VENEZUELA: Oil, Inflation and Prospects for Long-Term Growth Melody Chen and Maggie Gebhard 9 April 2007
BACKGROUND The economic history of Venezuela is unique not only among its neighbors, but also among other developing countries. In recent years, the South American nation has experienced political instability and remains exceedingly vulnerable to economic fluctuations, as evidenced by the sharp recession in 2002. This can partly be explained by the election of Hugo Chavez to the presidency in 1999. Elected on a populist platform, the so-called Bolivarian Revolution, Chavez has ushered in a new era of macroeconomic policies aimed at reducing poverty, ending corruption and redistributing the nation s wealth. These policies have significantly increased government expenditures, which have led to spillover effects throughout the economy. Overall, the Venezuelan economy has performed erratically since Chavez took office, especially with respect to the administration s initial platform to alleviate poverty. Moreover, the present actions of monetary and fiscal authorities are likely to threaten future growth prospects. Using the IS-LM-BP model, we will examine the domestic effects of recent macroeconomic policies, specifically looking at GDP (and its component variables), public debt, inflation, money supply and poverty. We contend that while there is evidence of economic growth, it is unclear whether this growth is beneficial to the poor or sustainable in the long run. We conclude with policy recommendations that address these concerns. RECENT MACROECONOMIC PERFORMANCE GDP and GDP per capita Since 1999, the year Chavez took office, real GDP has fluctuated considerably, undergoing periods of rapid expansion and contraction. Growth rates have ranged from a low of -9 percent in 2002 to a high of 18 percent in 2004. 1 The most current data shows that GDP grew 8.8 percent in 2006 to $176.4 billion, and GDP per capita reached $6,900 (adjusted to PPP), ranking third among Latin American countries behind Mexico and Chile. Venezuela continues to rely heavily on its reserves of natural resources, particularly oil revenues, which make up 30 percent of GDP. As such, changes in oil prices play a large role in how the Venezuelan economy performs. While some effort has been made to diversify the economy by bolstering heavy industry and revitalizing the agricultural sector, oil will likely remain the primary source of income in coming years. Currently, GDP is composed of 3.7 percent agriculture, 41 percent industry and 55.3 percent services. 2 It is important to note that changes in GDP for Venezuela have reflected both political and economic realities. The civil unrest and subsequent coup d état attempt which took place in 2002 serves as a fitting example. In order to increase the government s control over oil revenues, Chavez sought to restructure the state oil company Petróleos de Venezuela (PDVSA); however, his plans were resisted by PDVSA s senior management. After Chavez laid off top executives, the country s largest trade unions called for a two-day strike beginning April 9, 2002. The strike led to an attempted coup, in which Chavez was temporarily displaced. Although he regained 1 International Monetary Fund, World Economic Outlook 2006 Venezuela, http://www.imf.org (Accessed 12 March 2007). 2 CIA World Fact Book, Venezuela, Updated 8 March 2007, https://www.cia.gov/cia/publications/factbook/geos/ve.html (Accessed 18 March 2007). 2
power, Chavez faced continued resistance from PDVSA that year. In December 2002, PDVSA workers forced another strike and a lockout, which halted all activities for two months, including exporting 2.8 million barrels of oil per day. In the end, these activities (or lack thereof) cost Venezuela an enormous share of oil revenues, around $6 billion, and accounts for the drop in GDP growth in 2002 and 2003. 3 Government Expenditures Seeking to fulfill his campaign promises, Chavez has implemented macroeconomic policies focused on aiding Venezuela s poor. A sizeable amount of government spending has been committed to the Bolivarian Missions, an amalgamation of joint civil-military anti-poverty programs, of which Plan Bolivar 2000 was the first to be launched by Chavez in 1999. Plan Bolivar and successor projects have tackled such diverse activities as building public infrastructure and housing, to mass vaccinations and food distribution. 4 Whether or not these policies have successfully achieved their objectives, financing of propoor projects has dramatically increased government spending throughout Chavez s presidency. According to International Financial Statistics (IFS), pre-chavez government expenditures equaled 6.7 trillion Bolivar (roughly $10 billion) in 1998. This figure rose to 44.3 trillion Bolivar ($52.9 billion) in 2006 and is expected to continue its upward trend. Interestingly, despite absolute increases in government expenditures, relative levels of spending with respect to GDP have been fairly stable at 12 to 14 percent. 5 While government expenditures have undeniably driven growth in the economy, there are concerns that funding for programs like Plan Bolivar is overly dependent on revenues generated from oil exports and may not be sustainable in the future when oil prices weaken. Private Consumption Private consumption has risen since Chavez assumed the presidency although it did fall substantially during the economic downturn of 2002 and 2003, in tandem with the decline in government expenditures. As the Venezuelan economy has recovered, household consumption has boomed, jumping 15.5 percent in 2004, 17.8 percent in 2005 and 18.8 percent in 2006. 