BRV RELEASES 2007 NATIONAL BUDGET

UNCLAS SECTION 01 OF 03 CARACAS 003316 SIPDIS SENSITIVE SIPDIS TREASURY FOR KLINGENSMITH AND NGRANT COMMERCE FOR 4431/MAC/WH/MCAMERON NSC FOR DTOMLINSON HQ SOUTHCOM ALSO FOR POLAD E.O. 12958: N/A TAGS: ECON EFIN VE SUBJECT: BRV RELEASES 2007 NATIONAL BUDGET REF: A. CARACAS 2718 ¶B. CARACAS 3224 ¶1. (U) SUMMARY: The Minister of Finance delivered the proposed 2007 budget for Venezuela to the National Assembly (AN) on October 17, 2006. The budget calls for spending 115.2 trillion Bolivars (USD 53.6 billion) in 2007. The proposal assumes an exchange rate of 2150 Bs/USD, an average oil export price of USD 29/barrel, an inflation rate of 12 percent, a real GDP growth of 5 percent and a 1.7 percent of GDP deficit. The 2007 budget represents a 32 percent nominal increase over the original 2006 budget (inflation for 2006 is expected to end around 15-16 percent),though a 11.2 percent decrease from the 2006 budget with all additional credits. This does not include off-budget expenditures which in 2006 we estimate amounted to an additional USD 15 billion in BRV spending. Passage is expected in mid-November with cosmetic changes. Once again the "official" budget underestimates revenues, expenditures, inflation and growth. We do no expect the BRV to face any significant fiscal vulnerabilities during 2007. END SUMMARY. ¶2. (U) Two days after the constitutionally mandated deadline of October 15, Finance Minister Merentes delivered the 2007 budget to the National Assembly (AN). The proposed 2007 budget calls for total expenditures of USD 53.6 billion, or 33 percent of GDP (which is in line with the current 2006 budget). This marks a 32.4 percent increase in nominal terms over the budget proposed for 2006, though is 11.2 percent less than the 2006 budget when all additional credits are factored in. (Comment: The BRV bureaucracy is having capacity problems and is unable to spend all of the money it is receiving. One respected economic consultancy estimates that by year-end 2006 the BRV will have only spent USD 48.9 billion (31.5 percent of GDP),although USD 60.3 billion (39 percent of GDP) has been authorized with the additional credits. End Comment.) ¶3. (U) The 2007 budget breaks little new ground and follows the trends in the 2006 budget and subsequent additional credits. Social spending continues to increase and remains by far the largest segment of BRV expenditures (44.6 percent). The table below shows budget figures for 2005, 2006 and 2007 and demonstrates the huge spending increases of the past two years. (Note: This does not/not include off-budget spending. End Note.) Year Social Transfers Debt Defense Other Total Spending to states Service (in USD millions) 2005 16,576 7,858 6,599 3,195 6,619 40,847 2006* 16,562 9,080 6,709 2,999 5,129 40,479 2006** 21,053 13,342 12,081 3,482 10,363 60,321 2007 23,917 13,459 5,931 2,566 7,698 53,571 Other includes the ministries of infrastructure, agriculture, energy and mines, industry and tourism. *Original 2006 budget. **2006 budget with all additional credits. 2007 numbers are from the proposed budget for this year. Sources: Ministry of Finance, National Assembly. ¶4. (SBU) According to this budget, the BRV will spend approximately USD 2.7 billion (1.7 percent of GDP) more than it will take in during 2007. This will be met mostly through the sales of bonds and CDs on the local market. Total internal debt is currently 14.5 billion (9.3 percent of GDP) and external debt is 26.7 billion (17 percent of GDP). CARACAS 00003316 002 OF 003 (Comment: The fiscal outlook and debt load appear completely manageable for the duration of 2007, barring drastic drops in the price of oil. Standard and Poor's recently raised its short term rating for Venezuelan debt to B status and that of long term debt to BB. End Comment.) ¶5. (SBU) The budget proposal assumes an average oil price for the Venezuelan oil basket of USD 29/barrel, which is considerably less than the average for 2006 (USD 57.33 YTD as of November 3) and consensus estimates for 2007 (around USD 55). According to Finance Minister Merentes, the budget assumes 3.4 million barrels per day (mbpd) in production (although the budget as submitted to the AN doesn't include this figure). The production figure was contradicted publicly by Central Bank (BCV) governor Zavala on October 14, who put actual production at around 2.6 mbpd (which