Chávez’ inadequate macroeconomic and exchange rate policies have worsened the ongoing recession. He needs to get back to the drawing board if he wants to prevent Venezuela from a disaster. by Manish k Pandey

It’s not as if the Venezuelan Central Bank doesn’t realise the magnitude of the government’s fiscal troubles. In fact, with regards to fiscal condition, Banco Central de Venezuela has already submitted a report to Congress which clearly mentions that Venezuela’s fiscal deficit has already reached a 10-year high of 5.4% of GDP (2009), up sharply from 2.2% in the previous year. But it seems as if the Chávez administration has been sleeping over it as it continues with its policy of heavy public spending. In fact, it’s interesting to note that though the fiscal spending has reached 26.8% of GDP in 2009 (up from 26.2% in 2008), capital spending has actually fallen in 2009. This makes the situation further difficult for the policymakers who are already struggling to tame the galloping inflation which is all set to cross the 40% mark in 2010 (Royal Bank of Scotland estimate).

Further, a sharp decline in oil revenues is continuously widening the budget gap. Government oil revenues have already fallen as a share of GDP from 12.3% in 2008 to just 7.6% in 2009. But then, that’s a small problem, once the oil price in international market moves up, the revenues are likely to increase. What is more worrisome is that it’s the royalty revenues (For starters: Decline in royalty revenues reflects a sharp contraction in output) which have seen a major fall during this period, from 9% of GDP to just 5.1%. This points towards intensifying operational problems, and a lack of investment. In fact, oil production has already contracted by 10.2% in Q4 2009, which means a serious dent in revenue flow for the Venezuelan economy.

Though Venezuela’s international reserves – which despite higher oil price have fallen by about 20% since the end of 2009 and were at $28.97 billion on April 9, 2010, the lowest level in over a year – remain at a still-comfortable level (reserves currently cover about 10 months of imports, a relatively good ratio compared with other developing nations), yet the decline in reserves, if prolonged (a more likely phenomenon), can be really dangerous. Since Venezuela has limited access to international markets, a sharp drop in reserves could even lead to an external debt default. Moreover, such a scenario would certainly prompt a new devaluation of the bolivar extending stagflation. No doubt, as a counter step, Chávez has reopened Venezuela’s bond market which he had shut down on May 19, 2010, but how far will that help in controlling the situation is still a big question. Through the new system (which gives government full control of the exchange rate as companies will now necessarily have to buy dollar-denominated bonds rather than conducting direct sales of bolívars for foreign currency) Chávez plans to prevent the speculative trading that fuels inflation, but then the move only follows the trend of Chávez’ Leftist recession-fighting policies such as nationalisation of industries, controls on prices, et al, which have been a major reason for the outflow of capital from the country. In fact, critics feel the new system will actually increase inflation by another 5%.

Is Chávez listening? Apparently, he is. He recently quoted to Financial Times, “Certainly, inflation is high. But in the previous decade, inflation reached 80% on average. There was a year when it was 100%.” Professor Chavez, we seriously need something more encouraging than that.

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Source : IIPM Editorial, 2010.

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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