Significant changes have been taking place in the political landscape in Latin American in the past decade that will have lasting and profound consequences in the region. This new political order could have at least three downside risks:
1. President Chavez is moving the region away from its democratic moorings into an aberrant kind of socialism.
2. A region that has lived peacefully now faces instability and uncertainty.
3. Foreign investment may eventually dry up, placing some countries in the region in a very difficult economic predicament.
This new political order, unfortunately, will have a dramatically negative impact on how credit should be managed in the region.
Chavez's Anti-capitalist Crusade
The election of Hugo Chavez as president of Venezuela in April 1999 can be considered the beginning of the political change in the region from its democratic roots to a new order of self-defined autocratic socialism (Bolivarian Alternative). Under the mentorship of Fidel Castro, he began to influence the political environment of the region. Even though he had modest results at the outset, the recent surge in oil prices has provided Chavez, particularly in the past two years, a robust revenue stream. That largesse has allowed him to play a more active role in his quest to move Latin America to the left, a role in which he passes himself off as the new liberator of Latin America with his Bolivarian Alternative. In the process, he has been able to convince a small number of leaders in Latin America to join him on his anti-capitalist crusade, often targeting the U.S. in particular as an evil empire and an imperialistic country in his weekly television appearances.
Chavez's main objective is to replace right wing democracies with a new kind of socialism and, of course, to distance the region from the United States. By using unorthodox methods, Chavez has been able to form rather unique and strong alliances in the region. This is one of the first times, if not the first time, in Latin America that a political figure of one country has brazenly interfered with the internal political processes of another country by either openly criticizing a candidate of the opposition or by funding the presidential campaigns of his future allies. Any political figure in Latin America that does not agree with his ideology automatically becomes the target of his acerbic remarks.
Since Chavez came to power, nine Latin American countries have elected leftist governments: Argentina, Bolivia, Brazil, Ecuador, Chile, Guatemala, Nicaragua, Paraguay and Uruguay. Bolivia, Ecuador and Nicaragua seem to ally more closely with Venezuela's strong anti-American socialist platform. Of the remaining countries, Argentina appears to be Venezuela's closest ally as evidenced by the large purchases of its commercial paper and allegations that Chavez's political machine contributed to the presidential campaign of Cristina Fernandez de Kirchner. Brazil and Chile keep their distance from Venezuela and advocate free-trade policies among other things, which are not concordant with Venezuela's foreign policies and international business practices. Colombia, El Salvador, Mexico, Panama and Peru are right-leaning countries with relatively close ties to the U.S. and thus, by default, the recipients of Chavez's often insulting rhetoric. The recent incident involving Colombia and Ecuador, for example, was overplayed by Chavez with the purpose of creating a major confrontation that initially did not exist. In the end, common sense prevailed and the threat of a potential military incident was resolved without major consequences. But for how long can the region avoid an armed conflict?
Making Friends, Influencing Neighbors
The effort to implant socialism in the region has not been limited to the larger economies of the continent. Venezuela, through its Petrocaribe initiative, is making overtures to Caribbean and Central American countries. In a nutshell, Venezuela is supplying oil and providing long-term loans at very generous prices and terms. The hidden agenda is that while aid is provided, Venezuela expects these countries to join Chavez's Bolivarian Alternative. Fortunately, the reality is that many of these economies depend on the U.S. either through exports or tourism for foreign exchange, so a complete divorce from their neighbors to the north may not be as easy as it seems.
Venezuela has also been gradually expropriating and nationalizing assets from foreign and local companies. Venezuela will soon become the first country in the area to control or partially own industries such as energy, communications and construction (Bolivia has already nationalized its oil and gas industries). The most recent encroachment on the private sector involved the steel maker Sidor. The nationalization of Sidor comes on the heels of the nationalization of the cement industry. Chavez often invokes high moral grounds to justify the nationalization of these industries.
