VENEZUELA DEVALUES TO KEEP THE SPENDING MACHINE

C O N F I D E N T I A L CARACAS 000669

SIPDIS


TREASURY FOR OASIA - SIGNORELLI
NSC FOR SHANNON AND BARTON
SOUTHCOM ALSO FOR POLAD

E.O. 12958: DECL: 03/04/2015
TAGS: ECON EFIN PGOV VE
SUBJECT: VENEZUELA DEVALUES TO KEEP THE SPENDING MACHINE
RUNNING

REF: CARACAS 578

Classified By: Economic Counselor Richard M. Sanders. Reason: 1.4(b)
and (d).

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Summary
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1. (C) The GOV has announced announced the devaluation of
the bolivar from 1920 to 2150 bolivars per dollar. The rise
will mean that the GOV will have more local currency at hand
to continue its highly aggressive spending policies, which
have proven to be so politically popular. With high oil
prices underpinning the economy, the impact on internal
prices of the decision is, for the time being, likely to be
tolerable, and the GOV should be able to keep to its goal of
goal of 15 pct inflation for 2005. It is, however, already
looking at some price increases at the highly popular
state-run (and subsidized) discount food chain, Mercal. End
summary.

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New Rate Announced
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2. (U) On March 2, the Central Bank and the Finance
Ministry announced that the exchange rate, currently fixed at
1920 bolivars per dollar, would be changed to 2150 bolivars
per dollar, a 10.7 pct devaluation. (Venezuela has had a
fixed exchange rate since February 6, 2003, when it was
imposed during the general strike which had shut down exports
of Venezuela's principal foreign exchange earner, petroleum.
Initially fixed at 1600 bolivars per dollar, the rate was
changed to 1920 bolivars per dollar on February 9, 2004.)
The quasi-legal parallel rate, which had been heading upward
in recent days in expectation of an announcement, now stands
at 2857 bolivars per dollar, 24.8 pct higher than the
official rate, a relatively narrow spread. Finance Minister
Nelson Merentes suggested that the impact of the devaluation
on inflation would be minimal, while Vice President Jose
Vicente Rangel would spoke in general terms of "highly
satisfactory compensating effects" that the decision would
bring.

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One Economist's View
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3. (C) Alejandro Grisanti, formerly chief economist for
Spanish-owned Banco de Venezuela, now an independent
consultant, told econcouns that the devaluation was driven by
the GOV's desire for more cash to maintain its highly
expansionary spending policies. He said that the devaluation
would allow it to expend an additional 8.8 trillion bolivars
(USD 4.5 billion). (Note: the GOV would access the money in
two ways, by being able to convert dollar earnings from state
oil corporation PDVSA at the new rate, and by pressing the
Central Bank to remit to it more bolivars as earnings on the
foreign exchange it holds. End note.) Admittedly, Grisanti
went on, this would result in a jump in inflation of as much
as 3 pct. Nonetheless, he thought that from a purely
political calculus, the GOV had made the right decision.
Having to cut back on its welfare programs, which are
concentrated in the lowest income sectors, would probably be
more damaging to its popularity than inflation, which is
diffused among the whole population. Unemployment, although
dropping, remains high, and for many these welfare programs,
(such as "scholarships" for presumed high school or college
studies) are their only form of income. Even if inflation
means the recipients buy less, these transfer payments are
still much better than nothing for them.


4. (C) Grisanti suggested that the timing of the
announcement had been affected by the relatively low
inflation numbers which the year to date has brought. Even
with the price hikes which will be generated by the
devaluation, inflation may well yet come under the 15 pct
which Planning Minister Jorge Giordani has predicted.
Grisanti thought the next devaluation might not come until
the end of the year. He saw inflation continuing on its
downward trend, reserves staying strong, and the GOV able to
maintain high levels of spending through 2006, all sustained


by high oil prices. This is a classic Venezuelan story, he
added, with the final chapter being a brutal adjustment "when
the model stops working" once oil prices finally drop.

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A Key Price Rise in the Works Anyway
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5. (U) Even ahead of the devaluation, news stories in major
Caracas dailies suggested that prices would rise at the
massive state-run "Mercal" chain of stores which sell staple
foodstuffs at deep discounts. (The Mercal program, aimed at
low income Venezuelans, is one of the GOV's most popular
programs, see reftel.) Mercal President Jorge Luis Rodriguez
bemoaned increases in costs which the (highly subsidized)
chain most face ) in transportation, services, and salaries.
He said that he hoped that any price increase would be below
the predicted 15 pct inflation, and thus would conserve the
purchasing power of its customers. Any generalized price
increase will require approval by President Chavez.
(Comment: Bolivars obtained by devaluation may instead go to
further subsidies to keep Mercal prices down, but, given that
much of Mercal's inventory is imported, the devaluation will
further aggravate its fiscal situation. End comment.)


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Comment: A Devaluation Foretold
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6. (C) The GOV's 2005 budget had explicitly assumed an
exchange rate of 2150 bolivars per dollar, so this
devaluation is not a surprise. It had initially been
expected at the beginning of the New Year's (the traditional
time for such announcements, during the many periods in which
Venezuela has had a fixed exchange rate),but the GOV held
off, many analysts believed, to keep prices down for a few
months in order to assure that the 15 pct inflation target
would be met this year. Inflation, while relatively high in
January (1.9 pct,) came in very low in February (0.17 pct)
making this strategy workable. We agree with Grisanti's
suggestion that maintaining the various social "missions" has
become more important to the Chavez government's popularity
than avoiding a bump in inflation ) on a downward track
anyway. We expect that this expansive fiscal and with it
monetary policy will continue as long as oil revenue remains
abundant.
Brownfield


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2005CARACA00669 - CONFIDENTIAL