AFTER THE FIRST PASS, BRV GOES ON ATTACK AGAINST

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SUBJECT: AFTER THE FIRST PASS, BRV GOES ON ATTACK AGAINST
INFLATION

REF: A. CARACAS 291

B. 06 CARACAS 3375

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SUMMARY
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1. (SBU) At a press conference on February 11, Vice President
Jorge Rodriguez, Finance Minister Rodrigo Cabezas, and
Minister of Light Industries and Commerce (MILCO) Maria
Cristina Iglesias announced details of the BRV's
anti-inflation pact. Plans include eliminating the Value
Added Tax (IVA) on certain agricultural products, subsidizing
agricultural production, and implementing measures to reduce
liquidity, including dollarizing PDVSA tax payments. These
efforts combine harsh rhetoric with a surprising, if
rudimentary, understanding of a market economy for the BRV.
They also took the opportunity to continue attacks against
"speculators, hoarders and blackmailers" and exhorted
communal councils to be vigilant against price increases.
END SUMMARY.

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FIRST, THE CARROT
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2. (U) At a February 11 press conference from Maracaibo, Vice
President Jorge Rodriguez, Finance Minister Rodrigo Cabezas
and Minister of Light Industries and Commerce (MILCO) Maria
Cristina Iglesias announced a series of measures to combat
inflation, which grew 2 percent in January and, if
extrapolated, would mean an annualized rate of 27 percent for
2007 (reftel). The headline announcement was the elimination
of the country's IVA value-added tax (currently between 8 and
14 percent) for beef, pork, mayonnaise, oats, white cheeses,
turkey, and other foods considered to be of "primary
necessity."


3. (U) The IVA is charged at every step in the production
chain and in the case of meat, should cause a significant
reduction (around 25 percent) in the overall cost to the
consumer as it will remove the compounded rate charged when,
for example, beef is sold to the slaughterhouse, then to the
warehouse, then to the supermarkets, and finally on to the
consumer. However, even with the elimination of the IVA,
supermarkets will still have to sell meat for more than the
controlled price in order to break even. These changes are
expected to take effect on March 1. (Note: A large cattle
rancher told Econoff that the BRV will have a hard time
enforcing the controlled price on meat as there are over
35,000 sales points throughout the country. End Note).


4. (U) The VP also announced that the government would begin
subsidizing cotton, sugar cane, corn, sorghum and rice, and
that the BRV would spend USD 183 million in 2007 on these
subsidies, to be paid in two lump sums in February and
September. According to Rodriguez, these payments would be
part of an agreement with producers to lower their prices.


5. (SBU) Meat has begun to return to store shelves in
Caracas, though in limited quantities, and apparently is
still selling at prices above those set by the government.
In a rare act of economic good sense, Cabezas and others have
admitted that they cannot force supermarkets to sell meat
below cost, and instead are now aiming to reduce the cost at
which retail vendors purchase meat to below USD
2.30/kilogram, which according to them would allow vendors to
sell meat at the controlled price and still make a profit.


6. (SBU) On February 13, Iglesias announced a change to the
price control regime, increasing the price for meat by USD
1.20/kilogram and imposing price controls for meat at each
stage in the supply chain. In addition, MILCO is raising the
prices for chicken, eggs and powdered milk (all of which had
costs of production in excess of the regulated prices). It
is not clear whether these price increases will, when coupled
with IVA elimination and subsidies, make their sale
profitable for supermarkets. In Venezuela, meat currently
sells at an average price 35 percent higher than the new
5.45/kilogram ceiling.

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CARACAS 00000332 002 OF 003


THEN, THE STICK
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7. (U) At the same time, the Institute for the Defense and
Education of the Consumer (INDECU) has been raiding
businesses and warehouses that were supposedly hoarding
products. According to the VP, as many of 700 tons of food
have been retrieved and will be distributed to consumers. A
competition has sprung up between INDECU and the Venezuelan
tax authority, SENIAT, which seem to be trying to outdo one
another in closures and seizures.


8. (SBU) MILCO Minister Iglesias also announced an upcoming
decree from Chavez, entitled the "Law for the Defense of the
Right to Feed and the Restitution of Order in the
Distribution Chains of Foods under the System of Price
Controls." This decree reportedly would give the government
very wide latitude to take control of food distribution
chains in order to, in the words of Iglesias, put "food
commercialization in the hands of the people and the
revolutionary government."


