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UNCLAS SECTION 01 OF 06 CARACAS 002244 
 
SIPDIS 
 
SIPDIS 
 
NSC FOR DTOMLINSON 
 
E.O. 12958: N/A 
TAGS: ECON VE
SUBJECT: "TAN BARATO, DAME DOS" (SO CHEAP, GIVE ME TWO): 
CONSPICUOUS CONSUMPTION UNDERMINES VENEZUELA'S FUTURE 
ECONOMIC WELLBEING 
 
 
This message is sensitive but unclassified.  Please treat 
accordingly. 
 
¶1. (U) SUMMARY: Record high petroleum prices have handed 
Venezuela strong economic growth and a sharp increase in 
national income.  BRV fiscal and economic policies are 
incentivizing Venezuelans to direct this newfound wealth 
toward credit-financed consumption, in general, and 
consumption of imports, in particular, rather than toward 
saving and investment.  In the near term the steady flow of 
petrodollars will moderate the negative effects of these 
distortions in Venezuela's economy.  But failure to invest in 
and diversify Venezuela's non-oil-export and import-competing 
sectors will leave the country overly reliant on its oil 
sector for income, with painful consequences for ordinary 
Venezuelans.  END SUMMARY. 
 
--------------------------------------------- ---------- 
VENEZUELAN CONSUMPTION, SAVING, INVESTMENT, AND IMPORTS 
--------------------------------------------- ---------- 
 
¶2. (U) Venezuela's economy is growing briskly.  With 
petroleum prices at record levels and the Venezuelan oil 
basket currently selling at USD 64.83, Venezuela's real GDP 
grew 10 percent year-on-year through the first quarter of 
¶2006.  (NOTE: Broadly speaking, the BRV and the Venezuelan 
private sector can either consume or save the income derived 
from this growth in output.  In macroeconomic terms, 
consumption, by either the public or the private sector, is 
current expenditure on goods and services.  Saving is simply 
income not consumed.  Saving is in turn intermediated through 
the banking and financial sectors -- which transform savers' 
cash into loans and other credit for borrowers -- and thus 
becomes the domestic source of funding for investment. 
Investment is public- or private-sector expenditure intended 
to enhance future economic output, e.g., on infrastructure, 
plant and equipment, or inventories.  In short, the more of 
its income a country consumes, the less it saves and invests. 
 END NOTE.) 
 
¶3. (U) According to a recent analysis by MetroEconomica, a 
leading Venezuelan macroeconomic consulting firm, comparing 
the twelve months ending March 2006 with the twelve months 
ending March 2005, in constant 1997 prices (i.e., adjusted 
for inflation), overall Venezuelan consumption grew by 17.4 
percent.  Perhaps more important, much of this consumption is 
of foreign goods: imports to Venezuela increased by 22.6 
percent in real terms, while exports increased by 4.4 percent 
over the same period.  In 2005 roughly 25 percent of 
Venezuelan imports were consumer goods, 47 percent were 
intermediate goods, and the remainder capital goods for 
investment.  About 30 percent of Venezuelan imports came from 
the United States. 
 
¶4. (U) Comparing the twelve months through March 2006 with 
the preceding twelve, Venezuelan overall investment grew by a 
mere 0.5 percent.  MetroEconomica reports that recent changes 
to the Venezuelan Central Bank's methodology for compiling 
the national accounts make it difficult to distinguish 
public-sector from private-sector investment in constant 
prices.  But with overall investment growth of only 0.5 
percent -- despite greatly increased BRV spending on roads, 
metro systems, hydroelectricity projects, and buildings and 
infrastructure for its social programs -- the consulting firm 
concludes that private-sector investment is at best constant, 
and perhaps falling. 
 
¶5. (U) Longer term measures of these variables indicate that 
the recent figures in fact reflect trends under Chavez's 
watch.  Overall consumption as a percent of GDP has increased 
from approximately 67 percent in 1999 to 78 percent in 2006. 
 
CARACAS 00002244  002 OF 006 
 
 
Overall investment as a percent of GDP plummeted from roughly 
34 percent in 2001 to 12 percent in 2003 (due to acute 
political uncertainty at the time), bounced back to 30 
percent in the first quarter of 2005, but then fell again to 
roughly 25 percent in the first quarter of 2006.  Moreover, 
the ratio of Venezuelan exports to imports AT CONSTANT 1997 
PRICES has been falling (from 140 percent in 2003 to 80 
percent in 2005) as the country's oil production, which 
accounts for roughly 80 percent of its exports, has stagnated 
while the volume of goods and services it imports has grown 
markedly. 
 
