Venezuelan oil bonanza

Despite an influx of oil wealth, serious problems remain for the Venezuelan economy.

By Constatin Schoehl von Norman

Despite the bonanza of Petróleos de Venezuela S.A. (PdVSA), the Venezuelan state-owned oil company, shelling tremendous amounts of foreign exchange into the Venezuelan state budget, there are indicators that the increasingly state regulated economy is missing out on diversifying its industries and creating the environment for sustainable development. Little has been done to clean up the state budget deficit and create reserves for the future. The strong growth of the Venezuelan economy is almost solely based on the oil export revenues and fiscal measures, which have further strengthened this dependency. The government has used its oil revenues to markedly increase real wages in the public sector but a large part is being consumed by the highest inflation in Latin America.

[More]The enhanced level of state regulation of the economy seems to be unable to produce sustainable results and the state budget deficit will continue to grow during 2007, despite soaring oil prices and rising tax revenues. Indicators show that extreme poverty and unemployment are being reduced but high inflation is depreciating middle class savings which cannot be transferred out of the country or converted into dollars.

Expensive labor has made core foodstuffs more expensive and governmental price controls have just induced a lower production on the whole. Whereas the business community is making profits, the middle class seems to be the economic loser of the "Bolivarian economics", so far.

Decent economic growth in Latin America and excellent terms of trade for Venezuelan exports

Fueled by high commodity prices and surging demand from China, Latin America’s economies are enjoying a renaissance. The countries of Latin America and the Caribbean grew at a 5.4 percent clip in 2006, up from 4.5 percent in 2005.1 Due to the high oil price, Venezuela is enjoying very favorable terms of trade, for now. So far it has done little in the way of investing the money wisely, such as creating reserves or concentrating on the environment for sustainable growth of other Venezuelan industries.

State deficit despite oil windfall

High world market prices for oil are boosting the governmental budget; but the impressive economic growth, induced by a massive increase in public spending, has started to impact on the 2007 state budget deficit. The latter is expected to jump from last year’s moderate 1.8% of GNP to 4.9%. During 2005 the government could have recorded a surplus; however an increase of 74% in spending could not be covered by taxes. The government can react to this threat by either printing more money or rolling over the deficit to domestic banks. The former measure would further accelerate inflation whereas the latter would create frictions between banking sector officials and government representatives. The recent "saber rattling"2 of Chavez towards the banking sector might be understood in light of this dilemma. The threats might entail nervousness on part of the stock markets and create diplomatic rifts with Chavez-friendly countries whose businesses have so far profited from the current bonanza.

The Argentinean steel producer Siderurgica del Orinoco is pressured to satisfy domestic demand, whereas foreign banks like Banco Hispano de Santander (Spain) are pushed to roll over the internal debt and lend cheaply to the domestic sector. Right after the announcements, the main index of the Caracas stock exchange fell by 2.7%.

It is unlikely that Chavez will nationalize the banks but he intends to threaten them into compliance with his domestic fiscal policy. The government expects more gratitude after a year of tremendous earnings in the banking sector during 2006. Expropriations without compensation would cause economic disaster whereas a payoff would be another negative burden on the unbalanced deficit. It remains to be seen, however, whether we are witnessing the beginning of a rift in the comradeship between the business sector and Chavez.

Spending Venezuela’s income to foster political "Chavismo" throughout Latin America

Chavez’s government has been spending much of their national resources to foster the political ends of its envisaged Latin American revolution. In the first half of 2006, total public expenditures of the central government, in nominal terms, was 74.6% higher than the first six months of 2005, while the tax revenues were "only" up by 26.8%.3 Be it the massive support of lapdog candidates in foreign election campaigns or the assistance to the rising number of "like minded" governments in Bolivia, Cuba, Nicaragua or Ecuador, this kind of political encroachment has its price.