Assets that are expropriated from private companies seldom receive any compensation. Those that are nationalized are often offered far less than market value. According to an April 29, 2008 Latin Finance Daily Brief, the Government of Venezuela (GOV) assigned a value of about $800 million to Sidor, the largest steelmaker. This amount is far below the value of $3.2 to $4.8 billion assigned by Sidor's shareholders. In situations where a nationalized company disagrees with the GOV's assessed value, Chavez has threatened to nationalize a company's assets by decree subject to compensation based on the government's assessment. This was the situation involving Exxon Mobil who opted to leave the country over Chavez's nationalistic oil policy. Subsequently, the oil conglomerate decided to take the amount of compensation to international courts. The courts froze about $12 billion of Petroleos de Venezuela's (PDVSA) overseas-held-assets which action brought about the usual reaction from Chavez who called the company in his weekly television show "thieves" and "bandits"--a clear demonstration of his bizarre tyrannical behavior when affairs do not go his way. He went so far as to threaten to cut off all oil supplies to the U.S.
The spillover effect was a loss of value of Venezuelan bonds as the creditworthiness of PDVSA bonds went down temporarily. Even though the bonds recovered some of the losses within a short period of time, this situation created a wave of uncertainty and demonstrated to the business world that Chavez's actions do not exist in a bubble nor are they immune to world market reactions. Such events can indeed (and may continue to) have an overall adverse impact on Venezuela's financial future. According to S&P, any downgrading of PDVSA's commercial paper could be devastating for Venezuela since this is the gem of the country and contributes about 50% of government revenues and forms roughly 90% of the country's exports.
To further distance himself from the U.S., Chavez is forging commercial alliances with countries that support terrorism--adding more uncertainty to the area. By engaging openly in commercial ventures with rogue states like Iran and purchasing arms from Russian and China, he is openly defying the U.S. and the Latin American countries allied with the U.S. It is not a secret that the GOV is purchasing arms from these two countries at unprecedented levels. What makes those actions more concerning are the allegations that the GOV may have agreed to divert some of the arms to the terrorist group FARC and may have been helping the Revolutionary Forces of Colombia (FARC) with the intent of toppling the Colombia government. All these Machiavellian manipulations are transforming an area that has been relatively stable despite its internal economic, social and political shortcomings into a potential ground for cross border conflicts.
Admittedly, there have been and there are still internal struggles within the region and an occasional border dispute, but Latin America has not stirred up transnational armed conflicts nor has it needed to blatantly import terrorism. While the region has had to deal with revolutionary groups such as the Tupamaros in Bolivia, The Shining Path in Peru and FARC in Colombia, the scope of these revolutionary activities have been for the most part contained within each country. These transnational developments add very disturbing amounts of tension and uncertainty to the entire region.
Sustaining Relationships and the Venezuelan Economy
What elements must fall into place to allow Venezuela to maintain the current level of assistance to the countries in the region and promote the new political order? Venezuela will need oil prices to remain at the present bloated levels. Oil prices are on the high side driven by the emerging economies of China and India despite a flat or slight decrease in consumption in the U.S. As they stand, prices have been setting record levels not only in response to supply/demand fluctuations, but also because they are being pushed north of $100 per barrel by the manipulation of speculators/traders and hedge fund markets. The latter situation has kept prices at least at a 25% to 30% premium. When prices will peak out is anybody's guess at this juncture. High oil prices and high spending levels are key factors that sustain Chavez's Bolivarian Alternative. As long as oil prices keep at the current levels Chavez will maintain his grip on power. Despite his generosity, however, he is basically disliked in his own country and, if oil prices were to come down, he could be in trouble. For comparison, Uribe, the president of Colombia, has a popularity rate in the 70s while Chavez's rate is stuck in the mid 30s.
