The fortunes of Ecuador and Venezuela will continue to diverge in 2019
With Venezuela fast becoming a pariah state, its former radical left-wing ally Ecuador continues to make steady progress in re-opening the country for business. Foreign direct investment (FDI) levels remain low still - at less than 1% of GDP. But the centre-left government is committed to transparent, investor-friendly, and ecologically sustainable macro-economic and regulatory policy frameworks. This should pay dividends in the medium term. By contrast, Venezuela will need years to recover from the botched legacy of the Bolivarian Revolution, which has been disastrous on every level for the resource-rich country.
Investors in Venezuela face a high risk of expropriation
As of January 2019, President Nicolás Maduro sits at the helm of a military-backed dictatorship that is no longer recognised as legitimate by most Western countries. The democratic system has been captured and hollowed out by a radical left-wing civil-military regime, which now controls almost every branch of government, leaving the fate of investments in the hands of the leadership.
Maduro strongly advocates a centrally-planned economy, squeezing out the private sector by increasing state control over the economy since 2002-2003. Investors risk being caught up in competition between various military-backed factions. Companies in partnership with SOEs face abrupt changes in management and strategy.
Venezuela’s protracted bottom ranking score in our Resource Nationalism Index reflects the fact that companies in the extractives sector remain at extreme risk of expropriation.
For investors, this means a very uneven playing field, in which only those with ties to the government can expect to survive.
By law, the president and vice-president can expropriate assets via executive decree. Local trade group, Coindustria, estimates that the government has expropriated more than 1,400 private businesses since the ruling socialist PSUV took power in 1999. Seizures often occur on arbitrary grounds, with little warning or justification. Authorities have defended the expropriations by citing public utility, but also by alleging irregularities such as abusive pricing and monopolistic behaviour.
A lack of judicial independence means foreign investors face a high risk of biased treatment by courts. The Supreme Court has issued judgements that prevent expropriated companies from seeking legal recourse. Favourable dispute resolution at an international level is also difficult. In 2012, Venezuela formally withdrew from the World Bank’s International Centre on the Settlement of Investment Disputes (ICSID), meaning the country will not honour the court’s orders. Venezuela’s decision to exit the ICSID means that companies in dispute with the Caracas government are unlikely to recoup the full value of investments, and are forced into lengthy and expensive payment battles.
Ecuador re-joins the fold
By contrast, President Lenín Moreno is transitioning Ecuador from the authoritarian left-wing policies of his predecessor, Rafael Correa (2007-2017), towards a more moderate and consensual centre-left administration. Moreno has introduced changes that strengthen democratic norms, recover institutionality and tackle a legacy of systemic corruption. The net effect of this change has been positive for the rule of law, the business and investment climate, and the quality of governance.
Moreno pledged to restore a balance of powers and accept that the previously all-powerful executive must submit itself to meaningful checks and balances from the legislature and the judiciary. In support of that, the government has dismantled some of the more centralising and autocratic aspects implemented by the previous administration and restored a more effective separation of powers. Chief to this effort is the process of restoring judicial independence, after the judiciary became heavily politicised in the Correa era. We expect a gradual improvement in judicial performance as the country moves towards a more independent and professional institution.
What are the implications of the transition?
The transition has not been problem free. Unravelling the inherited authoritarian structures is a complex process that will take time. There are still systemic weaknesses in the judicial system that undermine its independence. Court proceedings are still very slow. In the past, foreign companies have experienced difficulties in the enforcement of contract rights, securing equal treatment under the law, and protecting IP rights. Regulatory regimes have been subject to sudden changes. Latterly, local judges have questioned extractives projects on environmental and prior consultation grounds, forcing the suspension of one of the country’s designated strategic mining projects.
New contracts whet foreign investor appetite
The overall expropriation risk is now low, as the cash-strapped Moreno government looks to make the country more attractive to FDI. We've seen an improvement of the country's score in our Resource Nationalism Index. A USD10 billion financing deal with the IMF and other multilaterals signed in February 2019 will also stabilise the policy environment to the next election in 2021.
Under a reinstated production sharing contract regime, the country successfully tendered seven oil blocks in its first auction of 2019. Initial investment is estimated at USD700 million and nominal revenues for the state forecast at USD1.8 billion upon production (based on a cautious assumed average oil price of USD60/barrel).
Moving forward, we expect a continued pivot back to policy orthodoxy by the Moreno government, followed by a transition to a centre-right business-friendly administration in the general election in 2021. This will successfully complete the transition away from Correa's discredited 'Citizen's Revolution'.