Just to furnish the equipment for 26 broadcast stations of the National System of Community Radios of the Original Peoples, the Venezuelan Government granted $1.5 million as a "donation."4 The authorities in charge of the network of community radios admitted that the system’s purpose is more political than communicational, related to defense and the promotion of the change policies of the Morales administration.5 In Nicaragua the Venezuelan government has allocated funds supporting the Sandinista campaign , such as supplying helicopters, agricultural fertilizers, subsidized oil imports, or assistance for medical and illiteracy campaigns through the Venezuelan government.6 The massive aid for the Cuban government, for Obrador’s campaign, for Correa in Ecuador or even the social heating oil campaign in the U.S. are further examples. TELESUR and Banco del Sur, a bank project designed to replace the IMF in the region,7 will demand additional funding to really take off. Chavez thumbed his nose at the IMF this week and said after paying back the last of his country’s debt that he would withdraw from the organization. 8

Investments in promoting hegemonial goals might overstretch the current, abundant resources of Venezuela. If not now, it will definitely cause problems for them in the long run.

Some of the resources would have well been invested in sustainable development of the Venezuelan government to prepare for a time after the current oil hike. Chavez’s ventures, Venezuelan investment abroad and the growing capital flight have resulted in a negative foreign direct investment of more than half a billion dollars while neighboring Colombia attracted $6.3bn in FDI.

Despite the soaring incomes, there has been no significant increase in the international reserves of the central bank. At the beginning of November 2006, reserves stood at US$ 34.0 billion, compared with US$ 29.6 billion at the end of 2005. This is mainly attributable to the elimination of the obligation of Petróleos de Venezuela (PDVSA) to sell its foreign exchange to the central bank.

Chile is a positive example of how to use money generated from resource extraction, creating a stable budget long term: a commission of experts conservatively estimates the world market price of copper for the decade to come. The state budget is tailored to achieve a surplus of 1% of GNP, with a copper price at its long term value. Given a copper price last year well over twice the estimated long term price, Chile had a fiscal surplus of the order of 9% of GNP. The resulting surplus is saved for a rainy day. Some Middle Eastern countries show similar strategies and more sustainable investment in infrastructure.9

Banking on continuous oil price hikes

Chavez seems to be banking on the continuation of soaring oil prices. More than any other Latin American country, the tax system has become dependent on resources derived from the exploitation of its non-renewable commodities.10 Chavez’ tax reforms have furthered this dependency. His government has reduced the VAT and abolished the corporate asset tax in 2004. The latter shows that Chavez has a keen interest in keeping the business elites content, as long as he is not criticized publicly. The domestic growth, however, is slowing down. Venezuela’s GDP increased 10.3 percent in 2006, experts expect a slowdown of growth to 7.8 percent this year and 6.6 percent in 2008.11 A further decline in Venezuela’s impressive economic growth would further reduce tax revenues, and subsequently create a larger budget deficit.

As long as prices continue to be about $60 a barrel, Chavez can continue his lavish spending programs, as well as his efforts to expropriate foreign companies in the telecommunications and electric utility sectors; if he keeps his promises to pay for the nationalization.12 If prices would ever fall below $45 a barrel13 Venezuela would rapidly run into massive fiscal problems.

Positive development in the job market

On the other hand, it is fair to admit that the government seems to be effectively reducing unemployment. The unemployment rate dropped for a third consecutive year and is lower than in many parts of the region.

The government has an excellent record of paying down the foreign debt; a sustainable achievement which the Chavez administration can indeed claim. It might be motivated to some extent by the desire to leave the international finance system but the result is among the best within the general spending party. Foreign debt has at least been reduced by more than $4bn during 2006. It still amounts to a quarter of the GDP, accumulated from the times when oil prices were lower.

The increase of the minimum wage has actually generated higher income amongst impoverished Venezuelans. The real wage increase is actually stunning, more than 22.1% in 2006. The minimum wage has been increased twice during 2006 adding up to a hike of 25% over the course of one year. In the growing public sector, handouts topped the average with 33.8% reflecting the expansionistic fiscal policy at home.

It is this massive wage increase that may have the most serious repercussions in the coming years and seriously damage Venezuelan competitiveness on the Latin American market. The wage increase has, in large part, morphed into consumption, mostly in private households. As a result, a hike in imports has been fostered, yet at the same time a future dependency upon these imports has been created.