is in line with our estimates). Thus, while continuing to underestimate the price of oil, the revenue surplus will not be as large as it first appears. Given that actual production is considerably less, the price of the Venezuelan oil basket would have to fall below USD 37.92/barrel (rather than below USD 29) for government revenues to fall below budgetary expectations. (Note: As part of the announced OPEC production cuts, Venezuela is supposed to cut production by 138,000 bpd. The BRV appears in some cases to be cutting production (rather than simply lowering the numbers on paper),so this break even point may be even higher. However, the extent of actual production cuts is not clear (see reftel B). The weekly price for the Venezuelan oil basket on November 2 was USD 49.38. End Note.) ¶6. (U) The current exchange rate of 2150 Bolivars to the dollar was instituted in March of 2005 and Chavez has publicly stated that there will be no devaluation in 2007. The parallel rate for Bolivars is currently hovering around 2900 Bs/USD, indicating the Bolivar is overvalued by between 30 and 35 percent. (Comment: There is much debate as to whether or not the Bolivar will be devalued in 2007. Most experts agree that if a devaluation does occur, it will be minor (5-8 percent) an would be based more on the government's desire to increase its spending power than to reduce the spread between official and parallel rates. In addition, foreshadowing a devaluation would have negative consequences for the economy, as consumers would splurge (exacerbating shortages and increasing inflation) and capital flight would increase before the money lost value. End Comment.) ¶7. (U) Official inflation is expected to close the year in excess of 15 percent, although official figures are misleadingly low (see reftel A). The 2006 budget presaged an unrealistic inflation rate of 10 percent and given increasing liquidity and government spending, 2007 inflation will likely be near, if not higher than 2006 levels. ¶8. (SBU) Planning Minister Giordanni noted on October 20 that GDP would grow from USD 150 billion to USD 200 billion in ¶2007. This implies a 33 percent nominal increase. (Comment: It is unlikely that more than 10 percent would come from GDP growth, although the remainder of Giordanni's estimate could be from inflation. This neat little trick of a 33 percent nominal GDP increase in USD terms is achieved by keeping the overvalued exchange rate anchored at 2150 Bs/USD and is not without its costs. End comment.) ¶9. (SBU) Comment: The draft budget for 2007 is just that, a draft. Given the lack of opposition in the AN it seems likely that there will be little debate on the budget and it will pass with cursory changes, probably in mid to late November. This election year the AN has already increased the budget by almost 49 percent through the approval of CARACAS 00003316 003 OF 003 additional credits, and that trend seems likely to continue in 2007. (Note: The BRV's inability to obligate all of its authorizations means that actual spending in 2006 is forecast to be only 29 percent higher than the original 2006 budget. End Note). In addition, the BRV spends substantial amounts of money using "off/parallel-budget" mechanisms including the Fund for National Development (FONDEN) and PDVSA which fund many social programs and large segments of the BRV missions. Off-budget spending for 2006 may reach USD 15 billion, though exact numbers are hard to come by. The BRV currently has around USD 40 billion in unspent reserves (in USD and Bolivars held in treasury accounts at the BCV, the Bank for Economic and Social Development (BANDES),the Treasury Bank (which holds FONDEN assets) and private sector banks (septel). (Note: This figure does not include BCV foreign exchange reserves, which as of November 2 are USD 34.7 billion. End Note.) Debt stock is relatively low and if necessary, the BRV could cover all of its financing needs for 2007 with these unspent reserves. The conservative forecasts for GDP growth by the Ministry of Finance will allow the BRV to take credit when GDP growth exceeds estimates. The low ball price for oil means that the government can continue to increase spending throughout the year and avoid additional constitutionally mandated payments to state governments or the macroeconomic stabilization fund as the "unexpected" windfall comes in. End Comment. BROWNFIELD