VENEZUELA MACROECONOMIC UPDATE

UNCLAS CARACAS 000704 SIPDIS SIPDIS STATE FOR WHA/AND, WHA/EPSC, EB TREASURY FOR OASIA - GIANLUCA SIGNORELLI USCINCSO FOR POLAD BUENOS AIRES FOR TREASURY - MHAARSAGER E.O. 12958: N/A TAGS: ECON EFIN PGOV VE SUBJECT: VENEZUELA MACROECONOMIC UPDATE REF: A. CARACAS 00485 ¶B. CARACAS 00512 ¶C. CARACAS 03601 ¶D. CARACAS 03782 ¶E. CARACAS 00632 ¶F. CARACAS 00208 SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET DISTRIBUTION. -------------- OVERVIEW -------------- ¶1. (SBU) Venezuela,s strong economic growth performance will most certainly continue through 2006 given the continued high oil price scenario and profligate BRV spending this election year, which is fueling a consumption boom. We also expect the state to continue to consolidate its role in the nation,s economic life. The quality of economic growth remains poor with low net new job creation, private sector direct investment remains anemic given the uncertain political environment, and the high levels of monetary liquidity are creating their own set of difficulties for the Central Bank. For now, the high levels of BRV spending, which could reach 40 percent of GDP this year, will continue to mask a multitude of economic distortions and structural weaknesses that have been created through Bolivarian economic mismanagement. -------------- ECONOMIC GROWTH -------------- ¶2. (U) Real GDP grew by 9.3 percent in 2005. The 2004 economic recovery continued in 2005, driven largely by a huge increase in government expenditures as a result of the continued oil bonanza (see table). Importantly, the non-oil sector has led the economic growth in 2005: mining (1.7 percent),manufacturing (8.7 percent),electricity and water (8 percent),commerce and repair services (19.9 percent), construction (20.1 percent),transportation and storage (13.9 percent),communications (15.9 percent),and finance and insurance (27.2 percent). The oil sector has only registered 1.7 percent growth due to low PDVSA investment to support increased production. The increase in economic growth in the oil sector is mainly due to the high oil prices. In 2006, we expect the economy to grow around 6 to 7 percent, assuming continued high oil prices and anticipated aggressive BRV election year spending (at least 30.5 percent of GDP, with potential off-budget spending of up to 10 percent of GDP). REAL GDP GROWTH RATE (PERCENTAGE) -------------- OIL NON-OIL TOTAL 1999 -3.8 -6.9 -6.0 2000 2.3 4.2 3.7 2001 -0.9 4.0 3.4 2002 -14.2 -6.0 -8.9 2003 -1.9 -7.5 -7.7 2004 11.6 17.8 17.9 2005 (1) 1.7 10.3 9.3 2006 (2) 3.0 7.4 6.7 (1) Preliminary figures. (2) Projections. SOURCE: Central Bank of Venezuela and Metroeconomica -------------- UNEMPLOYMENT -------------- ¶3. (U) Second semester 2005 figures from the National Institute of Statistics (INE) show an average unemployment rate of 11.4 percent, the lowest in seven years. However, workforce shifts from unemployed to inactive, rather than substantial new job creation, have helped to lower the unemployment rates. The inactive category includes all persons 15 years or older who are not seeking employment. This includes students, homemakers, retirees, those physically unable to work, and those that work for less than 15 hours a week without pay for other family members. The informal sector of the economy accounted for 48 percent of the occupied working labor force. ¶4. (U) Despite 2005,s impressive economic growth rate of 9.3 percent, the number of private sector jobs decreased by 230,890 (2.5 percent) and public sector jobs increased by 47,914 (2.8 percent),from December 2004 to September 2005. Some analysts suggest that private firms are producing more with the same number of employees because of the high costs to hire an additional employee. Under current Venezuelan labor laws, large companies in