VZCZCXYZ0948
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DE RUEHCV #2831/01 2582121
ZNR UUUUU ZZH
R 152121Z SEP 06
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E.O. 12958: N/A 
TAGS: EFIN ECON PGOV VE
SUBJECT: INFLATION GOING UP, UP, AND AWAY IN THE BRV 
 
REF: A. CARACAS 02718 
 
     ¶B. CARACAS 02825 
 
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SUMMARY 
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¶1. (SBU) Inflation rose 2.2 percent in August, reaching a 
total of 10.4 percent for 2006 and implying an annual rate 
exceeding 15 percent.  The BRV is now incapable of meeting 
its inflation target for 2006 of 10 percent and recent 
statements by Chavez and senior BRV officials demonstrate 
that the BRV has become increasingly concerned about the 
effect inflation is having on public support for the 
Bolivarian Revolution.  At the same time, the government 
shows no signs of slowing spending (one of the principal 
causes of inflation) as it tries to buy support for the 
December elections. 
 
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NUMBERS 
------- 
 
¶2. (U) Official inflation rose 2.2 percent in August and 
shows a worrying trend for the remainder of 2006.  Food and 
drinks showed the largest increase (4.3 percent) and there 
were also significant increases in the cost of transportation 
(2.8 percent), housing (2.4 percent) and hotels and 
restaurants (1.9 percent).  The price of foodstuffs between 
August 2005 and August of 2006 has increased 26.7 percent and 
during this time the overall Consumer Price Index (CPI) rate 
has increased 14.9 percent. 
 
¶3. (U) Inflation is particularly damaging for the poorest 
segments of society.  Venezuela,s 2 million impoverished 
households (31.5 percent of all households), or about 9 
million people spend half of their income on foodstuffs and 
the increase in prices hits them the hardest.  The current 
basic basket of goods and services for a family of five costs 
1,789,768 bolivars (USD 832) a month, which economists 
estimate only 20 percent of Venezuelans can afford.  An 
increase in the minimum wage this month (from approximately 
USD 216 per month to USD 238 per month) will do little to 
alleviate the burden as increases in salaries are not keeping 
up with inflation. 
 
¶4. (SBU) Official inflation numbers are also misleading.  A 
recent canvassing of business leaders at a VENAMCHAM meeting 
implies that actual inflation is running at significantly 
higher levels than stated. (Note: As high as 20-22 percent. 
End note.)  In addition, price-controlled goods (which rose 
1.5 percent in August) are distorting the market and hide 
real inflation.  As an example, white sugar is supposed to 
sell for 1200 bolivars a kilogram (56 cents).  Widespread 
sugar shortages last month left shelves bare as the import 
cost exceeded the controlled sale price.  (Note: Venezuela's 
domestic sugar production is insufficient to meet demand, and 
approximately 60-70 percent of the annual crop alone goes to 
carbonated beverages.  End note.)  Since the government 
bought 60,000 tons of sugar from Brazil, it has returned to 
supermarket shelves, but is on sale for approximately 3000 
bolivars per kilo. In the basket of goods used to judge 
inflation, the price of sugar has not changed (masking a 150 
percent real increase).  In the government subsidized Mercal 
markets, a kilo of sugar (when available) costs 750 bolivars. 
 
¶5.  (U) There is also a gap between increases in the CPI, on 
which this report is based, and changes in the wholesale 
price index (WPI) that demonstrates costs for suppliers and 
manufacturers.  After growing significantly faster than CPI 
in 2004 and 2005, WPI is growing at an annualized rate of 
12.2 percent (or 2.7 points lower than CPI). 
 
------ 
CAUSES 
------ 
 
¶6. (SBU) Inflation in Venezuela is a result of a variety of 
factors as predicted by orthodox economics.  Liquidity (the 
amount of money in the economy) has increased 60 percent 
since August 2005, and since 1998 has increased by over 730 
percent.  Santander, an economic consultancy, estimates that 
the amount of excess liquidity in Venezuela exceeds USD 19 
billion.  Oil revenues entering the economy are increasing 
liquidity, as is government spending.  Government 
expenditures have increased 95 percent in dollar terms since 
1999 (see reftel A).  In addition the government is creating 
incredible amounts of money.  A noted economist observes that 
as PDVSA repatriates a dollar, the Central Bank (BCV) 
converts that dollar into bolivars for PDVSA and then has 
been transferring another dollar (USD 10.7 billion since 
September 2005) in &excess reserves8 to the National 
Development Fund (FONDEN), thus creating a dollar out of thin 
air. 
 
¶7. (SBU) Increased government spending and currency controls 
are also causing large increases in consumption, which fuels 
inflation as demand outpaces supply.  The over-valued 
exchange rate (estimates range from 20 to 25 percent) makes 
imports cheaper, but also encourages short term consumption 
(as everyone expects the BCV to devalue at some point in the 
future).  People are also discounting the future (due to 
political and economic instability) in other ways and more 
than one analyst has commented that long term planning in the 
BRV means 3 months. 
 
¶8. (SBU) Despite the fact that inflation is running at least 
at 15 percent annually, the nominal interest rates for 
savings accounts is below 10 percent.  For Venezuelans, there 
is a huge disincentive to save money as interest rates below 
inflation mean that their money loses value every day it is 
in their account. (Comment: The BRV is probably hesitant to 
raise interest rates as it wants to avoid slowing the economy 
or raising the burden for the already debt-laden public.  End 
comment.) 
 