9. (SBU) Community Councils also gained new responsibilities
at the press conference, where they were charged by Iglesias
with forming a version of Neighborhood Watch programs,
designed to keep an eye on vendors and ensure adherence to
the 400-some odd price controlled items currently in place in
Venezuela. In revising the Community Council law, Rodriguez
argued that the government had to give "tools to the public"
to "attend to the necessities of the population," including
monitoring, and potentially being able to sanction,
supermarkets and salespeople.

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FINALLY, STEPS TO IMPROVE THE PLAYING FIELD
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10. (SBU) Finance Minister Cabezas also announced that the
Commission for the Administration of Foreign Exchange
(CADIVI) would increase dollar authorizations per person per
year for credit card purchases abroad (from USD 4000 to
5000),cash transactions (from USD 400 to 600),and internet
purchases (USD 2500 to USD 3000) to help drain liquidity. A
currency trader contact noted to Econoff that this action was
specifically targeted at the middle class, as the upper
classes have other means of obtaining dollars and Venezuela's
poor aren't taking vacations to Disney Land or purchasing
iPods online. Due to the country's overvalued official
exchange rate, a lively trade already exists where
Venezuelans purchase goods on-line from the U.S. at
2150Bs./dollar and then sell them here at the higher 3900
Bs./dollar parallel rate. A series of websites have been
setup to assist this trade.


11. (SBU) Cabezas also outlined a plan for PDVSA to pay its
taxes in dollars instead of Bolivars, which in theory could
temporarily reduce liquidity. As explained by Cabezas,
instead of paying its royalties, income tax, and dividends
(last year valued at around USD 26 billion) to the government
in Bolivars, PDVSA will now pay these taxes in dollars into a
special treasury account. These dollars will remain at the
Treasury until the government needs to spend money, at which
point the Central Bank will convert the dollars to Bolivars
as needed.


12. (SBU) PDVSA already has a dollar treasury account (USD
3.1 billion as of December 2006) where it accumulates dollar
proceeds until they are needed to pay expenses locally. It
remains to be seen if this new account will function
similarly. In addition, the private banking sector currently
holds approximately USD 9.1 billion in allocated, unspent
government funds. Banks make onward loans with these funds
and increase the money supply. Were the government to save
its money in dollars instead of in Bolivars in the banking
system, it could in turn reduce liquidity, but only as far as
the BRV holds back on spending. As soon as it starts
spending these tax revenues (in Bolivars),liquidity will
again rise. Given the BRV's insatiable desire to spend, it
is unlikely these dollars will remain untouched for long.
While most economists do not expect a devaluation in 2007
(barring a plummet in oil prices),holding its income in
dollars has the added benefit of protecting the government's

CARACAS 00000332 003 OF 003


liquid assets from devaluation and inflation.


13. (SBU) In additional bids to reduce liquidity, PDVSA and
the BRV are planning bond issuances. Having finally obtained
a credit rating (Moody's B1),PDVSA is purported to be
pondering up to a USD 3.5 billion issuance. At the same time
the Finance Ministry is planning another "bonos del sur"
issuance with Argentina valued at USD 1.5 billion. It is
currently unclear whether these instruments will be
convertible to dollars, or merely dollar-denominated
(inflation protected) bonds payable in Bolivars. As was the
case at the end of November, it is likely that any such
issuance will be over-subscribed (reftel). If there is
insufficient supply of dollar-convertible bonds (which allow
individuals and businesses in Venezuela to get their money
out),it is likely that the parallel market will spike again.

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COMMENT
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14. (SBU) This is the third "anti-inflation pact" in recent
history. As with previous anti-inflation pacts in the 1980s
and 1990s , this one too will do more to treat the symptoms
than the cause. As in many Latin American countries in the
last century, the government here believes that it can bully,
badger and threaten inflation away, while at the same time
promoting policies that encourage inflation to grow
(government expenditures, a fixed, overvalued exchange rate,
artificially low interest rates, etc.). While many of these
steps will likely dent inflation in the very short run, they
are unlikely to do much in the medium term. The Venezuelan
Central Bank is expected to announce additional measures this
week and it is likely that the government and National
Assembly will continue to gin up new ideas.


15. (SBU) At times sounding far more sensible than in recent
weeks, the VP and government ministers have admitted to the
problem and, in the case of meat, displayed a rudimentary
understanding of capitalism -- people won't sell products at
a loss. At the same time, much of the rhetoric and action
seems determined to blame those rascally capitalists as the
government's control over the economy seems to grow. END
COMMENT.

BROWNFIELD