Venezuela business: At the bottom of the heap

FROM THE ECONOMIST INTELLIGENCE UNIT

Venezuela is becoming an increasingly more challenging place to do business. Tough operating conditions include weak contract rights and government interventionism, shortages of foreign exchange and a growing bureaucratic burden—not least because of the introduction this year of a dual exchange-rate system. Added to this is a poor macroeconomic outlook, including high inflation and a profound recession, which the radical policies of the Chávez administration will only prolong rather than alleviate. Given these conditions, Venezuela now has the worst investment climate in Latin America, according the Economist Intelligence Unit’s latest Business Environment Rankings.

While most other countries in the region are already beginning to recover from the global recession of 2009, Venezuela is sinking deeper. Lower world oil prices and challenging world market conditions, combined with falling oil production, a lack of private investment and energy shortage, caused the economy to contract by 3.3% in 2009. This year there will be no respite, as the dual official exchange-rate system (plus the parallel market) introduced in January (along with a steep devaluation) will deepen distortions in the domestic economy. Activity will be further damaged by the ongoing energy crisis. Moreover, with the government continuing to seek scapegoats in the private sector, there is a risk of even more extensive nationalisation, which will further discourage investment.

Although Venezuela’s oil wealth will continue to place a floor under the decline in economic activity, the government’s heterodox and often impulsive policies will extend the recession into 2010 and 2011. The Economist Intelligence Unit now expects GDP to contract by a whopping 6.7% this year, and to continue to shrink mildly in 2011. Indeed, Venezuela’s performance will be the worst of any world economy this year. Only a feeble rebound is expected in 2012.

What’s more, in spite of a collapse in domestic demand, consumer price inflation will remain by far the highest in the Latin American region—up to 35% at year-end 2009—reflecting the devaluation and continued massive fiscal laxity. Although we expect the authorities to retain the BsF2.6:US$1 exchange rate for essential imports, further devaluations of the secondary BsF4.3:US$1 rate (at which dollar-denominated oil earnings are converted into local currency) are likely in 2011.

Meanwhile, the decay of the non-oil industry in recent years has intensified oil dependency, even as oil production capacity itself has been declining. Neither these problems, nor the inefficient and costly public bureaucracy, are expected to be adequately addressed as long as President Hugo Chávez remains in power. As a result, sustainable development of the non-oil economy over the medium term appears unlikely.

Competing for last place

We expect the improvisational heterodox policies of the Chávez government to further impair the investment environment. Government policy will become even more radical and unpredictable, deterring investment and exacerbating existing economic distortions.

These expectations are reflected in Venezuela’s deteriorating position in the Economist Intelligence Unit’s Business Environment Rankings. While in the historic period of 2005-09 Venezuela ranked near the bottom, 11th of the 12 Latin American countries covered in the rankings (out of 82 countries covered overall), for the 2010-14 forecast period it has dropped to last place, overtaking Cuba. In the global rankings, it has fallen to 81st position—ahead only of Angola—compared with position 69 previously (see table).

The highlights of our business environment forecast for Venezuela for the next several years include:

* Policy towards private enterprise and competition. Nationalisation of retailers which raise prices in reaction to the devaluation marks a further deterioration in the environment for businesses already hit by aggressive land reform and unilateral contract revisions. Unpredictable interventionism continues to restrict freedom of businesses to operate. Price controls and higher input costs erode profit margins. Risk that more sectors become targets for nationalisation and/or expropriation.

* Policy towards foreign investment. Difficult access to project finance and persistent uncertainty over contract and property rights. Favouritism towards investment from “friendly” countries. Nationalisation drive affects both national and foreign players. Government’s reluctance to offer international arbitration to prospective investors will deter foreign direct investment.

* Foreign trade and exchange controls. System becomes much more complex with introduction of dual exchange rates. Many firms face sharp increases in input costs following devaluation from BsF2.15:US$1 to BsF4.3:US$1, hindering trade. Mr Chávez will seek closer ties with the Mercado Común del Sur (Mercosur, the Southern Cone customs union), but Venezuela remains an unreliable trade partner. Risk of periodic protectionist measures and rising barriers to trade.

* Taxes. Ad hoc adjustments of the tax regime as the government seeks to boost revenue. The tax system remains complicated and unpredictable. Efforts to boost tax compliance or widen the tax base, creating a more stable long-term revenue source, are patchy.

* Financing. Unevenly distributed liquidity heightens instability in the banking sector. Long-term financing remains in short supply, reflecting a lack of confidence on the part of both banks and business. State intervention distorts credit markets. Investment is still mostly self-financed. Levels of financial intermediation remain low.

* Labour market. High non-wage costs, a large informal sector and skills shortages render the labour market unattractive. Labour-market rigidities worsen. Continued emigration of professionals exacerbates the skills shortage.

* Infrastructure. Risk that four-hour, rolling blackouts will worsen to 12-hour shortages amid critically low water levels at the Guri dam. Many firms required to cut usage by 20%. In the absence of transparent regulation, private-sector investment is limited. Risk of renewed electricity rationing.

Latin American business environment rankings
2005-09 2010-14
Total score Global rank Total score Global rank Change in Change in
(out of 10) (out of 82) (out of 10) (out of 82) total scorea ranka
Argentina 5.45 62 5.61 66 0.16 -4
Brazil 6.41 40 6.71 39 0.30 1
Chile 7.75 17 7.89 15 0.15 2
Colombia 5.94 50 6.18 51 0.23 -1
Costa Rica 6.34 42 6.33 46 -0.01 -4
Cuba 4.27 79 4.61 77 0.34 2
Dominican Republic 5.36 64 5.57 67 0.21 -3
Ecuador 5.05 67 4.76 73 -0.29 -6
El Salvador 5.85 53 6.01 59 0.16 -6
Mexico 6.61 36 6.91 35 0.30 1
Peru 6.12 47 6.31 47 0.19 0
Venezuela 4.95 69 4.12 81 -0.82 -12
a From historical period to forecast period.