VZCZCXYZ0001
PP RUEHWEB

DE RUEHCV #0454/01 0982135
ZNR UUUUU ZZH
P 082135Z APR 09
FM AMEMBASSY CARACAS
TO RUEHC/SECSTATE WASHDC PRIORITY 2887
INFO RUEHFSC/USOFFICE FSC CHARLESTON PRIORITY 4612

UNCLAS CARACAS 000454 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ABUD AFIN AMGT CMGT APER ECON EFIN VE
SUBJECT: INFLATION AND A FIXED EXCHANGE RATE INCREASINGLY 
STRAIN EMBASSY OPERATIONS 
 
REF: A. 2008 CARACAS 313 
     ¶B. 2008 CARACAS 376 
     ¶C. CARACAS 87 
     ¶D. 2008 STATE 101179 
 
¶1.  (SBU) Summary:  Budgetary pressures stemming from 
Venezuela's unorthodox economic policies have strained Post's 
operations and will almost certainly pose stark choices for 
Post and the Department in the coming year.  Inflation is 
high and growing, and the official exchange rate has been 
fixed at the same level for the past four years.  As a 
result, the official dollar cost of a given good or service 
paid for in the local currency (the bolivar, or Bs) has risen 
on average by over 100 percent since 2005.  Post has managed 
budgetary pressures thus far by converting many contracts 
from bolivars to dollars; using an ICASS carryover; and 
granting LES wage increases that are lagging behind 
inflation.  We have already exhausted the benefits of these 
measures.  With many economists predicting inflation of at 
least 40 percent in 2009, Post will need additional support 
to cover local procurements and to bring LES compensation up 
to the level of comparators as purchasing power drastically 
erodes.  One measure providing immediate relief would be to 
pay LES in dollars.  Absent an official devaluation, 
increased funding, or some other creative solution, Post may 
face a financial crisis before the end of FY 2009.  End 
summary. 
 
----------------------- 
The Economic Background 
----------------------- 
 
¶2.  (U) The Government of the Bolivarian Republic of 
Venezuela (GBRV) has maintained a fixed exchange rate regime 
with currency controls since 2003, last adjusting the rate 
from 1.92 to 2.15 Bs/USD in March 2005.  At the same time, 
populist economic measures have caused inflation to increase, 
from 14 percent in calendar year (CY) 2005 to 31 percent in 
CY 2008 (ref A).  From March 2005 through the present, prices 
have risen 110 percent on average.  In other words, an item 
that cost Bs 215 in March 2005 might now cost Bs 450. 
Accounted for in dollars at the official rate, the increase 
would be from USD 100 to USD 210.  Most local economists 
predict inflation of at least 40 percent in CY 2009 (ref B); 
some believe it could be as high as 60 percent.  Many 
economists believe the GBRV will not devalue the currency in 
2009, choosing instead to respond to low oil prices by 
restricting the quantity of dollars it sells at the official 
rate. 
 
¶3.  (U) Whenever currency controls exist, an alternative 
foreign exchange market develops.  Venezuelan law offers a 
legal means for foreign exchange transactions on this 
parallel market via "swaps" of securities.  The parallel 
market is growing in size as demand for dollars grows and the 
GBRV restricts the amount of dollars available at the 
official rate.  The market is also highly volatile:  the rate 
ranged from 2.5 to 3 Bs/USD from March 2005 to October 2006; 
rose rapidly the ensuing 12 months to peak at 6.8 Bs/USD in 
November 2007; quickly plummeted to a fairly steady 3.4 
Bs/USD from April to August 2008; and then rose steadily to 
its current level of 5.8 Bs/USD.  At the current level, one 
USD is worth 2.5 times more Bs when exchanged on the parallel 
market than at the official rate.  The GBRV has been the 
largest supplier of dollars to the parallel market, though 
the absence of a consistent intervention strategy is a 
leading cause of the market's volatility (ref C). 
 
----------------------------- 
Embassy Accounting and Budget 
----------------------------- 
 
¶4.  (SBU) All Embassy operations are accounted for at the 
official rate.  A local contract executed in Bs, for example, 
is converted to USD at the official rate for accounting 
purposes.  Visa applicants may pay MRV fees in USD or in the 
equivalent in Bs at the official rate (obviously, almost all 
pay in Bs).  As the Bs received through MRV fees far exceed 
the Bs needed for State operations (Bs 36.5 million vs. Bs 
21.3 million for FY 2008), there is no need for the USG to 
change USD into Bs.  Post understands that the USG, through 
an agreement with the Central Bank of Venezuela, is able to 
change excess Bs into USD at the official rate. 
 
¶5.  (SBU) Post's budget for State operations has declined 
roughly 5 percent over the period the exchange rate has been 
fixed at 2.15 Bs/USD, from USD 20.1 million in FY 2006 to USD 
19 million expected for FY 2009.  Embassy expenditures on 
State operations are currently more or less evenly split 
between USD and Bs (when converted to USD at the official 
rate).  In FY 2008, the Embassy disbursed a total of USD 18.7 
 
million (including obligations actually disbursed in FY 
2009), of which roughly 53 percent was spent in bolivars (Bs 
21.3 million, or USD 9.9 million at the official exchange 
rate).  LES salaries are the largest expense in Bs, amounting 
to Bs 9.2 million (USD 4.3 million) in FY 2008.  Contracts 
are the second-largest expense in Bs.  (Note:  The USD 
400,000 difference between the amount budgeted and the amount 
disbursed for FY 2008 is primarily due to unused DS (USD 
310,000) and MRV (USD 40,000) allocations.  End note.) 
 
