order and Progress - Half Right

* Real Flags Its Value * Feel The Heavy Hand Of Brazilian Government * Likely To Trade R$2.00 to R$2.10 To The USD The Brazilian motto embellished on its flag “Order and Progress” is an exhortation of the Brazilian promise. Recently, the central bank and the government whose policies are inseparable (in spite of claims to the contrary) have held up at least one at the cost of the other. John T. Sullivan, ForexSpace.com Markets Writer, The Americas, reports. The central bank has been actively intervening in the currency market through a series of currency swaps designed to maintain a floor and a ceiling on the real’s value. According to central bank statistics, the Real has traded since early May within a narrow range of R$1.914/USD (a high on May 2nd) and a low of R$2.0897 on June 28th. Each time the real has fallen below R$2.08, the central bank has intervened through a combination of a currency swaps and/or market guidance. The reverse occurred when the real appreciated above R$2.00. Concurrent to the movements in the foreign exchange rate has been the central bank’s reduction of the SELIC rate (the monetary policy rate). The President of Brazil, Ms. Dilma Roussef, and her Administration have made it known that they want interest rates lower. Since the beginning of 2012, the central bank has accommodated this wish by lowering the SELIC rate five times from 10.5 percent to the present level of 7.5 percent. The central bank has set an annual inflation target of 4.5 percent with a 2 percent band, allowing inflation to fluctuate up to 6.5 percent or as low as 2.5 percent. In August the annualized Consumer Price Index (CPI) recorded a 5.24 percent increase. Annualized inflation in January 2012 was 6.22 percent and consistently fell through June to 4.99 percent. Thereafter, the CPI has climbed as food and beverage costs grow by double digit annualized percentages. The Brazilian government through its interaction with the central bank’s monetary policy committee is interfering with the conventional wisdom that monetary policy should be independent of politicians. President Roussef has stated she wants real interest rates to decline further. It is a noble aspiration that should be left to an independent central bank. The manipulation of short term political objectives distorts not only the workings of the domestic economy but also international fund flows. Foreign exchange rates are dependent on interest rates. These rates determine not only the comparative advantage of holding one currency against another but also the forward risk. The central bank by acceding to the government’s desire to lower interest rates has also had to intervene in the foreign exchange markets. The combination may keep order in the short term but fails to allow the economy to naturally progress. In conclusion, the Brazilian real will be controlled not so much by market forces. Rather the government’s heavy hand executing through the central bank’s operations will decide the Brazilian currency movement. The real will likely trade within the narrow band of R$2.00 to R$2.10 to the USD until both the government and the central bank have decide that the monetary policy rate is at a level sufficient to promote ongoing domestic economic growth.