6 Car sales, for example, have increased 70 percent in the past year. 7 Today, private consumption is estimated to be 188.5 trillion Bolivar ($87.7 billion). 8 Several factors have contributed to the current consumption boom, namely tax cuts, minimum wage hikes and renewed government spending; however, worries about inflation as well as lower oil prices are likely to slow down private consumption. Compared to public spending, private consumption numbers have historically comprised of a much greater share of GDP. In the early to mid-1990s, household consumption hovered between 65 to 70 percent of GDP; more recently, it has decreased to 50 percent, largely due to 3 Venezuela s Bolivarian Movement: Its Promise and Perils, Venezuela s Bolivarian Movement (Accessed 29 March 2007), http://www.venezuelanalysis.com/articles.php?artno=1645. 4 Ibid. 5 International Financial Statistics (IFS), Venezuela (Accessed 29 March 2007). 6 Economist Intelligence Unit (EIU), Venezuela Country Data Annual Time Series (Accessed 29 March 2007). 7 CIA World Face Book, Venezuela. 8 EIU, Venezuela Country Data. 3
an emphasis on savings and investment. 9 As a final note, even though private consumption has expanded rapidly as a whole, individual household behavior has varied significantly. Many households have not participated in the consumption boom and remain in poverty. Savings and Investment Venezuela has an extremely high national savings rate, not only in comparison with its South American neighbors, but also compared to traditionally high-savings countries like Japan. Since 1999, national savings have consistently exceeded 28.6 percent, reaching a peak of 40.2 percent in 2005 and averaging 33.9 percent from 2000 to 2006. During the same period, Japan s average was 27.7 percent and the United States 14.5 percent. A substantial amount of private savings and relatively modest budget deficits have accounted for Venezuela s unusually high national savings rates. In particular, the Central Bank has repeatedly called on financial institutions to raise deposit rates, in order to encourage private savings. 10 Trends in investment have been highly erratic, experiencing the largest swings in association with shifts in the economy. Unsurprisingly then, investment plummeted in the recession years, but quickly regained ground in late 2003 and early 2004. By mid-2004, levels of investment had surpassed those achieved in pre-recession years. Investment has continued to rise: in 2005, investment totaled 61.2 trillion Bolivar ($28.5 billion) and increased to 87.9 trillion Bolivar ($40.9 billion) in 2006. Although investment is touted as one of Venezuela s new strategies for long-term growth, its share of GDP has remained constant around 22 to 24 percent. 11 Public Debt Despite record-high government expenditures, public debt ratios (total debt/gdp) have not posted any significant increases and have in fact improved in the past five or so years. This is mainly a result of the ongoing windfall in oil revenues, which has boosted GDP. In 2006, the Economist Intelligence Unit (EIU) reported that public debt was 24.3 percent of GDP and ranked 33 rd of 120 countries in lowest public debt ratios. 12 (Japan ranked 119th at 176.2 percent, and the United States ranked 90th at 64.7 percent.) Public debt is likely to grow as oil prices decrease. Inflation Venezuela has undergone episodes of severe inflation. Based on 1996 dollars (1996=100), the GDP deflator in 2006 was 1,018.76 and the CPI index was 847.74. As of February 2007, the Banco Central de Venezuela estimates inflation to be 20.4 percent, the highest in South America. 13 With recent cuts in VAT rates, inflation may decline temporarily but will manifest itself again as aggregate demand stays overly active. Speculation over devaluation of the Bolivar will be an additional source of inflationary pressure. The Venezuelan government has launched an anti-inflation plan that involves stepped-up action against speculators, a currency reform, a variety of ad hoc monetary measures and a sizeable reduction in indirect taxes. 14 9 EIU, Venezuela Country Data. 10 EIU, Venezuela Country Report (March 2007), 21. 11 EIU, Venezuela Country Data. 12 CIA World Fact Book, Rank Order Public Debt. 13 http://www.bloomberg.com/apps/news?pid=20601086&sid=awjxhvnkzyaa 14 EIU, Venezuela Country Report, 20. 4
Money Supply While oil revenues and GDP have thus far matched government spending, the Central Bank has also expanded the money supply considerably to pay for public expenditures. Unfortunately, this rapid growth in money supply has fueled inflation, as mentioned in the previous section. To contract the money supply and deal with excess liquidity, the Central Bank has announced that it will sell bonds to domestic investors worth $5 billion. 15 There are concerns that the Central Bank s independence is limited, and President Chavez may undermine the Bank s agenda. IS-LM-BP MODEL Interest Rate, r r 2 r* Y 1 Y 2 The IS-LM-BP model illustrates how recent fiscal and monetary policies have influenced interest rates and output. Venezuela currently operates under a fixed exchange rate regime. We also assume that Venezuela is a large, open economy due to its influence in the world oil market. Given this, domestic interest rates can deviate from the prevailing world interest rate (r*). The IS curve has shifted outward with recent expansionary fiscal policy. Normally, this action alone would be ineffective because the increase in output produced by the fiscal multiplier would be offset by a concurrent drop in net exports as the currency appreciated. However, the central bank has been forced to simultaneously engage in monetary expansion in order to maintain the fixed exchange rate. This reactionary policy is shown by an outward shift in the