Identifier
Created
Classification
Origin
09CARACAS454
2009-04-08 21:35:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Caracas
Cable title:  

INFLATION AND A FIXED EXCHANGE RATE INCREASINGLY

Tags:  ABUD AFIN AMGT CMGT APER ECON EFIN VE 
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VZCZCXYZ0001
PP RUEHWEB

DE RUEHCV #0454/01 0982135
ZNR UUUUU ZZH
P 082135Z APR 09
FM AMEMBASSY CARACAS
TO RUEHC/SECSTATE WASHDC PRIORITY 2887
INFO RUEHFSC/USOFFICE FSC CHARLESTON PRIORITY 4612
UNCLAS CARACAS 000454 

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ABUD AFIN AMGT CMGT APER ECON EFIN VE
SUBJECT: INFLATION AND A FIXED EXCHANGE RATE INCREASINGLY
STRAIN EMBASSY OPERATIONS

REF: A. 2008 CARACAS 313

B. 2008 CARACAS 376

C. CARACAS 87

D. 2008 STATE 101179

UNCLAS CARACAS 000454

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ABUD AFIN AMGT CMGT APER ECON EFIN VE
SUBJECT: INFLATION AND A FIXED EXCHANGE RATE INCREASINGLY
STRAIN EMBASSY OPERATIONS

REF: A. 2008 CARACAS 313

B. 2008 CARACAS 376

C. CARACAS 87

D. 2008 STATE 101179


1. (SBU) Summary: Budgetary pressures stemming from
Venezuela's unorthodox economic policies have strained Post's
operations and will almost certainly pose stark choices for
Post and the Department in the coming year. Inflation is
high and growing, and the official exchange rate has been
fixed at the same level for the past four years. As a
result, the official dollar cost of a given good or service
paid for in the local currency (the bolivar, or Bs) has risen
on average by over 100 percent since 2005. Post has managed
budgetary pressures thus far by converting many contracts
from bolivars to dollars; using an ICASS carryover; and
granting LES wage increases that are lagging behind
inflation. We have already exhausted the benefits of these
measures. With many economists predicting inflation of at
least 40 percent in 2009, Post will need additional support
to cover local procurements and to bring LES compensation up
to the level of comparators as purchasing power drastically
erodes. One measure providing immediate relief would be to
pay LES in dollars. Absent an official devaluation,
increased funding, or some other creative solution, Post may
face a financial crisis before the end of FY 2009. End
summary.

--------------
The Economic Background
--------------


2. (U) The Government of the Bolivarian Republic of
Venezuela (GBRV) has maintained a fixed exchange rate regime
with currency controls since 2003, last adjusting the rate
from 1.92 to 2.15 Bs/USD in March 2005. At the same time,
populist economic measures have caused inflation to increase,
from 14 percent in calendar year (CY) 2005 to 31 percent in
CY 2008 (ref A). From March 2005 through the present, prices
have risen 110 percent on average. In other words, an item
that cost Bs 215 in March 2005 might now cost Bs 450.
Accounted for in dollars at the official rate, the increase

would be from USD 100 to USD 210. Most local economists
predict inflation of at least 40 percent in CY 2009 (ref B);
some believe it could be as high as 60 percent. Many
economists believe the GBRV will not devalue the currency in
2009, choosing instead to respond to low oil prices by
restricting the quantity of dollars it sells at the official
rate.


3. (U) Whenever currency controls exist, an alternative
foreign exchange market develops. Venezuelan law offers a
legal means for foreign exchange transactions on this
parallel market via "swaps" of securities. The parallel
market is growing in size as demand for dollars grows and the
GBRV restricts the amount of dollars available at the
official rate. The market is also highly volatile: the rate
ranged from 2.5 to 3 Bs/USD from March 2005 to October 2006;
rose rapidly the ensuing 12 months to peak at 6.8 Bs/USD in
November 2007; quickly plummeted to a fairly steady 3.4
Bs/USD from April to August 2008; and then rose steadily to
its current level of 5.8 Bs/USD. At the current level, one
USD is worth 2.5 times more Bs when exchanged on the parallel
market than at the official rate. The GBRV has been the
largest supplier of dollars to the parallel market, though
the absence of a consistent intervention strategy is a
leading cause of the market's volatility (ref C).

--------------
Embassy Accounting and Budget
--------------


4. (SBU) All Embassy operations are accounted for at the
official rate. A local contract executed in Bs, for example,
is converted to USD at the official rate for accounting
purposes. Visa applicants may pay MRV fees in USD or in the
equivalent in Bs at the official rate (obviously, almost all
pay in Bs). As the Bs received through MRV fees far exceed
the Bs needed for State operations (Bs 36.5 million vs. Bs
21.3 million for FY 2008),there is no need for the USG to
change USD into Bs. Post understands that the USG, through
an agreement with the Central Bank of Venezuela, is able to
change excess Bs into USD at the official rate.


5. (SBU) Post's budget for State operations has declined
roughly 5 percent over the period the exchange rate has been
fixed at 2.15 Bs/USD, from USD 20.1 million in FY 2006 to USD
19 million expected for FY 2009. Embassy expenditures on
State operations are currently more or less evenly split
between USD and Bs (when converted to USD at the official
rate). In FY 2008, the Embassy disbursed a total of USD 18.7

million (including obligations actually disbursed in FY
2009),of which roughly 53 percent was spent in bolivars (Bs
21.3 million, or USD 9.9 million at the official exchange
rate). LES salaries are the largest expense in Bs, amounting
to Bs 9.2 million (USD 4.3 million) in FY 2008. Contracts
are the second-largest expense in Bs. (Note: The USD
400,000 difference between the amount budgeted and the amount
disbursed for FY 2008 is primarily due to unused DS (USD
310,000) and MRV (USD 40,000) allocations. End note.)