Inflation and high market prices are consuming higher wages and savings

The highest inflation in Latin America might become a growing problem for Venezuela’s economy. Only three Latin countries had higher inflation rates during 2006 as compared to the previous years. Among them, Venezuela posted by far the highest rate of 15.8% during the last year (up from 14.4% in 2005).14 Inflation is stimulated by the significant increase in private consumption which was buoyed up, in turn, by the considerable rise in public transfers to households, the recovery of real wages and the hefty increase in credit to the private sector.15

The government has tried to check inflation with classic populist means, introducing authority imposed price controls and cash-flow limitations. Currency appreciation in the Bolivarian Republic of Venezuela is due to the fact that the Central Bank of Venezuela has not altered the parity of the Bolívar since May 2005, even though the country has higher inflation than its trading partners.16

Venezuela also happens to have by far the highest variation in consumer prices. Again, the government tried to fix this problem with price controls on core edibles like eggs, chicken and bread. The success is, as mostly with socialist enforcement measures, meager. The regulated products are scarce now. The supply has dropped, since suppliers tend to produce goods whose prices are unregulated.

Prudent planning for the post-boom era

Venezuelan politics exhibit more "caudillo populism" than classic socialism. As long as the handouts to the poor keep coming and the artificially stimulated domestic sector generates handsome profits for their domestic and national enterprises, the "Chavez economic system" will keep going, and spending. However, few of these expenditures are designed to deliver sustainable results. The policy shows the antagonism of a government which immensely profits from an international free market system, while trying to ignore market mechanisms at home. So far most of the regulative measures have backfired. The whole system is tailored to the continuation of high oil revenues. Instead of using national wealth, investing in roads and infrastructure, or competitive education, the government has favored increased domestic consumption. Countries like Brazil will welcome the new MERCOSUR member and enter the market with competitive products. The good news is that Chavez’ ambition to be antagonistic towards "imperialist dominated organizations" has helped channel Venezuelan money into the reduction of foreign debt.

For now poor people and the business sector are doing better. The losers are the shrinking middle class and the political opposition who are deprived of participation in the public sector boom. If current trends continue, the Venezuelan people will have lost the chance to transform their possibly transitory petroleum bonanza into a permanent increase in long term growth rates and future prosperity.

Notes

1 Alan Field, Latin American experience, Florida Shipper, May 14, 2007.

2 See New York Times headline, "Chavez Rattles Takeover Saber at Steel Company and Banks", May 7, 2007.

3 Economic Commission for Latin America and the Caribbean (ECLAC), Preliminary Overview of the Economies of Latin America and the Caribbean, 2006, p. 70, available online, on May 11,at https://www.eclac.cl/publicaciones/xml/3/27543/lcg2327_i_chapterV_External_Sector.pdf .

4 BBC, Monitoring Latin America, May 9, 2007.

5 BBC, Monitoring Latin America, May 9, 2007.

6 Constantin Schoehl von Norman, The Americas Report, Elections in Nicaragua — how the disunity of the democratic factions may foster the recurrence of a Sandinista government, Vol. 2 – Issue 20 – October 13, 2006, Highlighted Story.

7 Chávez intends the new bank to have US$7bn in capital. What form this capital will take, whether it paid up or authorized, is unclear.

8 Brendan Boyle, Africa will survive global economic slowdown, Sunday Times (South Africa), May 06, 2007, Business Times Edition.

Hugo Chávez. Source: www.opinionist.com

9 Economic Commission for Latin America and the Caribbean (ECLAC), Preliminary Overview of the Economies of Latin America and the Caribbean, 2006, p. 71, available online, on May 11,at https://www.eclac.cl/publicaciones/xml/3/27543/lcg2327_i_chapterV_External_Sector.pdf.

10 Economic Commission for Latin America and the Caribbean (ECLAC), Preliminary Overview of the Economies of Latin America and the Caribbean, 2006, p. 57, available online, on May 11,at https://www.eclac.cl/publicaciones/xml/3/27543/lcg2327_i_chapterV_External_Sector.pdf .

11 Alan Field, Latin American experience, Florida Shipper, May 14, 2007.

12 Alan Field, Latin American experience, Florida Shipper, May 14, 2007.

13 Latin American Economy & Business, Looking good, May 3, 2007.

14 Economic Commission for Latin America and the Caribbean (ECLAC), Preliminary Overview of the Economies of Latin America and the Caribbean, 2006, p. 57, available online, on May 11,at https://www.eclac.cl/publicaciones/xml/3/27543/lcg2327_i_chapterV_External_Sector.pdf.

15 Ibid.

16 Ibid.