the formal economy pay on average the equivalent of 24 months of salary per employee per year. The increase in unemployment to 12.9 percent for January 2006 is normal for the first month of the year, after an adjustment for seasonal increases in employment for the Christmas holidays. UNEMPLOYMENT (percentage in second semester) -------------- 1999 14.5 2000 13.2 2001 12.8 2002 16.2 2003 16.8 2004 13.9 2005 11.4 2006 JAN 12.9 SOURCE: BRV National Institute of Statistics (INE). -------------- INTERNATIONAL RESERVES -------------- ¶5. (U) The Central Bank (BCV)-held international reserves increased to USD 30.4 billion at the end of 2005 because of higher than expected oil export revenue (approximately USD 48.1 billion). This level of reserves covers approximately 15 months of imports. The reserves would have been higher, but the BCV transferred USD 6 billion to the National Development Fund (FONDEN) during the last quarter 2005, as required by the Central Bank Law (passed in July 2005). The level of international reserves is expected to decrease during 2006 because the Central Bank Law established that PDVSA will only transfer foreign exchange earnings needed for its domestic expenses, taxes, royalties, and dividends to the BCV, and the rest to FONDEN. (Note: Currently, FONDEN has USD 8.425 billion, including direct transfers from PDVSA. End Note.) In February 2006, Chavez called for the transfer of USD 4.0 billion from the BCV to FONDEN. The Central Bank Law also directed the BCV to determine the adequate level of reserves, which we anticipate will be USD 25 billion, based on prior Chavez, statements (reftel A). ¶6. (U) The results below include the Macroeconomic Stabilization Fund (FEM),which was originally established in 1998 as a savings fund to reduce the impact of oil income fluctuations on the fiscal, foreign exchange and monetary balances (a rainy day fund). The maximum level reached by this Fund was USD 7,116 million on December 12, 2001. In 2002 and 2003, the Venezuelan government used the funds to cover the fiscal deficit and in a widely publicized scandal suspended transfers of USD 3.2 billion to the FEM. The balance was USD 737 million on March 1, 2006. INTERNATIONAL RESERVES (USD MILLIONS) -------------- BCV FEM TOTAL 1999 DEC 15,164 215 15,379 2000 DEC 15,883 4,588 20,471 2001 DEC 12,296 6,227 18,523 2002 DEC 12,003 2,857 14,860 2003 DEC 20,666 700 21,366 2004 DEC 23,498 710 24,208 2005 DEC 29,636 732 30,368 2006 JAN 27,888 734 28,622 FEB 28,603 736 29,339 SOURCE: Central Bank of Venezuela. -------------- MONEY SUPPLY/M2 -------------- ¶7. (U) Monetary liquidity or money supply grew 52.7 percent during 2005, largely as a result of foreign exchange controls and increased government expenditures (reftel B). This is the third annual consecutive huge increase, which implies potential higher inflation rates in the medium-term. Most of the excess liquidity accumulated in the economy during these months has been withdrawn by the Central Bank (BCV) issuing short-term certificates of deposits, mostly to domestic banks. The net balance in circulation of certificates of deposit was 30.10 trillion Bolivars (approximately USD 14.0 billion) at the end of January 2006, or 42.7 percent of the total money supply. ¶8. (U) The Finance Ministry also issued USD 3.0 billion in dollar-denominated bonds, purchasable in local currency (reftel C). This alleviated some of the excess liquidity, which if left unchecked, would cause inflationary pressures. The BRV also purchased USD 2.8 billion and resold approximately USD 1.1 billion in dollar-denominated Argentine bonds to local investors(reftel D). In both cases, local investors could sell the bonds overseas, obtaining dollars, and reducing the supply of Bolivars. We anticipate that the BRV will complete similar issuances in 2006. MONEY