Although oil prices are giving Venezuela the financial flexibility to carry on the Bolivarian Alternative, other developments are not as ebullient. On the economic front, based on IMF statistics, inflation was almost 19% in 2007 and it is projected to spike to about 25% in 2008. By any measure this is a very high and unsustainable condition. Inflation is being driven by a high level of liquidity as a result of the stream of revenues derived from the high prices of oil. These revenues have indeed facilitated the GOV's increase in spending on public projects, but they have also enriched the pockets of government officials and have been used to buy the support of pro-socialist allies by offering very attractive oil prices and financing. While all of this has been happening, the GOV continues to disregard local production which has been notoriously inefficient. A fixed foreign exchange rate and currency controls are adding another obstacle for local businesses that need to purchase raw materials and equipment parts. Moreover, the lack of access to foreign exchange is adversely impacting local growth and creating manufacturing inefficiencies.
To exacerbate the economic and social issues, there are food shortages, volatility in the markets and structural problems within the banking system. An economy that should be flourishing is sadly underperforming. As such, Venezuela will continue to depend on the outside world to supply most of its basic needs.
In addition to the economic ills, the main driver of the new political order may not be able to keep up its generous support as worries continue to mount over whether PDVSA can maintain current levels of production. There are concerns that production may be declining while consumption at home continues to increase. Production levels are not the only worries of Venezuela. Despite the high amount of revenues it is raking in, Venezuela is also bringing in huge amounts of imports and giving away large sums of money. Such mismanagement of the oil windfall is preventing the country from accumulating reserves for when the prices of oil fall back to more reasonable levels. According to a Latin Finance Daily Brief, PDVSA is selling oil futures to raise cash because the company is short of funds. This is an alarming situation for a country that is generating such huge oil revenues.
Added to all these disturbing economic factors, Chavez continue with his outbursts and political shenanigans. He could lose effectiveness and the country could face international isolation. Participants at a recent Latin Finance panel on Argentina's economic and political future stated that there are signs that Chavez's influence may be starting to wane in Latin America. The Venezuelan people and his allies may gradually perceive the grim reality of the situation and begin to align themselves with right-leaning democracies. Political leaders that follow his ideals may determine that Chavez is more of a petty tyrant than a liberator, that he will lose support and that his anti-U.S, charades will lose their charm and no longer be effective. They may decide that Chavez and his socialist policies are not the way of the future for the region and at the end he may cause more harm than good. Unfortunately, by that time, some of the significant progress the region accomplished over the past two decades may be lost in the process and the region may have a difficult time repairing the damage that has been done.
A Country on the Edge
Within the country, Chavez has been losing political support not only from the masses but from some of his closest supporters, as well. Some of them have publicly denounced the path in which the country is headed and have stated that they do not condone his economic and foreign policies. Chavez lost the elections in December 2007 in which he sought an open-ended presidency tenure--hardly a real expression of a true democracy. There appears as well to be a loss of patience with several of his questionable methods and actions.
One such telling incident of Chavez's corruption occurred in August 2007. The discovery at the Buenos Aires airport of a suitcase containing about $800,000 in cash from Venezuela, and which appeared was destined to support the presidential campaign of Cristina Fernandez de Kirchner, illustrates the widespread corruption in the country and how Chavez attempts to influence the political arena in the region. Franklin Duran, apprehended in Miami on charges associated with the cash-stuffed suitcase, described widespread corruption in Venezuela. Duran should know, since he purchased Industrias Venoco (a local lubricant manufacturer) at a real bargain following the political aftermath of the abortive attempt to overthrow Chavez in 2002. Pedro Carmona, the previous owner, left the country after sitting as president of the country less than a week. Duran went on to say that he rose as a businessman by bribing politicians, government officials and high ranking officials. It is not secret that those close to Chavez have created a new class of rich businessmen that enjoy an extravagant lifestyle under the banner of the Bolivarian Revolution.