¶6. (U) What do these figures mean in practical terms?  Using 
both cash and credit the BRV and ordinary Venezuelans are 
purchasing increasing amounts of imported consumer goods. 
Automobiles and cellular phones are two leading examples. 
The Venezuelan Automotive Chamber reported that vehicle sales 
increased nearly 70 percent in 2005, compared to 2004, and a 
report by Venezuelan financial research firm Softline 
Consultores found that car loans increased by 229 percent 
over the same period.  LG Electronics, a leading cellular 
phone and consumer electronics firm, recently reported that 
its Venezuelan sales have increased 700 percent since 2001. 
The Softline report further found that credit card purchases 
increased 73 percent in 2005.  According to Venezuelan 
Central Bank data, overall bank credit for consumption has 
increased 360 percent from December 2003 to May 2006.  Simply 
stated, Venezuelans are going shopping and incurring 
increasing amounts consumer debt. 
 
-------------------------- 
IT'S YOUR POLICIES, STUPID 
-------------------------- 
 
¶7. (U) Venezuelans' penchant for consuming instead of saving 
cannot simply be ascribed to cultural proclivities.  BRV 
economic policies are fueling this consumer behavior, both 
directly and indirectly.  Among the direct incentives are 
subsidies and price controls for goods of the basic food 
basket, health care services, and countless other consumer 
items.  Such measures facilitate consumption not only of the 
subsidized/price-controlled goods and services themselves, 
but, by freeing up additional income, also of automobiles, 
personal electronics, and the like.  In addition, 
Chavez-decreed increases to the minimum wage over the past 
two years have far outpaced the rate of inflation, increasing 
the real purchasing power of low-income earners. 
 
¶8. (U) In addition to these direct measures, there are at 
least three important policies indirectly driving consumer 
behavior: robust government spending, banking regulation, and 
the fixed foreign exchange rate regime.  With the public 
coffers as well as its off-budget financial vehicles (e.g., 
the National Development Fund or "FONDEN") full of 
petrodollars, the BRV has increased public spending 
substantially: from the equivalent of USD 26 billion in 2003 
to an estimated USD 42 billion for 2006.  Moreover, these 
figures do not include BRV spending through its off-budget 
accounts, which analysts estimate could total another USD 
10-15 billion this year.  According to the Central Bank, M2 
-- a monetary aggregate that includes currency in 
circulation, as well as demand, saving, and time deposits -- 
increased 57.5 percent, 50.4 percent, and 52.7 percent in 
2003, 2004, and 2005, respectively.  Despite the Central 
Bank's ongoing efforts to soak up excess liquidity (it sold 
roughly USD 1.6 billion in CDs to the banking sector from 
January to May of this year), M2 has increased more than 16 
percent to date in 2006. 
 
¶9. (U) This increased liquidity in turn has two primary 
effects.  First, more money circulating in the economy 
 
CARACAS 00002244  003 OF 006 
 
 
pursuing a slower growing quantity of available goods and 
services pushes up consumer prices, leading to inflation of 
27.1 percent, 19.2 percent, and 14.4 percent in 2003, 2004, 
and 2005.  While the BRV's stated aim is to reduce annual 
inflation to below 10 percent, most analysts forecast that it 
will hover around 12 percent for 2006.  Second, as happens 
with any good, the greater supply of money in the economy 
lowers its price, here the "price" being the interest rates 
banks charge borrowers when they take out loans.  Market 
interest rates have fallen steadily since 2003, squeezing 
banks' profitability.  In response banks have increased their 
fees for various services, lowered their own borrowing costs 
-- that is, the interest they pay out to clients on savings 
accounts and time deposits -- and aggressively marketed 
higher risk credit to consumers, such as personal consumption 
loans and credit cards. 
 
¶10. (U) Banks find their search for profitability hampered, 
however, by BRV-inspired regulation of the banking sector. 
Ostensibly, the Central Bank independently establishes 
interest rate regulations for banks, but few question the 
influence over the Bank's decision-making of Jorge Giordani, 
BRV Minister of Planning and Development, who sits on the 
board.  Under Central Bank regulations issued in 2005, banks 
must pay out at least 6.5 percent on savings accounts and 10 
percent on time deposits (e.g., CDs), and they may charge no 
more than 28 percent interest on loans and credits to 
borrowers.  In addition, banks must allocate 31.5 percent of 
their loan portfolios among various classes of borrowers -- 
home buyers, farmers, small business owners, and the tourism 
industry -- all at preferential rates.  Thus while banks' 
revenues and profits have been growing in absolute terms as 
they manage more market liquidity, their net financial margin 
per average asset, which measures profitability, has been 
narrowing: it shrank from 5.89 percent in December 2004 to 
3.66 percent in December 2005. 
 
