VZCZCXRO3013
RR RUEHAO RUEHCD RUEHGA RUEHGD RUEHGR RUEHHA RUEHHO RUEHMC RUEHNG
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DE RUEHCV #0959/01 1312119
ZNR UUUUU ZZH
R 112119Z MAY 07
FM AMEMBASSY CARACAS
TO RUEHC/SECSTATE WASHDC 8701
INFO RUEHWH/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS
RUMIAAA/HQ USSOUTHCOM MIAMI FL
RUEATRS/DEPT OF TREASURY
RUCPDOC/DEPT OF COMMERCE
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 CARACAS 000959 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR KLINGENSMITH, NGRANT, AND MMALLOY 
COMMERCE FOR 4431/MAC/WH/MCAMERON 
NSC FOR DTOMLINSON 
HQ SOUTHCOM ALSO FOR POLAD 
 
E.O. 12958: N/A 
TAGS: ECON EFIN SOCI VE
SUBJECT: AN ECONOMIC SNAPSHOT: THE CRACKS ARE SHOWING 
 
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SUMMARY 
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¶1. (SBU) Inflation continues to rise despite government 
efforts to talk it down, and the government's tools to drain 
liquidity are increasingly ineffective.  Foreign exchange 
reserves have fallen by 33.5 percent this year.  Government 
spending continues apace, with the BRV running a large, 
though manageable, fiscal deficit of almost USD 4 billion 
during the first two months of 2007.  Shortages are becoming 
more common and foreign exchange controls and the continual 
threat of nationalizations have led to a drop in the 
bolivar's parallel market rate.  The hodgepodge of retrograde 
economic policies are generating growing distortions that are 
becoming increasingly prominent. 
 
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INFLATION 
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¶2. (SBU) Official Inflation was 1.4 percent for the month of 
April, and 19.4 percent for the past 12 months (almost double 
what it was a year ago).  This increase followed a 0.7 
percent decrease in March, caused mainly by the government's 
decision to cut three percentage points from the Value Added 
Tax (IVA).  While the BRV sticks by its annual inflation goal 
of 12 percent, most private analysts expect inflation to 
exceed 20 percent in 2007 (it was 17 percent in 2006), 
continuing Venezuela's ranking for the highest inflation in 
the hemisphere. 
 
¶3. (SBU) Five sectors grew above the average percentage rate 
for the month, including health care (3.4), general goods and 
services (2.5), food and non-alcoholic beverages (2.5), 
alcoholic beverages and tobacco (1.9) and home furnishings 
(1.9).  The cost of food and non-alcoholic beverages (the 
sector where Venezuela's D and E classes spend most of their 
income) has increased 31.9 percent in the last 12 months. 
 
¶4. (SBU) Inflation in Venezuela is being driven by a variety 
of factors, including large increases in government spending, 
excess liquidity, increasing demand, and stringent currency 
controls that push importers to use the parallel market. 
While Chavez and senior BRV officials are seized with 
addressing inflation, realizing that it burdens their 
supporters in the lower rungs of Venezuela's economic ladder, 
they have done little to confront the causes.  Price controls 
have led to widespread shortages.  A recent trip by Econoff 
to the local grocery store found shelves lacking staples such 
as chicken, meat, butter, milk, black beans, and eggs 
(septel). Threats to nationalize supermarkets and private 
health care clinics (the two sectors showing the highest 
increase in prices this year) have led to lower investment 
and more anxiety. 
 
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LIQUIDITY 
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¶5. (SBU) Venezuela's money supply grew by 66 percent in 
bolivar terms in 2006, and the excess liquidity is apparent 
in the system where credit is easy and sales of everything 
from cars to whiskey has skyrocketed.  BRV attempts to rein 
in liquidity (through selling BCV certificates of deposit to 
local banks and issuing dollar-denominated bonds) have been 
unsuccessful.  The recent USD 7.5 billion PDVSA bond issuance 
is a prime example of the failure of BRV monetary policy.  By 
selling USD 7.5 billion worth of dollar-denominated bonds to 
local investors in bolivars, the BRV hoped to reduce 
liquidity as those investors gave up their bolivars for 
dollars.  However, liquidity has fallen by less than one 
percent since the issuance.  Many people purchased bonds on 
margin (borrowing a percentage of the cost and paying the 
bank back after selling the bond overseas) and thus did not 
drain their accounts to buy the bonds.  The money supply was 
not affected because banks chose not to renew USD 6 billion 
of the USD 16.2 billion worth of BCV CDs that they already 
held.  Thus, they took money that was already removed from 
the money supply to cover the bond purchases.  In the words 
of business school professor Gustavo Garcia, "the BCV's short 
term debt in bolivars was exchanged for PDVSA's long term 
debt in dollars," hardly a sound business practice. 
 