Another such incident concerns the information found on computers belonging to a terrorist leader killed by Colombian forces inside Ecuador in March. It seemed to undeniably tie FARC to Chavez. The documents appear to provide enough evidence to support the allegations by the Colombian government that Venezuela has been actively involved in supporting FARC. The support has been not only to provide them sanctuary in Venezuela but also to obtain arms for them, to consent to the use of its ports to receive arms and to provide a training ground where they would instruct Venezuelan troops in guerrilla warfare. The GOV emphatically denies the validity of these documents but the fact is that the findings have been confirmed by Interpol. Consequently, Venezuela could face a move to be declared a nation that sponsors terrorism. Such declaration could mean U.S. economic sanctions and could add additional concerns to an already jittery global oil market. What seems to be obvious is that if Venezuela continues on its path, the region could become so polarized that an armed conflict might not be avoidable.
Potential Problems for the Whole Region
Venezuela, however, is not the only country in the region experiencing internal political challenges. Two of Venezuela's strongest allies are having their share of problems. In Bolivia, several states are planning referendums to gain autonomy from the central government. Basically, these states seek more control on how to manage their financial affairs and property titles rather than to run the risk of redistribution as championed by President Morales' erratic domestic policies. In Argentina, President Cristina Fernandez has failed to deliver on her promises to maintain economic growth, heal social tensions and improve foreign relations. Inflation is running at about 25%, the economy is underperforming, farmers are revolting to protest high export taxes and investors are losing confidence in the government. Consequently, it is not surprising that her popularity ratings are only a shade greater than 30%.
Latin America's fundamentals had become stronger in the past two decades, a fact widely recognized by financial and political experts. Democracy allowed the region to focus on strengthening its macro-economic policies, reducing inflation and improving their credit ratings, all of which have provided the region with abundant capital investment and opportunities for IPO offerings. Economic growth in the region has been robust; however, GDP growth estimates will be modest at best in the region during 2008 (IMF forecast is about 4.0%-4.5%). Up to now, the region has been able to weather the turbulence in the financial global markets but it may not be able to completely escape a slowdown in the world economies, even if it is a minor one. The U.S. is experiencing some exceptionally uncertain times mainly due to the subprime mortgage crisis that has now spread to other global financial markets. The slowdown of the U.S. economy (although not the main economic engine in the world but still a key economy) is starting to be felt in other world economies. Given this scenario, it seems unlikely that Latin America is resilient enough to be able to escape the deterioration of capital markets and an economic global slowdown.
Contagion to other economies and markets will happen and will have an adverse impact as banks and investors become more selective in funding projects, particularly in countries where the rights of investors are not honored and respected. The U.S. is already experiencing a severe credit crunch and this crunch is extending beyond its borders. Consequently, it is reasonable to assume that the availability of credit and foreign investments to other global economies may be curtailed. The recent news by Latin Finance Daily Brief reveals the uncertain times in which credit markets operate. A New York court ruling concerning Argentina's unresolved default on its debt was enough to convince global investors to reduce their exposure to the struggling nation. Argentina has defaulted on its debt twice in the past decade causing significant losses to global investors.
A Tough Road Ahead
Given the current tightness in the credit markets, global lenders are becoming more careful where they place their investments. Foreign Direct Investment (FDI) could be difficult to take place in a high-risk country in the base case and even more difficult in any country that nationalizes industries without proper compensation. No investor in his right mind will fund any project in a country where the odds of compensation and repayment are very low or nil. It comes as no surprise then that Ecuador private investors pulled back exposures due to President Correa's socialist policies and Ecuador's underperforming economy.
The new political order is raising questions and some pundits like Mr. Mark Weisbrot of the Center for Economic and Policy Research, a Washington think tank, feels that the change is not only deep but irreversible. Contrary to this assessment, the left-wing trend may not be irreversible, but it could persist for several years until a new round of right-wing governments take hold in the region. Socialism as envisioned by Chavez, which includes isolation from the largest world economy and forging partnerships with rogue states such as Iran, will not work in Latin America without a significant degree of coercion and corruption. Open markets where supply and demand dictate the pace of economic activity--locally and globally--best fit the economic future of the region.