¶11. (U) The net effect of the increased liquidity, inflation, 
falling interest rates, and banking regulations is that 
ordinary Venezuelans have far greater incentive to consume 
than to save and their banks have tremendous incentives to 
help them do so.  Saving makes little financial sense for 
ordinary Venezuelans: with 14 percent inflation outpacing the 
7 percent interest paid on savings accounts, would be savers 
face a real interest rate of approximately negative 7 
percent.  Time deposits look little better, offering a real 
interest rate of around negative 4 percent, and banks anyway 
disfavor them because paying their regulation-mandated higher 
interest rates further squeezes profit margins. 
 
¶12. (U) On the other hand, with interest rates on all forms 
of credit capped at 28 percent, ordinary Venezuelans face a 
maximum real interest rate on consumer and credit card debt 
of roughly 14 percent, favorable even by U.S. standards. 
Banks, moreover -- with approximately 46 percent of their 
asset portfolios in BRV bonds and Central Bank CDs paying 
them just over 10 percent, and another 31.5 percent of their 
assets in mandated lending at preferential rates -- have been 
aggressively and creatively marketing the remainder of their 
portfolios to higher-risk, higher-interest consumer credits. 
Beyond stepped up advertising, Venezuelan banks have been 
creating and promoting a wide array of consumer credit 
products: prizes for using credit cards; personal credit 
lines giving customers three times their monthly salaries and 
thirty-six months of financing for consumer purchases; and 
specialized personal credit lines for purchases of travel, 
cars, electrical appliances, furniture, televisions, video 
and sound equipment, computers, and cellular phones. 
 
¶13. (U) BRV economic policy not only directly and indirectly 
encourages ordinary Venezuelans to consume instead of save, 
 
CARACAS 00002244  004 OF 006 
 
 
it also encourages them to consume imports instead of local 
products.  Here, the most culpable policy prescription is the 
fixed exchange rate.  The BRV enacted exchange rate and 
currency controls in February 2003 to staunch widespread 
capital flight then taking place due to sharp political 
uncertainty.  Since then it has kept the official exchange 
rate fixed, devaluing it periodically until it reached its 
current level of 2,150 Bolivars per USD (Bs/USD) in the first 
quarter of 2005.  With the parallel market rate hovering 
around 2650 Bs/USD, most analysts estimate the Venezuelan 
currency to be overvalued by approximately 24 percent. 
 
¶14. (SBU) Though the justification of severe capital flight 
perhaps no longer pertains, the BRV has maintained the fixed 
exchange rate policy, among other reasons, to help anchor 
inflation: by keeping the exchange rate fixed, the government 
artificially depresses the local prices of imported consumer, 
intermediate, and capital goods (tradables, in economic 
jargon).  By way of example, if the government permitted the 
Bolivar to depreciate to its parallel market rate of 
approximately 2,650 Bs/USD, a USD 100 imported cellular phone 
now costing Bs 215,000 would instead cost Bs 265,000.  Most 
analysts have been anticipating a devaluation of the Bolivar 
in 2007 after the December elections, but Rodrigo Cabeza, 
Chavista President of the National Assembly's Finance 
Committee, told EconCouns that the BRV would not devalue the 
currency next year (we shall see). 
 
¶15. (U) Unless or until the BRV devalues the Bolivar, Chavez 
will be able to reap political gain for "keeping inflation in 
check," and ordinary Venezuelans will enjoy access to cheaper 
imports, incentivizing their consumption thereof.  There are, 
however, important medium- and long-term negative 
consequences associated with the overvalued currency: it 
undermines the competitiveness of both Venezuela's non-oil 
export sector and its domestic, import-competing businesses. 
(NOTE: Because petroleum is sold on international markets in 
USD, the overvalued Bolivar does not affect oil exports.  END 
NOTE.) 
 
¶16. (U) Consider the following simplified example.  Under the 
fixed exchange rate of 2,150 Bs/USD, a Venezuelan-produced 
manufactured good costing Bs 21,500,000 to make could be 
profitably sold overseas (eliminating transport costs, 
duties, etc., for present purposes) for any price over USD 
10,000.  If the Bolivar were depreciated to 2,650 Bs/USD, on 
the other hand, any would be buyer with US dollars could 
obtain the same item instead for only USD 8,113.21.  The 
overvalued Bolivar thus makes Venezuela's non-oil exports 
more expensive and less competitive.  The flip side of this 
coin is that a Venezuelan consumer with 21,500,000 overvalued 
Bolivars can reach for a foreign-manufactured good (and the 
quality and cache associated with it) worth USD 10,000, 
instead of settling for a locally produced competitor.  With 
the same 21,500,000 Bolivars depreciated to their parallel 
market value of 2,650 Bs/USD, the same Venezuelan would only 
be able to purchase foreign goods worth USD 8,113.21, making 
locally produced options more attractive. 
 
