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Map of South America |
CIAO DATE: 04/03
Venezuela Alert: The Economy Continues to Deteriorate
Lowell Fleischer *
Hemisphere Focus: 2001-2002
October 2, 2002
Overview
Beginning with his run for the presidency of Venezuela in 1998, Hugo Chávez’s primary focus has been the exercise of political power. The economy, on the other hand, has been a distant second priority. But even Chávez must now realize that the economy’s continued deterioration poses a serious threat to his political survival. Enrique Mendoza, governor of Miranda state and one of the opposition leaders often mentioned as a possible presidential candidate, said last month that the recession would hasten the end of Chávez’s self-styled revolution. According to Mendoza, Venezuela’s shrinking economy and increasing opposition pressure could combine to force early elections.
A recent IMF report described Venezuela’s present economic situation as “extremely fragile.” Recent polls show that two-thirds of the population think unemployment and inflation (personal insecurity was a third factor) are the country’s most important problems.
The Venezuelan economy contracted by nearly 10 percent in the second quarter as a decrease in oil revenue cut seriously into economic growth. According to the Central Bank, the petroleum sector, which accounts for 30 percent of the country’s $110 billion GDP, contracted 16.7 percent and the nonpetroleum sector by 6.5 percent-bleaker figures than were expected by most analysts. The economy sank 4.2 percent in the first quarter. Because of continuing political and economic uncertainties as well as the performance of the economy in the first half of the year, it is almost certain that the year will end with a considerable economic decline, probably in the 5 to 6 percent range. According to government estimates, the economy will shrink by only 2 to 3 percent this year. Venezuela’s economic growth has fluctuated wildly over the past 10 years, from a high of about 7 percent in 1992 to a low of -7 percent in 2000.
In June, inflation hit 16.2 percent, the highest level in almost three years and is now running at an annualized rate of some 30 percent. So far this year, the bolivar has dropped in value by 46 percent against the U.S. dollar. Unemployment is over 16 percent, and almost 60 percent of the workforce toils as informal workers without benefits of any kind.
With all these economic difficulties, the government’s immediate priority is to fill an estimated $4.5 billion budget deficit by year’s end and to raise about U.S.$7 billion to cover this deficit and public debt obligations. Some analysts fear that this fiscal hole could deepen to as much as $15 billion next year as other bills come due for debt repayments and postponed spending, even though more than half of the government’s income is in dollars and the weakening bolivar will give officials more money in local currency to pay its obligations.
Government Seeks Inter-American Development Bank (IDB), World Bank Loans.
The government is discussing the possibility of attempting to sell $1 billion in bonds on Wall Street, and both Planning Minister Felipe Pérez and Finance Minister Tobías Nóbrega are expected to make the rounds in New York in October. The two have talked with the IMF, the World Bank, and the IDB about loans totaling about $1.2 billion. There have been persistent reports that Chávez has been seeking a $5 billion loan from Libya’s Mu’ammar Qadhafi. It seems doubtful that the risk-adverse international financial markets will have much appetite for a large Venezuelan issue now.
After the second quarter growth figures were announced, President Chávez promised that the country’s struggling economy would soon rebound despite what he called attempts by the opposition to sabotage the recovery. “The April coup plotters, the privileged classes . . . they are still looking to stop this revolution, they are still looking for a thousand ways. They are trying to create an economic coup,” he said during a recent Sunday TV broadcast of “Hola Presidente.” He cited a recent deal between Petroleos de Venezuela (PDVSA) and five foreign oil companies to develop Venezuela’s biggest offshore field of natural gas reserves, which, of course, will take years to develop and bring on line.
After three years in office, the policies of Chávez and his economic team have led to worsened social conditions, especially for the poor, who nevertheless still constitute the backbone of his waning support. Many Venezuelan analysts have gone as far as to claim that the government still has no economic policy. “For the past three years Venezuela’s economy has been driven on an explosive combination of incompetence, misinformation, dogmatic blindness, and borderline lunacy,” Antonio Herrera-Vaillant, vice president and general manager of the Venezuelan American Chamber of Commerce and Industry said recently.
With close to 70 percent of the population at a critical poverty level, and salaries at 20 percent of what they were in 1980, there is a consensus that the Venezuelan standard of living has fallen to levels lower than 1962, when the country ranked first in per capita income in Latin America. Today its per capita income in real terms is about the same as then. According to the latest UN Human Development Index, 23 percent of Venezuela’s population survives on less than one dollar a day and 20 percent are chronically undernourished. The Institute for Higher Administrative Studies (IESA), the prestigious graduate business school in Caracas, calculates that since 1978 the per capita annual income has fallen continuously from $2,300 to $550 today.
Chávez is now on his fifth finance minister since he took office, none of whom has had the international contacts or prestige within the country or abroad to be able to function effectively. Nevertheless, the new economic team appointed at mid-year represents an improvement in terms of practical qualifications over those who have managed the economy up to now. The biggest question mark raised by the mid-year appointments is whether they will receive the necessary support from radicals within the Chávez government.
