Venezuela foreign exchange controls

Widespread industrial closures are likely in the one-year outlook amid tightening price controls, intensified regulatory burden, and US sanctions as incumbent President Nicolás Maduro secures re-election in an electoral process not recognised by the international community.

• Conindustria, Venezuela's most representative confederation of manufacturing industries, claimed on 12 March that 44% of its 2,400 members will fully close operations before end-2018, and that the manufacturing sector is operating at just 24% capacity.
• The automotive sector is more likely to be affected both in terms of assembling vehicles and the fabrication and manufacturing of auto parts; others affected will include firms producing metal goods and those in the paper, graphic arts, and plastic sectors.
• Regime change is unlikely in the upcoming 20 May presidential election with incumbent President Nicolás Maduro highly likely to manage the entire process, taking advantage of his control over the electoral authority and the armed forces. US sanctions are a likely consequence, exacerbating Venezuela's economic problems and providing Maduro further recourse to institute foreign-exchange and price controls in response to severe economic imbalances. Venezuela's regulatory burden and already-high non-payment and expropriation risks are likely worsen even further, significantly deteriorating the business environment and forcing widespread closures within the manufacturing sector.

As stated above, Juan Pablo Olalquiaga, president of Conindustria, claimed on 12 March that 44% of its members will close operations during this year, noting that the confederation 2,400 members currently were operating at 24% of their installed capacity. Olalquiaga reported that there are still 3,800 manufacturing industries operational in Venezuela, of which 3,200 are privately owned and 600 state-owned. Most state-owned manufacturing activity results from past expropriations and currently much of the state-owned segment is unable to operate. Conindustria also reported that Venezuela's industrial manufacturing sector is currently operating at just 7% of the level it maintained in 1997 – the year before late president Hugo Chávez (1999–2013), incumbent President Nicolás Maduro's predecessor and mentor, was elected.

Manufacturing businesses in Venezuela already have been significantly affected by a heavy regulatory burden, including a 30% cap on profits, an unfeasible price control system, along with widespread foreign-exchange controls. This mixture has dramatically disrupted supply chains and affected both import and export operations. The sector also has suffered widespread expropriations. According to Conindustria, the government has expropriated more than 1,300 companies since 2002. Of these, 40.5% were from the construction sector, 32.3% from manufacturing industries, while the remaining 27.2% were spread between the oil, retail, and service sectors. We estimate that of these companies, fewer than 30% have received compensation.

Firms that halt operations or are accused of hoarding or price speculation face severe expropriation risks, especially in the food and basic goods sectors (including pharmaceuticals) and to a lesser extent in the retail, oil, and, automotive sectors. These sectors are already facing shortages and productivity problems due to state intervention, regulation, and tightly restricted hard-currency allocations. Local Venezuelan companies are not the sole targets of government action; foreign firms are also subject to heavy expropriation risk. Companies from the oil, mining, food, agribusiness, power, telecoms, banking, pharmaceutical, cement, iron, steel, chemical, tourism, and construction sectors all have been expropriated since 2007.

Outlook and implications

We share Conindustria's assessment that a wide range of Venezuelan manufacturing companies are likely to close in the one-year outlook. This also extends to small and medium-sized companies not represented by Conindustria. The sectors most at risk, notably automobiles, are listed in the initial summary.

Venezuela is holding a presidential election on 20 May but Maduro is highly likely to be re-elected given the control his government has over the National Electoral Council and senior members of the armed forces, and growing divisions within the opposition. Opposition candidate Henri Falcón from the Progressive Advance (Avanzada Progresista: AP) is not being supported by the Democratic Unity Roundtable (Mesa de la Unidad Democrática: MUD), which continues being the most representative opposition coalition and is boycotting the election. The MUD, which has now expelled Falcón from its files, claims that there are no international observers or minimum electoral guarantees for free and fair elections. The MUD has urged Falcón to withdraw his candidacy but he argues that abstaining from voting will only make it easier for Maduro to be re-elected. Nevertheless, the international community refuses to recognise the election and the United States is likely to impose with sanctions against Venezuela's oil sector – which provides 50% of fiscal revenues, 25% of GDP, and 96% of foreign-exchange earnings. The US already imposed sanctions on 24 August on the issuance of new debt and equity issued by the Venezuelan government or national oil company PDVSA.

Further economic deterioration will likely lead the government to make even wider use of price and foreign-exchange controls, and will worsen the regulatory environment. More frequent audits and inspections from tax and consumer protection agencies also are likely. Energy and water supply shortages, widespread protests, and rampant corruption are likely to present mounting operational constraints for industries operating in Venezuela throughout its already debilitated economy.

We forecast that economic activity will continue declining steeply in 2018 given this highly adverse background and Maduro's political stance, and the country's instituted National Constitutional Assembly, which has side-lined the opposition-controlled legislature and become the de facto parliament, will continue to block urgently needed economic reforms and adjustments to the Venezuelan-style socialist model in the coming year. Official data for 2016 and 2017 have not yet been published but unofficial data from the National Assembly's Commission of Finance point to a decline of nearly 18.5% decline in GDP last year. Our forecasts indicates that GDP will contract at least a further 13.5% in 2018. In addition to the directly affected sectors, other businesses likely to be severely harmed by the prevailing economic scenario include construction and retailing. In addition, we are forecasting a 7,500 annual inflation rate in 2018, from an estimated 5,369 in 2017.

Firms that halt operations will face increased risk of expropriation; in this regard the seizure of equipment, machinery, and assets by the government is an indicator that would confirm the increased expropriation risk. A second key indicator for industrial-sector prospects would be a material increase in protests staged by unions. Traditionally, unions in Venezuela are more likely to pursue industrial action in state-owned industries than in the private sector, driven by collective bargaining agreements with the government. We anticipate labour dispute risks to increase in the one-year outlook given the background for workers of high inflation, the growing scarcity of US dollars, the lack of medicines and food, and sharp economic shrinkage. Despite this, major events of property damage against commercial assets remain unlikely.