BANCO MERCANTIL PRESENTS POLITICAL AND ECONOMIC

C O N F I D E N T I A L CARACAS 000186 SIPDIS SIPDIS HQ SOUTHCOM ALSO FOR POLAD TREASURY FOR MMALLOY NSC FOR JCARDENAS AND JSHRIER COMMERCE FOR 4431/MAC/WH/MCAMERON E.O. 12958: DECL: 02/14/2018 TAGS: ECON EFIN PGOV VE SUBJECT: BANCO MERCANTIL PRESENTS POLITICAL AND ECONOMIC OUTLOOK FOR 2008 Classified By: Economic Counselor Andrew N. Bowen for reasons 1.4 (b) a nd (d). ¶1. (C) Summary: In a February 12 meeting with the Ambassador, senior economists of Banco Mercantil, one of Venezuela's four largest banks, argued that President Chavez was facing simultaneous adverse political and economic shocks following the December 2 referendum. Given his current vulnerabilities, the November 2008 elections for governors and mayors would be vital for Chavez' political project and be the focus of BRV political and economic policy. The economics team predicted an even more expansive fiscal policy in 2008 but discounted major economic policy changes because of high short-term costs. While we agree with many aspects of the team's analysis, we cannot rule out that Chavez will continue to push forward forcefully in the short run with some of the political and economic components of his Bolivarian revolution. End summary. -------------- Political and Economic Outlook For Chavez -------------- ¶2. (C) The Banco Mercantil economics team noted that President Chavez was facing simultaneous adverse political and economic shocks. On the political side, following the December 2 defeat of proposed constitutional reforms, Chavez no longer appeared invincible; fractures were developing among his supporters; and people were starting to hold him accountable politically. On the economic side, he was faced with inflation, shortages, increasing perceptions of corruption, and poor public management. Given these vulnerabilities, winning the November 2008 elections for governors and mayors would be vital to Chavez' "socialist-hegemonic" political project. The team concluded that Chavez would for the time being focus on political survival rather than rapidly forcing his socialist vision on the economy. ¶3. (C) The group outlined the following political consequences of their assessment: (a) Chavez would seek to broaden and give flexibility to his political supporters as long as they acknowledged his leadership; (b) Chavez would feel pressure to deliver on issues such as security, public services, and corruption; (c) Chavez would back off from his socialist rhetoric; (d) Chavez would favor candidates with strong popular bases over ideologues for the upcoming elections; (e) Chavez would seek to consolidate international support where he could (e.g., from Bolivia and Nicaragua); and (f) Chavez would maintain a confrontational stance toward Colombia and the U.S. to distract Venezuelans from their real problems (and his responsibility for them) and as a potential reason for postponing the 2008 municipal and state elections if it were clear he and his supporters would lose significant ground. ¶4. (C) The Banco Mercantil team reasoned that, on the economic side, Chavez would focus on short-term results and shun major policy changes that would carry high near-term costs. They forecast an even more expansive fiscal policy in the run-up to the elections, with spending focusing on social needs rather than productive public investment. They predicted that Chavez would lift or change some price controls to alleviate scarcity, but noted that many of his tactics to address scarcity would only aggravate underlying supply-side problems and thus contribute to inflation and scarcity. -------------- A Rosy Macroeconomic Outlook - For 2008 -------------- ¶5. (C) The team presented a generally rosy macroeconomic picture for 2008 thanks to an increasing oil windfall. They predicted real GDP growth of 6.6 percent, concentrated in the non-tradable sector; petroleum export earnings of USD 76 billion (as opposed to USD 63 billion for 2007); and on-the-books central government spending of USD 91 billion (as opposed to USD 63 billion in 2007, with bolivars converted at the official rate). Given local banks' appetite for government debt, the group predicted the government would have no trouble raising the USD 8 billion it would need to cover its primary deficit and debt payments and roll-over. They noted that inflation, which they expected to reach 24.3 percent, would be the BRV's macroeconomic "Achilles heel" in ¶2008. Banco Mercantil's senior economist contrasted his optimistic short-term scenario with his certainty of a medium-term economic crisis, born from a well developed sense of "deja vu" over Venezuela's repeated boom-bust cycles. -------------- A Few Facts That Don't Fit -------------- ¶6. (C) During conversation after their economic team's presentation, Banco Mercantil executives expressed discomfiture about several "facts on the ground" that did not square with their team's analysis. They noted they had no explanation for why financial support to the BRV,s social missions appeared to diminish in the run-up to the December referendum. Similarly, they questioned why, given the political urgency and the ample economic resources at its disposal, the government had been unable to ensure adequate supplies of staple items such as milk. Questioned as to the accuracy of their figure for the value of petroleum exports in 2007, which was based on Central Bank figures, the senior economist agreed that it might in fact be lower and might also include promised payments (e.g., from PetroCaribe countries) that would never materialize. -------------- Comment -------------- ¶7. (C) As the Ambassador noted to his hosts, we concur with many aspects of Banco Mercantil's analysis. Given Chavez' unpredictability, however, it is impossible to write off the possibility that he will continue to seek to force major policy changes both politically and economically in the short term. We also believe that their macroeconomic analysis does not adequately account for problems like crime and the microeconomic issue of scarcity, which will place increasing pressure on the BRV in 2008. DUDDY