Oil Prices Recover.
In addition, despite recent price increases, 2002 oil revenues will be far short of what is needed to keep the country afloat. OPEC quotas and the inability of PDVSA to pump out more oil even if conditions warrant it are just two of the constraints. The government is expecting $8 billion in oil revenue this year, $5 billion less than in 2001. Oil output slowed to a near standstill in the weeks leading up to the April 12-14 coup as white-collar workers staged a slowdown to protest a new Chávez-appointed board of directors. OPEC production curbs also contributed to the fall in oil production.
Growing fiscal liabilities include wage and social security arrears inherited from previous governments, officially estimated at about $20 billion, and a much-needed increase in social investment, social security reform, and a rationalization of the bureaucracy. Chávez has not yet agreed to meet with CTV president Carlos Ortega to discuss labor’s demands, which include wage and salary increases and full payment of the government’s nearly $15-billion debt to public workers accumulated over the last 40 years. Given the increasing cost of living, it is also likely that there will be calls for higher wage settlements in the public sector, over and above the 20 percent increase in the minimum wage that took effect in May.
Venezuela’s foreign reserves have dropped from $19 billion in November 2001 to about $10 billion in late May, according to the Central Bank’s Web site, of which $5.6 billion is in the macroeconomic stabilization fund. Despite the devaluation earlier this year, many analysts still predict that capital controls in one form or another will soon be imposed, in part to try to stop continued capital flight that could surpass $5 billion this year (some estimates are as high as $12 billion in the last 12 months). Both the government and the Central Bank vehemently deny that there has been any discussion of exchange controls, but the VenAmCham’s Herrera has warned that if Chávez does not put together “a coherent economic program fast, the country will soon be spiraling into exchange controls."
Tax Collections Down.
According to Venezuelan tax authorities (Seniat), tax revenue in May was only 78 percent of that anticipated, and the take from January through June was 15 percent less than planned. Seniat said recently that some 50 banks and 1000 businesses had avoided $800 million in taxes last year. More than 49 percent of assets held by the Venezuelan banking sector are tax deductible because they are composed of government bonds. Chávez recently said some banks might have registered false losses to avoid paying taxes (there is a long history in Venezuela of not paying taxes) and ordered an investigation into about $5 billion in losses reported by 40 banks last year. Businesses “have robbed Venezuela for decades. That’s how large fortunes were made,” the president said. Earlier this month, he advised Venezuelans to take their money out of private banks and deposit it in those owned by the state.
This was not the first time that he threatened the business community. During a rally last June, the president warned leading bankers, industrialists, and media owners that they could soon be arrested on tax evasion charges and would have to forfeit personal and corporate assets.
On March 1, President Chávez announced a package of social and economic spending aimed at reducing unemployment and easing poverty, despite an announced 7 percent cut in government spending. He pledged to spend $1.33 billion on housing projects this year and a further $1.16 billion to capitalize the state banking system with a focus on small businesses. Then at the end of May, Finance Minister Nóbrega announced another limited fiscal adjustment package, which raised sales and financial transaction taxes and again slashed public spending-the results of which have so far not been encouraging. A new value added tax rate of 16 percent went into effect on September 1. Chávez said that windfall oil revenues above a budgeted price of $16 a barrel this year would be divided between social spending and the macroeconomic stabilization fund (FIEM). Since the first of the year, however, the government has been withdrawing funds from FIEM, not paying into the so-called rainy day fund. Chávez also said some $193 million to fund these programs would come from exchange-rate profits from the Central Bank’s sale of dollars.
It is not easy to make informed judgments about the Venezuelan budget, which is constantly being revised. The Venezuelan budget process also consistently underestimates spending and overestimates income, almost always leading to increased borrowing.
Petroleos de Venezuela.
The biggest question mark with regard to Venezuela’s economic well being in the years ahead is the health of PDVSA, which has nearly 40,000 employees and $50 billion a year in sales. Chávez’s post-April 11 choice of former oil minister and OPEC secretary general Ali Rodriguez to be the president of PDVSA as well as other new board members has attracted widespread support from analysts and PDVSA employees. Rodriguez agreed to hire back dissident managers whose protests spurred the organization of the April 11 march, which in turn resulted in the coup attempt. Things are still not back to normal at the company, but an uneasy truce seems to be in effect for now.
Although Rodriguez says his aim is to “strengthen Venezuela’s role as an oil producer,” he is close and loyal to Chávez and backs state oil policy set by the president and the Oil Ministry. The new board will have to comply strictly with OPEC output policy, reduce operating and labor costs, and pay hefty taxes to keep the Chávez government afloat. At his swearing in ceremony, Rodriguez, a 1960s guerrilla fighter who has never abandoned his leftist ideas, said the company “should be a key instrument in the fight against poverty.” The company has resumed selling oil to Cuba at bargain prices, a practice that had been interrupted by the protests and turmoil.