SUPPLY/M2 (3) MONETARY BASE -------------- -------------- End of: (million Bs.) Pct.Chg. (million Bs.) Pct.Chg. 1999 12,740,836 20.0 4,909,822 32.1 2000 16,284,578 27.8 5,790,841 17.9 2001 16,976,364 4.2 6,478,295 11.9 2002 19,573,369 15.3 7,701,120 18.9 2003 30,835,975 57.5 11,274,439 46.4 2004 46,363,672 50.4 16,524,461 46.6 2005 70,794,342 52.7 23,086,512 39.7 2006 (4) JAN 70,434,577 (0.5) 22,042,400 (4.5) (3) M2 includes currency, demand deposits, savings, and certificates of deposit. (4) Preliminary figures. SOURCE: Central Bank of Venezuela (BCV). -------------- EXCHANGE RATES AND BCV LIQUIDATIONS -------------- ¶9. (U) The National Exchange Control Administration (CADIVI),created in February 2003, oversees authorized foreign exchange transactions. Currently, approximately 95 percent of the private foreign exchange is processed through CADIVI and approximately 5 percent is processed by the parallel market. Public sector entities can acquire foreign currency directly from the Central Bank for public sector imports, debt payments, and other expenses abroad. In 2005, CADIVI authorized on average USD 83.2 million a day, and the BCV liquidated on average USD 78.6 million a day in exchange transactions. The parallel market exchange rate was 2,616 Bolivars per dollar as of March 1, 2006. BRV officials have promised no devaluation for this year. At 2,150 Bolivars per dollar, we estimate that the Bolivar is approximately 20 percent overvalued. Economic sources anticipate a devaluation in early 2007. END OF PERIOD EXCHANGE RATES (Bs./USD) AND BCV LIQUIDATIONS -------------- -------------- OFFICIAL FOREX OFFICIAL MARKET PARALLEL MARKET LIQUIDATIONS (MILLIONS USD) -------------- -------------- 1999 648.25 2000 699.75 2001 763.00 2002 1,401.25 2003 1,600.00 2,875.00 4,594.52 2004 1,920.00 2,673.41 14,780.80 2005 2,150.00 2,586.08 19,430.50 2006 JAN 2,150.00 2,643.80 1,867.20 SOURCE: Central Bank of Venezuela, and Metroeconomica. -------------- CONSUMER PRICE INDEX -------------- ¶10. (U) The BCV reported that consumer prices for the Caracas metropolitan area rose 12.5 percent from February 2005 to February 2006. This is the lowest annual inflation rate of the last 50 months. However, around 50 percent of all consumable goods have been under a price control regime since February 11, 2003. Core inflation removes the most volatile categories from the CPI. Both indicators increased at similar rates during the last two years. Effective February 1, 2006, the government increased the minimum wage by 15 percent to 465,750 Bolivars (USD 216.6) per month. This is expected to have a limited effect on 2006 inflation, which could be higher than 2005. For 2006, the BRV has an inflation target of 10 percent (Dec-Dec). CONSUMER PRICE INDEX (1997 AVG = 100) and CORE INFLATION -------------- -------------- CPI CPI CORE INFLATION END OF PERIOD (% change) (% change) 1999 181.6 20.0 N/A 2000 206.0 13.4 12.8 2001 231.3 12.3 11.3 2002 303.5 31.2 31.2 2003 385.7 27.1 37.9 2004 459.7 19.2 21.1 2005 525.7 14.4 14.6 SOURCE: Central Bank of Venezuela. -------------- BALANCE OF PAYMENTS -------------- ¶11. (U) The overall balance of payments may show a deficit during 2006 for the first time in the last four years because of the expected continued capital flight, including PDVSA,s depositing funds abroad. This deficit is the equivalent to a decrease in the international reserves. During the period 2003-2005, with exchange controls in force, private sector capital flight increased by around USD 15.7 billion. Additionally, public sector assets abroad also increased during those years by USD 18.9 billion. One of the main reasons for the large public sector deposits abroad for 2005 is the reform of the Central Bank Law in July 2005 by which the BCV transferred USD 6 billion to the National Development Fund (FONDEN). Currently, FONDEN holds an estimated USD 8.425 billion, including transfers from PDVSA. With additional transfers from PDVSA and an additional USD 4 billion transfer from the international reserves, FONDEN could have USD 18 billion by year,s end. BALANCE OF PAYMENTS SUMMARY (USD BILLION) -------------- - 2002 2003 2004 2005 2006 (1) (2) CURRENT ACCOUNT (A) 7.6 11.4 13.8 25.4 13.7 EXPORTS, FOB 26.8 27.2 38.7 55.5 55.4 IMPORTS, FOB -13.4 -10.7 -17.3 -24.0 -31.8 TRADE BALANCE 13.4 16.5 21.4 31.5 23.6 NET SERVICES AND RENT -5.6 -5.0 -7.5 -6.0 -9.8 NET TRANSFERS -0.2 -0.1 -0.1 -0.1 -0.1 CAPITAL AND FINANCIAL ACCOUNT (B) -9.2 -5.0 -9.0 -16.1 -11.9 DIRECT INVESTMENT -0.2 1.3 1.9 1.5 3.2 PORTFOLIO INVESTMENT -2.3 -1.0 -2.0 2.7 3.1 OTHER INVESTMENT -6.7 -5.3 -8.9 -20.4 -18.2 NET ERRORS AND OMISSIONS (C) -2.8 -1.0 -2.9 -3.8 -3.4 OVERALL BALANCE (A) (B) (C) -4.4 5.4 1.9 5.5 -1.6 (1) Preliminary figures. (2) Projections. SOURCE: Central Bank of Venezuela, and Metroeconomica. -------------- OIL EXPORTS -------------- ¶12. (U) Total value of the oil exports reached USD 48.059 billion during 2005 with an average export price for the Venezuelan oil basket of USD 45.4 per barrel. Venezuela,s current OPEC production quota is 3.22 million barrels. However, Venezuela,s oil production remains below the quota, according to OPEC figures. According to OPEC,s Monthly Oil Report for February 2006, Venezuela,s oil production was 2.54 million barrels per day. The average oil price per barrel was USD 53.0 as of February 24, 2006. OIL EXPORTS (THOUSAND B/D) -------------- AVERAGE EXPORTS (1) EXPORT PRICE EXPORTS (THOUSAND B/D) (USD/B) (USD MILLION) 1999 2,785 16.0 16,735 2000 2,791 25.9 27,874 2001 2,711 20.2 21,745 2002 2,681 22.0 21,532 2003 (2) 2,339 25.8 22,029 2004 (2) 2,635 33.1 31,917 2005 (2)(3) 2,900 45.4 48,059 (1) Includes crude oil and oil products. (2) Figures for 2003 onward appear to include orimulsion and production from Strategic Associations. (3) Preliminary figures. SOURCES: Central Bank of Venezuela, Ministry of Energy and Petroleum, OPEC, and Embassy,s estimates. -------------- MERCHANDISE TRADE BALANCE -------------- ¶13. (U) Total imports increased 38.7 percent during 2005 compared to 2004, largely due to the economic recovery, and increased approvals and liquidations of foreign exchange requests by CADIVI. With continued exchange controls, we believe the Bolivar, valued at 2,150 per dollar, is overvalued by approximately 20 percent, acting as a subsidy for imports to Venezuela. According to the National Statistics Institute (INE),the United States was the largest exporter to Venezuela (30.4 percent),followed by Colombia (11.0 percent),Brazil (9.2 percent),Mexico (7.2 percent), Japan (3.8 percent),and China (3.7 percent). For 2006, we expect a continued high merchandise trade surplus due to a stable oil price outlook. MERCHANDISE TRADE BALANCE (USD BILLION) -------------- 2002 2003 2004 2005(1) 2006(2) OIL EXPORTS (A) 21.5 22.0 31.9 48.1 47.1 NON-OIL EXPORTS (B) 5.3 5.2 6.8 7.4 8.3 TOTAL EXPORTS (C) 26.8 27.2 38.7 55.5 55.4 TOTAL IMPORTS (D) -13.4 -10.7 - 17.3 -24.0 -31.8 MERCHANDISE TRADE BALANCE (C)-(D) 13.4 16.5 21.4 31.5 23.6 (1) Preliminary figures (2) Projections. SOURCE: Central Bank of Venezuela, and Metroeconomica. -------------- FOREIGN DIRECT INVESTMENT -------------- ¶14. (U) Foreign direct investment showed an inflow of USD 1,497 million during 2005. Foreign oil companies operating in Venezuela reinvested USD 1,519 million of earnings, and non-oil companies in Venezuela made new foreign direct investments of USD 990 million. On the other hand, the Venezuelan oil sector increased investments abroad for an amount of USD 1,332 million, including reinvestment of earnings. Foreign direct investment in Venezuela has been relatively low since 2002 because of the uncertain