¶17. (U) As a result of these incentives created by the 
overvalued fixed exchange rate, Venezuela's export-import 
ratio has been falling in real terms and its domestic 
private-sector manufacturers have suffered.  The drop in the 
number of industrial firms doing business in Venezuela since 
Chavez came to power highlights these effects: CONINDUSTRIA, 
the Venezuelan industrial chamber, reports that roughly 
11,000 manufacturers were open for business in 1999, while 
only 6,700 were operating in 2004. 
 
¶18. (U) The phenomenon described above is known in economics 
literature as "Dutch Disease".  Dutch Disease entails an 
 
CARACAS 00002244  005 OF 006 
 
 
income boom to a single-commodity export economy appreciating 
its local currency, undermining the competitiveness of its 
export and import-competing sectors, reinforcing the 
economy's reliance on its primary export (here, oil) for 
foreign exchange, and leaving the country overexposed to a 
downturn in world prices for its export.  (NOTE: The moniker 
comes from the travails of the Netherlands' manufacturing 
sector after natural gas deposits were discovered there in 
the 1960s.  END NOTE.)  Venezuela's oil endowment, elevated 
crude prices, the BRV economic policies detailed above and 
its general fostering of an uncertain business environment 
have generated symptoms of Dutch Disease in Venezuela. 
Facing a difficult and unpredictable climate, the private 
sector in general and small and medium businesses in 
particular are not investing in new production capacity. 
MetroEconomica, the macroeconomic consulting firm, estimates 
that investment would need to increase by 10 percent of GDP 
for Venezuela to maintain healthy economic growth: a 
development little likely given the current policy landscape. 
 
---------------------------------- 
WHAT HAPPENS WHEN THE MUSIC STOPS? 
---------------------------------- 
 
¶19. (SBU) COMMENT: Economic analysts are not as yet sounding 
alarms that Venezuela's economy faces grave short-term 
difficulties.  Elevated petroleum prices foreseen for at 
least the next two to two and a half years will continue to 
cover a multitude of sins, enabling the BRV to reap 
short-term political gains by spending extravagantly, 
maintaining an overvalued Bolivar, and allowing -- indeed, 
encouraging -- ordinary Venezuelans to consume as if they 
were wealthier than they truly are. 
 
¶20. (SBU) But history teaches that profligate government 
spending on large-scale infrastructure projects and populist 
subsidies and wage increases are politically difficult to 
restrain or cut back.  Budgetary rigidities could thus 
overwhelm the Venezuelan oil sector's capacity to generate 
revenue, even in a climate of sustained high crude prices. 
During the price booms of the 1970s and early 1980s, 
Venezuela accumulated unmanageable levels of both domestic 
and foreign debt and experienced balance of payment 
difficulties even before oil prices began to fall.  The 
eventual decline in oil prices made a difficult situation 
critical.  It is thus possible, and even likely, that 
continuing on its current path Venezuela will experience 
macroeconomic and fiscal difficulties that render it unable 
to sustain the policies and public spending currently driving 
the consumption boom, even under a scenario of elevated oil 
prices in the near and medium term. 
 
¶21. (SBU) History also teaches, however, that those same high 
prices will bring new petroleum production online and 
encourage conservation, increasing supply and moderating 
demand.  When (not if, but when) crude prices fall, or if the 
oil sector is unable to maintain current levels of 
production, Venezuela will find itself, as it did in the 
1980s, with an anemic non-oil export sector, starved of 
adequate investment, and little able to earn the hard 
currency the country will need to maintain public spending 
and repay its hard-currency-denominated debts.  As the flush 
of excess liquidity diminishes, market interest rates rise, 
and the BRV can no longer afford to defend the Bolivar's 
artificial strength, overly indebted Venezuelans will find 
themselves unable to afford their loan and credit card 
payments.  Moreover, the imports they have been enjoying at 
bargain prices will no longer be as affordable, and the local 
economy will not have the productive capacity installed to 
meet domestic demand or create jobs.  The ramifications for 
ordinary Venezuelans will be painful. 
 
CARACAS 00002244  006 OF 006 
 
 
 
¶22. (SBU) Precisely how these events will unfold cannot be 
known for sure, but Venezuela's current course is not 
sustainable.  One thing, however, is certain: if President 
Chavez is still in power when the music stops, the hardships 
then suffered by the Venezuelan people will no doubt, 
according to him, be the exclusive fault of the "The Empire". 
 END COMMENT. 
BROWNFIELD