UPDATE 1-Venezuela's economy slows sharply as 'stagflation' looms

* Economy grew 0.7 pct in Q1 vs 5.9 pct a year earlier

* Slowdown follows heavy government spending in 2012

CARACAS, May 31 (Reuters) - Venezuela’s economy slowed sharply in the first quarter, the central bank said on Friday, auguring a difficult year for the OPEC nation that is already struggling with galloping inflation and shortages of basic consumer goods.

The economy grew only 0.7 percent compared with 5.9 percent the same period a year earlier, influenced by lower growth in the oil sector and a contraction in construction.

A lack of hard currency that left businesses struggling to import key consumer products also contributed to the disappointing figure, the bank said. Venezuelans have struggled in recent months to find goods ranging from wheat flour to toilet paper.

The news is a blow to new President Nicolas Maduro, whose popularity depends on continuing the heavy spending of his predecessor, the late socialist leader Hugo Chavez. Maduro won by only 1.5 percentage points in April and opposition leaders are challenging the results.

With inflation at nearly 30 percent, Venezuela faces the prospect of rising prices and slowing growth - economic malaise known as “stagflation” - as well as growing questions about the Chavez-era state-driven economic growth model.

“This confirms stagflation. The economy is stagnant and inflation is rising, all of this with the price of oil at $104 (per barrel),” wrote Jose Guerra, a former central bank director turned government critic, via Twitter.

A key factor was the 1.2-percent contraction of the construction sector versus an expansion of 31.4 percent a year earlier, the result of slowdown in a massive home-building project last year.

Critics say that effort, which put hundreds of thousands of families in new apartments and helped Chavez win re-election five months before he died of cancer, constituted an unsustainable stimulus to the economy.

The manufacturing sector - crucial for job creation - shrank nearly 4 percent. State-run manufacturing, which expanded during Chavez’s six-year wave of nationalizations, contracted 12 percent.


Economists had widely predicted a slowing of government spending in the first quarter from its torrid pace of 2012, when Chavez showered the country with social spending on homes, pensions for the elderly and stipends for poor mothers.

Central Bank President Edmee Betancourt on Thursday said Chavez’s death “disrupted” the economy.

Months of uncertainty over the state of his health and more than a week of official mourning after he died likely contributed to the slowdown.

Chavez was widely supported among the poor who benefited from his social spending programs. Soaring oil prices kept government coffers full, and a consistently expanding economy ensured victories at the ballot box.

Maduro, Chavez’s anointed successor, now faces slowing growth even though the price of oil - which provides more than 95 percent of Venezuela’s export revenue - has remained strong.

“Probably in the third or fourth quarter we’re going to be in negative territory with an economic contraction of 1 percentage point,” said Angel Garcia of economic consultancy Econometrica, a harsh critic of the government.

Government supporters scoff at the opposition’s gloomy forecasts, noting that many of Wall Street’s dire predictions have proven to be considerably off the mark.

The Maduro administration is targeting 6-percent growth and 15-percent inflation for 2013.

A weaker economy may spur concerns among foreign investors who have for years flocked to the country’s lucrative bonds despite Chavez’s diatribes against capitalism.

Opposition leaders say the only solution is a gradual transition away from the Chavez-era policies such as frequent nationalizations and rigid price controls to convince private businesses to resume investment.

But Maduro’s slim victory in April gives him little room to reverse the main planks of his predecessor’s “21st century socialism” that included dramatic state takeovers and confrontations with businesses.

Many of his supporters, unimpressed by his 1.5-percentage-point election win, will want him to show the same social largesse as Chavez.

He will likely seek to spur the economy through state spending, but stretched public finances and the threat of worsening inflation may make this difficult.