----------------------------- 
Strains on Embassy Operations 
----------------------------- 
 
¶6.  (SBU) Inflation has presented challenges for companies 
and other institutions operating in Venezuela.  The strain 
has been even more pronounced for the Embassy.  Whereas 
companies can increase the bolivar prices of their products 
to keep pace with rising expenses, the Embassy's budget is 
fixed in USD and, as noted above, has declined slightly since 
FY 2006.  If an Embassy services contract in Bs were to have 
increased at the same rate as inflation, to use the example 
of paragraph 2, the same services purchased with Bs 
equivalent of USD 100 in March 2005 would now cost the Bs 
equivalent of USD 210.  While the increases have been less 
pronounced, even local goods and services the Embassy has 
traditionally acquired in USD are subject to inflationary 
pressure.  The best example is dollar denominated apartment 
leases, which have been increasing 10 to 15 percent annually 
on average. 
 
¶7.  (SBU) The Embassy has managed the strain from rising 
prices in several ways over the past three years.  First, LES 
compensation increases have been kept below inflation.  The 
table below shows the average LES compensation increase and 
inflation for the last three FYs, all in percentage terms. 
 
           LES Compensation Increase    Inflation 
 
FY 2006              5.3                  15.5 
FY 2007             10.0                  17.2 
FY 2008             10.0                  31.1 
FY 2009              8.3                  tbd 
 
Over the last three years, therefore, even LES who qualify 
for Within Grade Increases (which have averaged about 5 
percent a year) have not seen their compensation keep pace 
with inflation.  The difference is significant from the 
Embassy's budgetary perspective.  If LES had been granted an 
increase commensurate with inflation in FY 2008, the 
additional annual cost would be on the order of USD 900,000. 
(Note:  The increases for FYs 2006 to 2008 went into effect 
in the spring of the respective year.  For FY 2009, post 
requested an early compensation review given the impact of 
rising inflation on LES morale.  The 8.3 percent increase 
subsequently granted went into effect in November 2009.  End 
note.) 
 
¶8.  (SBU) In addition to LES compensation lagging behind 
inflation, the second way the Embassy has managed the strain 
is by converting key service contracts from Bs to USD 
starting in February 2008.  Recent examples include contracts 
for cleaning, health insurance for local staff, and post 
language classes.  The USD rate is set based on the cost of 
the services in Bs and an expected parallel foreign exchange 
rate.  Thus, with an expected parallel rate of 5 Bs/USD, a 
contract that might have cost 50,000 Bs/month, or USD 23,000 
at the official rate, only costs USD 10,000 per month.  In 
this example, there would be a one-time annual savings of USD 
120,000.  From the three contracts mentioned above, the 
Embassy estimates it will realize one-time annual savings of 
USD 370,000, spread out over FYs 2008 and 2009.  While 
conversion of these and other contracts have provided the 
Embassy with significant one-time savings, allowing us in 
effect to devote more funds to expenses we cannot convert to 
dollars, we have picked all the low-hanging fruit.  How fast 
the USD cost of these contracts increases as they are renewed 
in the future depends on whether changes in the parallel rate 
keep up with local inflation. 
 
¶9.  (SBU) Finally, in some cases the Embassy has simply cut 
back on expenses in ways that reduce our effectiveness. 
Representation is a good example, though it represents only a 
small percentage of the overall budget.  Prices for the food 
and hotels/restaurants categories are rising even faster than 
the general inflation index.  In response, we have shifted 
the type and scale of the representational events we host and 
cut back on the number.  (Note:  We are beginning to 
implement a plan whereby U.S. direct-hire officers will be 
reimbursed for representational expenses in USD, with the 
parallel rate used to convert from Bs to USD.  This plan will 
 
stretch our severely depleted representational capacity.  As 
is the situation with contracts, future year-on-year changes 
in representational capacity will depend on how changes in 
the parallel rate compare with inflation.  End note.) 
 
----------------------- 
Difficult Choices Ahead 
----------------------- 
 
¶10.  (SBU) The most critical strain on Embassy operations in 
2009 will likely be related to LES compensation.  If 
inflation remains in the 30 to 40 percent range as expected, 
LES purchasing power, already depleted over the past several 
years, could drop up to 50 percent before they receive 
another salary increase.  Post may consequently need to 
request another early review, which we expect would show that 
compensation at comparators has risen at least 20 percent 
relative to the early FY 2009 review.  If the official 
exchange rate remains unchanged, the Department must be 
prepared for a large increase in dollars allocated for LES 
compensation:  a 20 percent increase (possibly below the 
expected increases for comparators) would amount to roughly 
an additional USD 900,000 on an annual basis. 
 
¶11.  (SBU) There is one step that would instantly raise LES 
purchasing power and increase morale without necessarily 
increasing compensation (in an accounting sense at least), 
namely paying LES salaries in dollars rather than bolivars. 
There would be no accounting cost to the USG and no actual 
cost as long as the Central Bank of Venezuela continued 
converting excess Bs to USD at the official rate for the USG. 
 Post understands the Department would not normally authorize 
payment in dollars unless comparators also predominantly paid 
in dollars (ref D).  Anecdotal conversations indicate that an 
increasing number of multinational companies and embassies 
are paying some LES at least partially in hard currency. 
Post will follow up with comparators and other similar 
organizations and report septel on our findings and on other 
considerations specific to the issue of paying LES in dollars. 
 
¶12.  (SBU) The second area of strain in 2009, should 
inflation remain high and the official exchange rate remain 
constant, will be in locally procured items.  With the FY 
2008 ICASS carryover spent (and no similar carryover 
available for FY 2009), prices rising rapidly, and few 
additional opportunities to dollarize local procurement, Post 
may be forced to postpone planned and necessary local 
acquisitions, such as vehicles, and to put off facilities and 
maintenance projects requiring locally procured materials. 
CAULFIELD