CAUTION: THE ROAD IS WET - TREASURY REP GETS VIEWS

C O N F I D E N T I A L CARACAS 003575

SIPDIS


STATE FOR WHA/AND
NSC FOR CBARTON
TREASURY FOR OASIA-GIANLUCA SIGNORELLI
HQ USSOUTHCOM FOR POLAD
BUENOS AIRES FOR TREASURY (MHAARSAGER)

E.O. 12958: DECL: 11/15/2014
TAGS: ECON EFIN PGOV VE
SUBJECT: CAUTION: THE ROAD IS WET - TREASURY REP GETS VIEWS
OF VENEZUELAN ECONOMY

REF: CARACAS 3015

Classified By: ECONOMIC COUNSELOR RICHARD M. SANDERS FOR REASON 1.4 B A
ND D.

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SUMMARY
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1. (C) U.S. Treasury representative for South America Mathew
Haarsager visited Caracas from November 2-5, and in a series
of meetings with the Venezuelan private and public sectors
was treated to a variety of perspectives. GOV officials
asserted that, with the strike, presidential referendum, and
regional elections behind them, high fiscal spending would
continue to create sustained economic growth. Private sector
representatives, while acknowledging that economic indicators
are currently healthy, believe that short-term growth depends
entirely on maintaining current oil prices, and long-term
growth will require the unlikely occurrence of structural
reforms. Multilateral lenders are trying to avoid any
appearance of controversy, even if that means reducing their
portfolios in Venezuela and not pressing the GOV to make
needed reforms. END SUMMARY.

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GOV - NO MORE TROUBLE
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2. (C) GOV officials took the view that things are good, and
are going to get better. Guillermo Ortega, General
Coordinator for Public Policy at the Ministry of Finance,
emphasized increased non-oil revenues and a drop in debt/GDP
ratio. Luis Rafael Quiaro and William Grillet, respectively
Vice President of Planning and General Manager of the
state-owned Economic and Social Development Bank (BANDES)
cited the rapid increase of their lending portfolio to small
businesses in particular. Jose Rojas, Vice President of
Finance of state oil corporation PDVSA, noted that it is
currently contributing about half of 2004 GOV revenue (USD 15
billion) in taxes and royalties, and added that PDVSA was
spending close to USD 5 billion more (NOTE: at least USD 2
billion is off-budget END NOTE) on social/infrastructure
needs.


3. (C) The GOV officials made it clear that they saw the
government as the engine of growth for the economy. Ortega
said it was essential for expenditure to be sufficient to
maintain growth, and that the GOV is still trying to bring
spending up to its desired level. Quiaro stated that BANDES
has a special emphasis on micro-credit, especially to spur
import substitution and in services, but also certain
domestic "value chains," citing cocoa as an example. Rojas
cited PDVSA's ability to spend more quickly and efficiently
than the GOV in general as their contribution to growth.
Generally, GOV officials emphasized that their development
strategy - termed "endogenous growth" - is based on greater
state involvement in the economy, import substitution, and
reliance on domestic resources - ideas that were in vogue in
the 1950s and 1960s, as freely admitted by Quiaro.


4. (C) Venezuelan Central Bank (BCV) directors Domingo Maza
Zavala (noted for his independence and hence widely seen as a
thorn in the GOV's side) and Bernardo Ferran, while
recognizing the difficulties of dependence on oil revenues,
were critical of GOV policy. They stressed that GOV policy
is to spend oil revenue now rather than invest it to create
conditions for growth, a problem shared by previous
administrations. They noted that, though Venezuela has never
suffered from hyperinflation, the current inflation rate is
much higher than the 40-year average. They asserted that it
would be much higher if not for BCV operations. Maza Zavala
and Ferran praised the idea of the Macroeconomic
Stabilization Fund (FEM - a separate account created in 1999
to save high oil revenues to spend when revenue is low),but
criticized the GOV for spending what had been saved (NOTE:
the balance peaked at over USD 7.1 billion in 2001, but is
currently only USD 708 million),plus increasing debt
simultaneously. Finance's Ortega, however, thought the FEM


needed to be reformed, in part by setting the reference value
(currently defined as the average of oil revenues for the
last five calendar years) in real terms rather than nominal.
A better guide, he said, would be determining the proper
level of primary expenditure necessary for continued strong
economic growth and saving anything above that.