Despite the truce, the government-owned petroleum firm, the largest in Latin America, is in deep trouble financially and operationally as a result of Chávez’s continued politicization of the company, investment cutbacks (in his speech announcing the devaluation and government spending cuts, Chávez also said the PDVSA’s budget would be reduced by 28 percent), and the government’s insatiable need for additional revenue. PDVSA had 2001 revenues of $46.2 billion from its worldwide operations which produced a net profit of $4.33 billion. The company paid a total of $7.07 billion in royalties and income tax to the state and another $4.77 billion in dividends.
Venezuela agreed to reduce its output by about 170,000 barrels per day (bpd) to 2.497 million bpd as of January 1 as part of a larger oil cartel agreement to trim 1.5 million bpd to shore up flagging prices. Through February, Venezuelan oil has averaged about $16.32 a barrel, down significantly from $20.18 last year and $25.91 in 2000. The Venezuelan basket of crude has since recovered nicely and averaged about $20 a barrel in the January-June period. Recently, it has been as high as $25 a barrel. Every $1 drop in the average price of oil reduces revenue by about $1 billion a year and vice versa. In 1974, oil contributed $1,540 per person to the government and represented more than 80 percent of total government revenues. Twenty years later it contributed just $200 per person and accounted for less than 40 percent of total fiscal revenues. Oil accounts for about a third of the country’s gross domestic product. Venezuela now accounts for just three percent of global production, down from 10 percent in the 1970s.
Reflecting its continued concerns about the prolonged political and economic uncertainty in the country, Fitch Ratings in mid-September downgraded the debt ratings of CITGO, a wholly owned subsidiary of PDVSA. Fitch said it feared the Venezuelan government might begin to interfere with the operation of CITGO, one of the largest independent crude refiners and the third-largest brand gasoline retailer in the United States, impairing its financial flexibility. According to Fitch, since 1998 CITGO has paid dividends of about $1.1 billion to PDVSA.
Concern over Hydrocarbons Law.
Before Chávez’s election, PDVSA was embarking on an ambitious expansion program, but with repeated cutbacks, the company’s production capacity has declined to the point that it needs foreign investment more than ever. However, because of the political and economic uncertainty, as well as the new hydrocarbons law that took effect on January 1, potential investors are likely to take their money elsewhere. Oil Minister Alvaro Silva, speaking to reporters at the installation of the new PDVSA board, made it clear that no adjustment of the controversial hydrocarbons law is needed, “at least not immediately.” The VenAmCham, however, recently cited the hydrocarbons law introduced late last year, as one of the pieces of legislation that could threaten private property. This law “provides no explicit guarantee of respect for property rights, contractual obligations on existing contracts, and conditions in the petroleum industry,” the business association said in a letter to President Chávez.
Energy analysts say that due to investment declines, PDVSA has lost nearly 1 million barrels of capacity per day since 1999. Venezuela is the world’s fourth-largest oil producer and has the largest oil reserves outside the Middle East and so has the potential to recover. Recovery of that lost capacity, however, is likely to take three or four years and billions of dollars. According to industry estimates, bringing back 100,000 barrels of capacity requires $1 billion-money the company does not have. A pickup in the fortunes of the company is not likely as long as Chávez is president.
The investment environment is likely to remain unfavorable for the foreseeable future because of the lack of a clear regulatory framework and policy uncertainty. Telecommunications, hydrocarbons, and mining may be the only exceptions, and there are difficulties even in these areas. In an early September letter to President Chávez, the VenAmCham said that crime and political violence, including “mob rule” in parts of Caracas, are seriously damaging business and foreign investment. “There is a climate of increasing insecurity, both judicial and as regards the physical integrity of human resources and assets, which is seriously limiting the ability of our affiliates to conduct business in Venezuela,” the business organization said.
Most analysts firmly believe that structural fiscal reform is required to place public finances on a more sustainable footing. Prior governments have failed to institute such reforms and the political environment is not conducive to reform now. Progress will not be possible without a broad political consensus, which does not now exist.
Chávez is not the architect of the many economic problems facing Venezuela today, but he has done little to resolve these long-standing difficulties and in many cases has exacerbated them.
Endnotes
Note *: Lowell R. Fleischer is a senior associate in the Americas Program at CSIS and the chair of the Western Hemisphere Studies Program at the Foreign Service Institute. He is also contributing editor of the Latin American Law and Business Report and the North American Investment Report. A retired foreign service officer, he served in Venezuela and is former deputy director of the Washington office of the Council of the Americas. Fleischer has taught at the University of Connecticut and the University of Massachusetts and has served as consultant to the World Bank and the U.S. Institute of Peace. He is a graduate of Ohio Wesleyan University and holds M.A. and Ph.D. degrees from the University of Connecticut. Back.
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