The political changes in Latin America will unfortunately make it very difficult--particularly for U.S. companies--to sell products and services to a number of countries in the region. History has taught us that countries that go to political extremes impose foreign exchange controls and establish fixed foreign exchange rates. These countries also resort to manipulation of their currencies to portray a more healthy financial condition. In this vein, Venezuela is operating under foreign exchange controls, its currency is arbitrarily fixed, and the country has dropped a few zeros from the Bolivar to project an image that the local currency is strong and to disguise inflationary forces. If we add the risk of nationalization of industries and businesses, this provides a background where sales on open account terms can hardly be justified. These conditions may narrow the level of opportunities unless companies want to take undue risks. If open terms are extended to local companies, the risk of non-payment and considerable payment delays looms hauntingly over such transactions. Under these conditions, the collection process takes on a different meaning and becomes a real burdensome and frustrating experience. Even if local companies want to meet the terms of sale, importers will have a tough time applying and getting foreign currency to make payments on time.
To make things more complicated, historically some customers in the region have always had a different interpretation of contractual payment terms, thus adding a few more days to foreign exchange remittances. If product and services sales can only be made on a secured basis, then there are not that many choices. Letters of credit remain the workhorse of international trade, but obtaining them could be difficult and expensive. Insurance might work, but premiums and exceptions could make it an expensive option. Drafts may have limited applications in some countries but do not offer any risk protection. Cash and guarantees are rarely used and given the current conditions in Latin America may not be available at all. Not a very ideal situation to complete a sale under such complex and challenging conditions.
Opportunities Come With Tough Challenges
Unquestionably, the region is at a critical crossroads and must decide which fork of the road to take. Latin America can stay on the road to democracy and continue to build in the process strong economies where free enterprise and access to global markets is available. This is the environment the region enjoyed for the past two decades--a time of peace, strong business and political relationships, and economic growth. Or, the region can embrace Chavez's Bolivarian Alternative. If this is the choice, leaders in the region must be aware that Venezuela's main objective seems to be to tilt the balance of power in the continent in its favor. To accomplish this, the country is willing not only to create instability but to possibly foment armed conflict.
Recently, tensions have escalated between Venezuela and Colombia. The raid by Colombian troops on March 1 into Ecuador, which resulted in the death of one of the principal leaders of FARC, understandably brought some tensions between Colombia and Ecuador. Ecuador expelled Colombia's ambassador and subsequently broke off diplomatic relations. Venezuela and Ecuador sent troops to the Colombia border. Ecuador's actions were justified; however, Venezuela dispatching army troops and fighter jets to the Colombia border were another paranoia reaction of President Chavez. Colombia is perhaps the strongest U.S. ally in Latin America. Chavez resents this alliance and continuously threatens to send troops to the border; therefore, the mobilization of troops in March was not entirely unexpected.
What is concerning is that these tensions may spread to other parts of the region, bringing along undesired instability and potential conflicts. Increasing instability, underperforming economies, a spreading credit crunch, imposing controls and revoking existing contracts under false nationalistic ideals are not the kind of fundamentals foreign investors rely on to place their investments in any given country. The major concern with an uncertain political environment is not only the loss of potential new investments, but also a pullback of existing financial commitments, thus placing the countries impacted in a very difficult economic predicament.
Accordingly, managing risk and an accounts receivable portfolio under these uncertain conditions present both tough opportunities and tough challenges. Market conditions and a company's appetite for risk drive decisions to enter, stay or exit a given country. There is always risk on any credit decision. The question is how much risk can be taken to balance risk and business profitability. With some exceptions, U.S. companies face a tough road ahead in the region and potential bad debt losses can mount quite rapidly not only because local companies cannot obtain foreign exchange to pay for imports but because countries may decide to retaliate by simply withholding payment to U.S suppliers. Given this draconian scenario, seeking security or walking away from high-risk sales seem to be the proper approach rather than to risk total loss of an accounts receivable portfolio.
Lucas Gomez, CCE can be reached at email@example.com.…