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PRIVATE SECTOR - WAITING IN VAIN
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5. (C) Meanwhile, the private sector, after an extended
period waiting to see if there would be a change in
administration, is acknowledging that - fairly or not -
Chavez is firmly in charge until at least 2006, and quite
possibly more. There is consensus that GDP growth will
exceed 12% for 2004 (which still will not be enough to return
economic output to 2001 levels),and be around 5% in 2005.
Efrain Velazquez, President of the National Economic Council,
thinks growth will continue through 2006, as long as oil
prices remain high. Inflation is dropping and could be even
lower (but still above 10%) next year, and foreign exchange
liquidations are at their highest since exchange controls
were imposed in January 2003. (September liquidations were
more than the 2002 average.) Alejandro Grisanti, economic
advisor to Banco Santander, noted that public/private sector
dialogue to promote growth has begun.


6. (C) However, behind the recognition of good news, there is
still a call for the GOV to implement structural reform, and
little hope that it will. Albis Munoz, President of business
umbrella group FEDECAMARAS, opined that the public/private
dialogue would be limited, as neither group trusted each
other. She cited continued punitive behavior by the
Venezuelan tax authority (SENIAT - see reftel) and exchange
control administration (CADIVI) as examples that political
retaliation would not end. She stated that both entities
were using the list of those who signed in support of the
presidential referendum as criteria for actions. Banesco (a
major private bank) Vice President and Chief Economist Pedro
Coa noted that, should investors lose confidence in
short-term GOV/BCV bonds, the money supply could quickly
double, with terrible inflationary results. He added that
the BCV is indeed combating inflation through constant
sterilization, but having to do so is putting its solvency at
risk. since they are offering high interest bonds (currently
over 11%, but some outstanding bonds have rates over 21%) to
reduce liquidity. Grisanti opined that increased CADIVI
liquidations, given the artificially low official exchange
rate, were like subsidies for the import sector - "how can
anyone compete with the price of imports from China?" - which
will further undermine local investment.

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MULTILATERALS - DON'T ROCK THE BOAT
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7. (C) Multilateral development bank lending in Venezuela is
currently below traditional levels, which local
representatives attribute to efforts to avoid politically
sensitive issues. The World Bank, for example, according to
consultant Angel Cardenas, does not plan to move forward with
a new loan to the Venezuelan Supreme Court, despite pleasure
with the results of a similar project that was recently
completed, but will seek projects only in areas of
infrastructure and urban development. He also mentioned
being "afraid (the GOV) would change the rules of the game"
as another reason to avoid sensitive loans. The
Inter-American Development Bank (IADB) and the Andean
Development Corporation (CAF) also plan to focus on
infrastructure projects. IADB rep Roman Mayorga and CAF Vice
President Fidel Jaramillo both cited inefficiency in the
public sector as limiting factors for greater disbursement.
Cardenas added that the GOV thinks it is doing things right,
and therefore does not want help from multilaterals. Such
help would, of course, also require greater transparency.

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COMMENT


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8. (C) The stark disparity between public and private
perspectives on the future of the Venezuelan economy
underlines the uncertainty that the country faces. The GOV
appears hell-bent on not just spending its oil boom as
quickly as possible, but taking on new debt to ensure the
highest possible growth in advance of the 2006 presidential
elections, ignoring the fact that it will leave Venezuela
extremely ill-equipped to deal with a fall in oil prices.
The new "Bolivarian" economic model - which is still only
loosely defined - will also do nothing to address the
uncompetitiveness of the non-oil sector. Instead, it
reverses the trend during the 1990,s toward both
privatization and decentralization, forces the private sector
into a position of dependence on the government and gives the
central government an increasing role in industry and
commerce, with little concern for efficiency or waste. At a
minimum, these mark a return to the failed policies of the
70,s and 80,s. This model seems certain to depress foreign
investment and entrepreneurial activity (though we may see
some new decisions to put money into deals which offer
relatively rapid returns as recovery lasts). As the
multilateral lenders have no leverage with which to influence
the GOV toward policy reform, and high oil prices require no
change, the GOV will continue to set the agenda. However,
until it is clear which way it is pushing the Venezuelan
economy, the conditions for private sector commitments will
remain elusive. Judicial insecurity, uncertainty over GOV
macro-economic management, and high inflation (by regional
standards) all lead to a situation which reduces the
probability of significant investment - foreign or domestic -
and takes the initiative from the private sector. Without
the job creation that those would bring, growth will last
only as long as high oil prices can sustain the spending boom.


9. (U) Treasury representative Haarsager has reviewed this
cable.
Brownfield


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2004CARACA03575 - CONFIDENTIAL