political environment, increased government intervention in the economy, and BRV support for expropriations and seizures of land and property. Abroad In the country Net flow 1997 -557 6,202 5,645 1998 -1,043 4,985 3,942 1999 -872 2,890 2,018 2000 -521 4,701 4,180 2001 -204 3,683 3,479 2002 -1,026 782 -244 2003 -1,318 2,643 1,325 2004 348 1,492 1,840 2005 (1) -1,460 2,957 1,497 (1) Preliminary figures Source: Central Bank of Venezuela. -------------- CARACAS STOCK EXCHANGE INDEX -------------- ¶15. (U) The Caracas Stock Exchange (CSE) index recovered during the first two months of 2006 after declining 31.9 percent in 2005. This recovery could be explained by the excess liquidity in the market, the decreasing interest rates in the Venezuelan banking system, the government controls on the capital movements, and the lack of options to invest. According to the CSE President Nelson Ortiz, 2006 could be a good year for the Venezuelan capital market. As an indicator of the current strong market, local media report that in three years the price of a trading desk at the Caracas Stock Exchange increased from USD 14,000 to USD 465,000. CARACAS STOCK EXCHANGE CAPITALIZATION INDEX (DECEMBER 1993 = 1,000) -------------- 2004 2005 2006 JANUARY 27,956.14 29,303.14 25,119.59 FEBRUARY 27,484.76 30,388.61 28,260.50 MARCH 26,579.69 28,977.07 APRIL 25,879.34 25,089.14 MAY 25,405.73 22,493.91 JUNE 25,285.17 21,595.64 JULY 25,611.18 20,561.79 AUGUST 27,263.38 19,702.21 SEPTEMBER 30,111.62 20,769.36 OCTOBER 29,618.87 19,651.74 NOVEMBER 29,306.54 19,992.69 DECEMBER 29,952.18 20,394.83 SOURCE: Caracas Stock Exchange, Banco Mercantil, and Metroeconomica. -------------- CENTRAL GOVERNMENT FINANCIAL RESULTS -------------- ¶16. (U) Total central government ordinary expenditures increased to 27.4 percent of GDP. This increase in public spending was initiated in mid-2003, and has been possible because of stronger oil prices, as well as higher internal tax collection, especially sales tax and import duties. The Venezuelan Tax Authority (SENIAT) has increased tax collection 106 percent from USD 8.66 billion in 2003 to USD 17.85 billion in 2005. Although the 2005 central government financial results show a fiscal surplus (2.1 percent of GDP), total government off-budget expenditures could have reached USD 5 billion. During the first two months of 2006, the National Assembly approved 8 trillion Bolivars (USD 3.7 billion) in additional credits to be spent by the government. This is in addition to the already approved 2006 National Budget (USD 40.5 billion). We anticipate that at government expenditures to be at least 30.5 percent of GDP, with potential off-budget spending of up to 10 percent of GDP in ¶2006. CENTRAL GOVERNMENT FINANCIAL RESULTS (Percentage of GDP)(1) -------------- 2004(2) 2005(2) TOTAL REVENUES 23.9 29.5 Oil income 11.5 14.6 Non-oil income 12.5 14.9 TOTAL EXPENDITURES 26.3 27.4 OVERALL FISCAL SURPLUS/DEFICIT(-)-2.4 2.1 (1) Including FONDEN (2) Preliminary figures Source: Central Bank of Venezuela. -------------- PUBLIC SECTOR DEBT -------------- ¶17. (U) The government has been actively refinancing its domestic and external debts since 2003. In late February, the Finance Minister announced that the BRV will reduce debt by 27.4 percent by the end of 2007. The BRV plans to prepay some of its most expensive external debt and improve the maturity profile of domestic debt (reftel E). During November 2005, the Ministry of Finance allocated bonds for the equivalent of USD 3.0 billion (reftel C). These dollar denominated bonds, which mature in the years 2016 and 2020, were bought by local investors in local currency. Domestic debt increased substantially (295 percent in current US dollars) during Chavez, administration, from USD 4.1 billion at the end of 1998 to USD 15.5 billion at the end of 