CARACAS 00000959  002 OF 003 
 
 
 
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SPENDING 
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¶6. (SBU) According to recently released BCV figures, the 
government ran a budgetary fiscal deficit of USD 3.8 billion 
(a little over 2 percent of GDP) during the first two months 
of 2007, and spending increased 30 percent over the same 
period in 2006.  At the same time, non-oil tax revenues 
increased and revenues from oil sales decreased in line with 
a lower price for the Venezuelan oil basket and reduced 
production of approximately 2.4 million barrels per day. 
This amount of deficit spending is manageable in the short 
run as the government can increase revenues by producing more 
oil, and can dip into FONDEN or other off-budget funds.  The 
deficit does demonstrate, however, the BRV's continued desire 
to spend, spend, spend and implies that at some point it will 
not be able to maintain the spending increases of the past 
few years. 
 
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CURRENCY 
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¶7. (SBU) While the official exchange rate is Bs. 2150 to the 
dollar, the parallel rate is on the rise again.  The parallel 
rate rose to Bs. 4,000 to the dollar following threats by 
Chavez to withdraw from the IMF and World Bank and to 
nationalize the banking sector.  The PDVSA bond issuance had 
a short term effect on the rate, but it shows no signs of 
returning to its historical average of 20-25 percent above 
the official rate. 
 
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RESERVES 
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¶8. (SBU) As of May 8, Venezuela's foreign exchange reserves 
had decreased by USD 12.5 billion since the beginning of 
2007, to about 24.7 billion.  This 33.5 percent decrease in 
four months poses a challenge for Venezuela's central 
bankers.  This drop is due to a variety of factors, 
including: transfers to the National Development Fund 
(FONDEN) (USD 6 billion), Venezuela's implementation of OPEC 
cuts at the beginning of the year (USD 1.2 billion), an 
increase in Commission for the Administration of Foreign 
Exchange (CADIVI) approvals (USD 3.5 billion more than the 
first trimester of 2006), payments to U.S. companies for the 
"nationalizations" of CANTV and EDC (USD 2.6 billion 
including the CANTV dividends), the BRV's decision to 
allocate a portion of PDVSA tax payments in dollars to a 
special treasury account outside of the BCV's control, and 
capital flight. 
 
¶9. (SBU) Since the revision of Venezuela's Central Bank Law 
in 2005, the BCV has set a target for its foreign exchange 
reserves such that they would cover 12 months of foreign 
reserve needs (including imports, debt servicing, and other 
ancillary government requirements).  "Excess" reserves have 
been transferred to FONDEN for use in social and development 
projects as well as debt buybacks and the purchase of 
Argentine and Ecuadoran debt.  When one deducts the BCV's 
gold holdings (USD 7.6 billion), IMF position (USD 485 
million), and special drawing rights (less than USD 1 
million), its operative international reserves fall to around 
USD 16.7 billion.  Due to the massive amount of consumption 
in Venezuela, the USD 29 billion level is no longer adequate 
to cover 12 months of requirements and USD 16.7 billion 
probably would not cover 6 months of imports at current rates 
of consumption.  In 2006, Venezuela imported over USD 32 
billion in goods. 
 
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COMMENT 
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¶10. (SBU) Recent announcements by Chavez and various 
officials indicate they are in denial about the mounting 
problems in the Venezuelan economy.  For them, inflation and 
shortages are caused by profit-seeking oligarchs and 
capitalist-hoarders seeking to upset their socialist harmony. 
 Minister for People's Power of Development and Planning 
 
CARACAS 00000959  003 OF 003 
 
 
Giordanni recently blamed Venezuela's high growth rate, 
noting that 10 percent annual growth was bound to cause 
inflation and allow for demand to outstrip supply (apparently 
he has not read much about China). 
 
¶11. (SBU) Given the refusal to modify fiscal policy (read 
reduce spending) and the ineffectiveness of monetary policy 
(evidenced by the PDVSA bonds debacle and mounting parallel 
rate), it seems that the BRV has precious few options 
effectively to deal with the mounting distortions.  Post 
expects the BRV to fall back on propaganda -- as has been the 
case with crime, poverty, and unemployment statistics -- 
simultaneously denying that problems exist, eliminating the 
methodology that allow people to measure the problem, and 
finding scapegoats for the problems that come to the surface. 
WHITAKER