¶9. (SBU) The government is also holding large amounts of 
demand deposits in private sector banks (see reftel A). 
Banks are using government deposits to make loans, increasing 
the money supply further. (Note: Estimates are that for every 
1 dollar of government deposits, banks create 3 dollars in 
additional liquidity.  End note).  The recent decrease in 
interest rates from 10 to 6 percent on government 
certificates of deposit (CDs) has meant that banks can no 
longer profit from arbitrage (paying Venezuelans 6-8 percent 
interest on savings accounts and then using those funds to 
buy CDs at 10 percent).  Instead banks will now try to 
increase their loan and credit card portfolios, which will 
cause an increase in consumer spending. 
 
--------------------- 
HISTORICAL PRECEDENT 
--------------------- 
 
¶10. (U) Venezuela, like many Latin American countries, has 
had a recurring problem with inflation.  During the past two 
decades, inflation has ranged from 8.8 to almost 100 percent 
a year.  Spikes in inflation have been historically 
associated with increases in oil prices, but are also 
contingent on monetary policy.  The mid 1990s were 
characterized by modest oil prices, yet very high inflation 
as successive governments were unable to break the cycle 
where deficit spending resulted in a devaluation, which in 
turn caused more inflation and necessitated more deficit 
spending. 
 
------------------- 
GOVERNMENT RESPONSE 
------------------- 
 
¶11. (U) During his weekly television program, &Alo 
Presidente,8 on September 3 Chavez played the role of 
Economics Professor in Chief for the BRV.  With a series of 
graphs and charts behind him, Chavez explained to the 
Venezuelan public the historical precedents for the current 
state of the Venezuelan economy and how the BRV deserved much 
credit for current economic growth and "price stability." 
Chavez demonstrated the growth in the minimum wage as 
compared to the growth in inflation and said that in the 
early 1990s inflation outpaced wages.  According to his 
chart, since 1998 the minimum wage has increased quicker than 
inflation (Note: though overall wages are about 20 percent 
less in real terms than in 1998).  Chavez then discussed 
inflation with Minister of Planning and Development Jorge 
Giordani, who outlined the 28 percent increase in food costs 
and the shortages of tomatoes, peppers, and onions.  Chavez 
made it very clear that the BRV must lower inflation, for 
example by increasing domestic production of tomatoes, and 
admitted that it was important to import goods to prevent 
shortages and price increases. 
 
¶12. (U) The Committee for the Administration of Foreign 
Currency (CADIVI) has increased its authorizations in the 
past month and in August authorized USD 2.3 billion in 
conversions.  The increases come at a time when it is under 
criticism from both the opposition and the National Assembly 
for helping fuel the fires of inflation by preventing money 
from leaving the system and imports from entering the market 
(importers need CADIVI to get dollars to buy goods to 
import).  (Note: An increase in imports may temporarily 
alleviate inflation as supply catches up with demand, though 
does nothing to deal with the longer term issues of 
de-industrialization occurring in Venezuela.  End note.) 
 
¶13. (SBU) The BRV is also attempting to reduce the money 
supply in the economy.  The USD 1 billion, dollar-denominated 
&bonos de sur8 issuance planned by Venezuela (USD 500 
million) and Argentina (USD 500 million) would reduce the 
supply of bolivars.  The issuance has been delayed as 
contacts note that Argentina does not need additional 
financing this year.  Nonetheless, Finance Committee Chairman 
Rodrigo Cabezas has announced that the BRV will issue bonds 
(per Chavez,s insistence) before October 15. 
 
¶14. (SBU) The past week saw announcements that PDVSA may a) 
issue USD 3.5 billion in dollar-denominated bonds on the 
local market (see reftel B) and b) will send USD 4-6 billion 
in excess dollar profits to be held in escrow in a special 
Treasury account.  While both of these actions would reduce 
liquidity, the director of a local economic consultancy is 
doubtful they will occur as the debt issuance has been 
criticized as unnecessary (why take on debt when PDVSA is 
making huge profits from high oil prices).  The treasury 
account is supposed to be inviolate, but the BRV has a long 
history of raiding supposedly inviolate accounts (such as 
foreign reserves at the BCV).  In a normal country such 
inflation-fighting measures would fall under the purview of 
the Central Bank rather than the state oil company. 
 
¶15. (SBU) Other measures the BRV is floating for controlling 
inflation are reducing the Value Added Tax (IVA), enacting 
more price controls, increasing imports, and punishing price 
gougers.  These actions, while unlikely to do much to combat 
systemic inflation or help the economy, could bring some 
short-term relief or have a public relations benefit, and so 
are likely to occur in the run up to December.  Contacts in 
the retail sector worry that Chavez will force a 
confrontation with some supermarkets and start shutting them 
down in November.  This would be damaging for the private 
sector and for the supply of foodstuffs, but in the weeks 
leading up to the election, could provide a boogeyman for the 
public to blame for inflation and shortages. 
 
---------- 
CONCLUSION 
---------- 
 
¶16. (SBU) The BRV seems preoccupied with inflation and at the 
same time incapable of stopping it, which places it in league 
with the majority of modern Venezuelan governments.  During 
his Alo Presidente presentation, Chavez's economic 
explanations were open and he fully admitted to a flaw in the 
BRV's economic policies.  Many analysts have labeled 
inflation the "Achilles heel" of the BRV and note that 
inflation tends to hurt the poorest segments (Chavez's base) 
of society the most. 
 
¶17. (SBU) Proven orthodox measures to slow inflation include 
decreasing public spending, raising interest rates and 
draining liquidity.  Rather than taking these difficult 
steps, it seems likely the BRV will continue its stopgap 
measures that further distort the economy and slowly emaciate 
the private sector, while at the same time touting solutions 
that mislead the public as to the true nature and causes of 
inflation.  Embassy contacts estimate that the BRV can 
continue its spending binge for 1-2 years before the 
imbalances and deficits catch up, which combined with lower 
oil prices will result in economic upheaval, as has been the 
case in Venezuela,s series of boom and bust cycles ever 
since the 1970s. 
WHITAKER