March 28, 2011 / 11:13 AM / 8 years ago

Venezuela economy and risks

CARACAS (Reuters) - Venezuela’s economy is the laggard in Latin America, with sluggish growth predicted for this year despite surging prices for oil, its main export. Public spending by President Hugo Chavez ahead of his bid for re-election in 2012 should partially make up for decline in private sector investment.

ECONOMIC GROWTH

Venezuela’s $285 billion economy was the fourth largest in Latin America in 2010 but it contracted 1.4 percent in a second year of recession. GDP grew a tepid 0.6 percent in the fourth quarter compared with a year earlier. Despite a jump in oil prices — nobody is predicting a return to the rapid expansion the OPEC member nation enjoyed until 2008. The finance ministry forecast growth of 2 percent in its budget for 2011, although Chavez says the target is higher.

INFLATION

Slow growth is exacerbating Venezuela’s decades-old problem of double-digit inflation, and real buying power has shrunk rapidly in the last couple of years despite large annual pay rises mandated by the government. Twelve-month inflation through February was 28.7 percent, one of the highest rates in the world. Venezuela has avoided hyper-inflation thanks to its oil income, which allows it to import a large amount of consumer goods.

Government-mandated wage hikes of up to 30 percent are common, but labor unrest is on the rise among both public and private workers and could become a headache for Chavez.

OIL PRODUCTION

Oil output fell in 2010 to 2.78 million barrels per day, its lowest level since a strike froze output eight years ago, according to data released by the Energy Ministry. South America’s top oil exporter, Venezuela sits on some of the largest crude reserves in the world.

Oil sales provide 95 percent of Venezuela’s export income and falling output is a problem for Chavez, who uses the money to finance costly social programs and nationalizations and is widely expected to ramp up spending ahead of presidential elections in 2012.

However, with oil prices at their highest level since 2008, state oil company PDVSA’s cashflow situation may improve this year. New investment in the Orinoco extra heavy crude belt should start producing some oil by the end of next year.

CURRENCY AND DEBT

Venezuela has a complex system of foreign currency controls, with an official pegged rate of 4.3 to the dollar, limits on the amount of foreign currency legally available to individuals and a series of rates set via bond transactions. On the black market the dollar sells at about double the official rate. Devaluations are common.

The central bank also sells some dollars at around 5.3 bolivars in auctions that last year accounted for roughly a quarter of the foreign exchange bought legally by local businesses and individuals, about $33 million per day.

Between sovereign debt and bonds issued by PDVSA, Venezuela has borrowed $10 billion from international markets in the last 12 months. On top of that, China agreed to pay at least $20 billion last year for future oil deliveries.

Appetite for Venezuelan bond issues is high, thanks to local demand for the paper which can be used as a currency exchange instrument to side-step stiff foreign exchange controls. Overseas investors are attracted to Venezuelan debt by high yields, even though it is seen as risky. It is also seen as a hedge against high oil prices. Some investors are worried by oversupply.

Venezuela’s banking system has negative real interest rates, so they are not effective, or used, as a monetary lever and have no bearing on attracting foreign money to the country. Local currency bonds are bought by local investors.

Despite its sluggish performance overall, as a major oil exporter Venezuela reported a $3.6 billion current account surplus in the fourth quarter.

POLITICAL RISK

All eyes are on the December 2012 presidential election, where Chavez will seek a new six year term. The opposition is hopeful it can beat Chavez, whose popularity ratings slid last year as the economy slumped.

First though, opponents from 20 parties must chose a single candidate to face him, a process that will dominate their agenda this year. Meanwhile, Chavez will start campaigning. His ratings are currently rising and are above 50 percent thanks to increased public spending on the back of higher oil prices.

Scarcity of certain products such as milk is a potential problem, but the government will seek to overcome shortages with imports. Expect more nationalizations as Chavez seeks to increase the role of the state in most areas of the economy.

Sources:

GDP - International Monetary Fund. Venezuela’s GDP is hard to measure in dollars because of its heavily regulated exchange rate and frequent devaluations. Calculated using Purchasing Power Parity, Venezuela’s is the fifth largest economy in Latin America.

Oil Production: Energy Ministry

Other data: Banco Central de Venezuela

Reporting by Frank Jack Daniel; Editing by Daniel Wallis and W Simon

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