2005. END OF PERIOD PUBLIC SECTOR DEBT (USD BILLION) -------------- -------------- 2003 2004 2005(1) CENTRAL GOVERNMENT 38.6 42.0 46.0 FOREIGN DEBT 23.7 26.6 30.5 RESTRUCTURED DEBT 5.8 4.8 4.4 NON-RESTRUCTURED DEBT 17.9 21.8 26.1 DOMESTIC DEBT 14.9 15.4 15.5 AGENCIES 1.1 0.9 0.6 -------------- -------------- -------------- PUBLIC SECTOR DEBT (2) 39.7 42.9 46.6 (1) Preliminary figures. (2) It does not include PDVSA,s nor Central Bank,s debts. SOURCES: Ministry of Finance, and Santander Investment. -------------- BANKING SYSTEM -------------- ¶18. (U) Profits (net financial margin) decreased during 2005 because around 32 percent of the total loans given by the banks must be allocated by law to specific economic sectors at preferential interest rates, including housing (10 percent),agriculture (16 percent),micro-busines (3 percent),and tourism (2.5 percent) (reftel F). However, loans for consumption increased 91 percent during 2005. This increase can be attributed to the strong economic growth (9.3 percent) prompted by increased BRV spending, relatively low interest rates, and probably a desire to buy now before an expected devaluation in early 2007. The car loans increased 180 percent during 2005, while the mortgage loans increased by 146 percent. A new government-owned bank (Treasury Bank) started operations during 2005, but it is not fully operative. The BRV created the Treasury Bank in August 12, 2005 to act as the BRV financial agent, to pay the debt service for domestic and external debt, conduct foreign trade operations, receive income taxes, and serve as the BRV cashier. The new Treasury Bank will also hold accounts for FONDEN and FIEM (Now FEM). BANKING SYSTEM KEY INDICATORS (percentages) -------------- DEC 04 JUL 05 DEC 05 Past due loans/ gross loans 1.65 1.47 1.08 Credit portfolio allowance/ past due loans 224.45 205.99 251.34 Equity/total assets 12.57 12.03 11.12 Net financial margin/ average asset 5.89 3.57 3.66 Net financial margin/ average equity 45.21 30.86 32.49 Net loans/ total deposits 48.04 47.75 54.86 Source: SUDEBAN -------------- INTEREST RATES -------------- ¶19. (U) The BCV started to apply interest rate regulations at the end of April 2005, by which a maximum and a minimum levels were set for the banking system lending (28 percent) and deposit (6.5 percent) interest rates. On January 31, 2006, the BCV issued a resolution keeping the same maximum and minimum interest rates, but reducing the interest rates that the BCV pays on the certificate of deposit issued by the monetary authority (28 days) from 11.5 percent to 10.0 percent (reftel B). AVERAGE INTEREST RATES OF THE SIX MOST IMPORTANT COMMERCIAL AND UNIVERSAL BANKS -------------- --- Loans Deposits -------------- -------------- Savings 90 days 1999 31.89 7.05 18.90 2000 23.91 3.35 14.80 2001 25.64 2.40 14.13 2002 37.08 3.90 28.29 2003 24.05 6.15 17.58 2004 17.06 4.52 12.93 2005 15.36 6.64 11.74 2006 JAN 14.93 7.39 10.48 SOURCE: Central Bank of Venezuela. -------------- INTERNET RESOURCES -------------- ¶19. INTERNET RESOURCES: AMEMBASSY CARACAS WEBSITE: www.embajadausa.org.ve - EXCHANGE RATES AND INTERNATIONAL RESERVES: www.bcv.org.ve - STOCK EXCHANGE: www.caracasstock.com - TRADE AND LABOR FORCE STATISTICS: www.ine.gov.ve - BUSINESS INFORMATION: www.venamcham.org - INVESTMENT OPPORTUNITIES: www.conapri.org - PETROLEUM INFORMATION: www.pdvsa.com, www.mem.gov.ve - PUBLIC FINANCE INFORMATION: www.mf.gov.ve - FINANCIAL INDICATORS: www.sudeban.gov.ve - ECONOMIC PUBLICATIONS: www.metroeconomica.com.ve, www.veneconomy.com, www.bancomercantil.com, www.provincial.com - NEWSPAPERS: www.eluniversal.com, www.el-nacional.com - LEGAL PUBLICATIONS: www.datalegis.com.ve, www.bpmaw.com, www.traviesoevans.com, www.tpa.com.ve, www.drba.com.ve - VENEZUELAN GOVERNMENT: www.venezuela.gov.ve, www.platino.gov.ve BROWNFIELD