--------------
Strains on Embassy Operations
--------------


6. (SBU) Inflation has presented challenges for companies
and other institutions operating in Venezuela. The strain
has been even more pronounced for the Embassy. Whereas
companies can increase the bolivar prices of their products
to keep pace with rising expenses, the Embassy's budget is
fixed in USD and, as noted above, has declined slightly since
FY 2006. If an Embassy services contract in Bs were to have
increased at the same rate as inflation, to use the example
of paragraph 2, the same services purchased with Bs
equivalent of USD 100 in March 2005 would now cost the Bs
equivalent of USD 210. While the increases have been less
pronounced, even local goods and services the Embassy has
traditionally acquired in USD are subject to inflationary
pressure. The best example is dollar denominated apartment
leases, which have been increasing 10 to 15 percent annually
on average.


7. (SBU) The Embassy has managed the strain from rising
prices in several ways over the past three years. First, LES
compensation increases have been kept below inflation. The
table below shows the average LES compensation increase and
inflation for the last three FYs, all in percentage terms.

LES Compensation Increase Inflation

FY 2006 5.3 15.5
FY 2007 10.0 17.2
FY 2008 10.0 31.1
FY 2009 8.3 tbd

Over the last three years, therefore, even LES who qualify
for Within Grade Increases (which have averaged about 5
percent a year) have not seen their compensation keep pace
with inflation. The difference is significant from the
Embassy's budgetary perspective. If LES had been granted an
increase commensurate with inflation in FY 2008, the
additional annual cost would be on the order of USD 900,000.
(Note: The increases for FYs 2006 to 2008 went into effect
in the spring of the respective year. For FY 2009, post
requested an early compensation review given the impact of
rising inflation on LES morale. The 8.3 percent increase
subsequently granted went into effect in November 2009. End
note.)


8. (SBU) In addition to LES compensation lagging behind
inflation, the second way the Embassy has managed the strain
is by converting key service contracts from Bs to USD
starting in February 2008. Recent examples include contracts
for cleaning, health insurance for local staff, and post
language classes. The USD rate is set based on the cost of
the services in Bs and an expected parallel foreign exchange
rate. Thus, with an expected parallel rate of 5 Bs/USD, a
contract that might have cost 50,000 Bs/month, or USD 23,000
at the official rate, only costs USD 10,000 per month. In
this example, there would be a one-time annual savings of USD
120,000. From the three contracts mentioned above, the
Embassy estimates it will realize one-time annual savings of
USD 370,000, spread out over FYs 2008 and 2009. While
conversion of these and other contracts have provided the
Embassy with significant one-time savings, allowing us in
effect to devote more funds to expenses we cannot convert to
dollars, we have picked all the low-hanging fruit. How fast
the USD cost of these contracts increases as they are renewed
in the future depends on whether changes in the parallel rate
keep up with local inflation.


9. (SBU) Finally, in some cases the Embassy has simply cut
back on expenses in ways that reduce our effectiveness.
Representation is a good example, though it represents only a
small percentage of the overall budget. Prices for the food
and hotels/restaurants categories are rising even faster than
the general inflation index. In response, we have shifted
the type and scale of the representational events we host and
cut back on the number. (Note: We are beginning to
implement a plan whereby U.S. direct-hire officers will be
reimbursed for representational expenses in USD, with the
parallel rate used to convert from Bs to USD. This plan will

stretch our severely depleted representational capacity. As
is the situation with contracts, future year-on-year changes
in representational capacity will depend on how changes in
the parallel rate compare with inflation. End note.)

--------------
Difficult Choices Ahead
--------------


10. (SBU) The most critical strain on Embassy operations in
2009 will likely be related to LES compensation. If
inflation remains in the 30 to 40 percent range as expected,
LES purchasing power, already depleted over the past several
years, could drop up to 50 percent before they receive
another salary increase. Post may consequently need to
request another early review, which we expect would show that
compensation at comparators has risen at least 20 percent
relative to the early FY 2009 review. If the official
exchange rate remains unchanged, the Department must be
prepared for a large increase in dollars allocated for LES
compensation: a 20 percent increase (possibly below the
expected increases for comparators) would amount to roughly
an additional USD 900,000 on an annual basis.


11. (SBU) There is one step that would instantly raise LES
purchasing power and increase morale without necessarily
increasing compensation (in an accounting sense at least),
namely paying LES salaries in dollars rather than bolivars.
There would be no accounting cost to the USG and no actual
cost as long as the Central Bank of Venezuela continued
converting excess Bs to USD at the official rate for the USG.
Post understands the Department would not normally authorize
payment in dollars unless comparators also predominantly paid
in dollars (ref D). Anecdotal conversations indicate that an
increasing number of multinational companies and embassies
are paying some LES at least partially in hard currency.
Post will follow up with comparators and other similar
organizations and report septel on our findings and on other
considerations specific to the issue of paying LES in dollars.


12. (SBU) The second area of strain in 2009, should
inflation remain high and the official exchange rate remain
constant, will be in locally procured items. With the FY
2008 ICASS carryover spent (and no similar carryover
available for FY 2009),prices rising rapidly, and few
additional opportunities to dollarize local procurement, Post
may be forced to postpone planned and necessary local
acquisitions, such as vehicles, and to put off facilities and
maintenance projects requiring locally procured materials.
CAULFIELD