LM curve, which has amplified the effects of fiscal expansion. The impressive growth in GDP that Venezuela has recently achieved can be attributed to the combined policies of fiscal and monetary expansion. Under this scenario, output has increased significantly, but the monetary expansion has not been as large because the domestic interest rate can be above the world interest rate. While the observed outcome is beneficial to growth, the model does not capture the consequences of inflation that result from expansionary policies. LM 1 IS 1 IS 2 LM 2 BP 1 Output, Y RECOMMENDATIONS I. Allow for Discretionary Monetary Policy At present, Banco Central de Venezuela has little control over monetary policy other than to maintain the official exchange rate. The Central Bank must be given the opportunity to conduct discretionary monetary policy in order to target other macroeconomic variables besides the exchange rate. The government can accomplish this by allowing the Bolivar to float, giving the Central Bank more flexibility to target the more pressing concern of inflation. Venezuela 15 EIU, Venezuela Country Report, 9. 5
previously adopted a floating exchange rate regime in 2002, but quickly pegged the Bolivar back to the dollar after a sharp depreciation. Returning to such a regime would permit the monetary authority to reduce inflation to a sustainable level, although this would come at the expense of high levels of growth and predictability in trade. The immediate move to a floating exchange rate could cause another sharp depreciation, but this may be preferable to an evitable, and perhaps more painful, devaluation in the future. A corollary to allowing for discretionary monetary policy is tolerating the complete autonomy of the central bank. Although independence of this institution is guaranteed in the country s constitution, the central bank is still utilized by the government for political purposes. 16 Moving beyond rhetorical autonomy would help the central bank better control monetary policy with an eye for long run economic prosperity. II. Reduce Reliance on Oil Revenues Implementing Chavez s populist campaign pledges have drastically increased government expenditures without a concurrently large increase in government revenue. Using revenues from oil exports to finance a disproportionate share of government expenditures is an unsustainable policy given the high volatility of oil prices on the world market and the finite supply of oil available for export. Government spending will continue to be influenced by levels of oil revenue, which makes policy planning extremely difficult. Given that the expansion of educational opportunities has been funded largely by the national oil company 17, it is to the government s advantage to ensure that such programs can continue to be financed in the absence of windfall oil revenues. Instead, the country should develop a more consistent and selfsufficient tax system for raising revenues. Such a system would allow oil revenues to finance the gap between revenues and expenditures during times of recession without dictating the level of government spending. Separating government expenditures from oil revenues could also help impose fiscal responsibility by limiting the pool of funds from which the government can draw. This policy could have negative short-term impacts on spending on social programs should the government choose to scale back expenditures until additional tax revenue is generated. Alternatively, the public debt could balloon if government spending is maintained at its current level. CONCLUSION The last several years have been tumultuous for the economic and political landscape of Venezuela. Hugo Chavez s election in 1999 has resulted in both positive and negative adjustments to the economy. Healthy levels of domestic consumption, savings, and investment have contributed to impressive output growth; however, expansionary monetary and fiscal policies have created inflationary pressures. The policy of using oil export revenues to fund massive public expenditures is unsustainable and leaves the country exceedingly vulnerable to shocks. The future challenge for Venezuela will be to weigh the social benefits of implementing Chavez s populist policies against long-term economic costs. 16 EIU, Venezuela Country Profile 2007 (2007), 31. 17 EIU, Venezuela Country Profile 2007, 18. 6
Appendix Figure 1: GDP Growth GDP and GDP per capita Growth 20 15 10 % change 5 0 Real GDP Real GDP per capita -5 1996 1998 2000 2002 2004 2006-10 -15 Figure 2: Government Expenditures and Private Consumption 300,00 Venezuela: Government Expenditures and Private Consumption (1997-2007) 250,00 Government Expenditures Private Consumption 200,00 Bolivar (in billions) 150,00 100,00 50,00 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 7
Figure 3: National Savings Rates National Savings Rates (1997-2007) 10 9 8 7 6 Percent 5 4 3 2 1 Venezuela Japan (2000-2006) USA (2000-2006) 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Figure 4: Changes in GDP, Private Consumption and Investment Rates 6 Venzuela: Comparing Changes in GDP, Private Consumption and Investment (1997-2007) 5 4 3 2 Percent 1-1 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007-2 -3-4 -5 GDP Private Consumption Investment 8
Figure 5: Public Debt and % GDP Venezuela: Public Debt and % GDP (1997-2007) 120,00 100,00 Public Debt % GDP 10 9 8 80,00 7 Bolivar (in Billions)) 60,00 40,00 6 5 4 3 Percent 20,00 2 1 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Figure 6: Inflation Venezuela: Inflation measured by CPI and GDP Deflator (1997-2006) 4 35.00 3 25.00 Percent 2 15.00 1 5.00 CPI GDP Deflator 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 9