The streets of downtown Caracas seem to reflect, by Latin American standards, an affluent consumer society. The tower blocks are shiny and new. The restaurants are upscale. The gas-guzzling 1970s American cars, famous for clogging up the city streets are still there, but they’re far outnumbered by brand new sports utility vehicles.
The problem is that the urban highrises will be the last to be built for a while. The construction industry is at a virtual standstill. The restaurants serve marvelous food, but few people can afford it. On a recent day, an excellent restaurant in the middle of town had only one occupied table. And the new cars, in one sense, are hardly cars at all: first and foremost, for many buyers, they’re a means of storing value.
It’s easy to say that the fundamental problem is oil. As the biggest oil exporter in the western hemisphere, Venezuela has one of the most oil-dependent economies in the world. Oil accounts for more than 80% of export earnings, 40% of government revenues and 25% of GDP. Every time the international oil price falls, as it did last year, the domestic economy suffers a prolonged knock-on effect: government spending, locked in at high levels during boom times, sends the budget into deficit; investment and consumer confidence fall; recession follows. This year, the economy is expected to contract by at least 3%. GDP in the first quarter alone fell by 4.2%.
But even following last year’s depressed oil prices, Venezuela should be awash with cash. In the past three years, according to José Toro, a board director at state oil group PDVSA from 1995 to 1998 and now a private businessman and university lecturer, Venezuela earned $75 billion in oil revenues. For a country of 28 million people, that’s a lot of money, even though just about half of it went to the government and it doesn’t include non-oil taxes and $10 billion in debt raised on the international capital markets. Yet Venezuela this year faces a fiscal deficit heading towards 8% of GDP. Where has all the money gone?
One answer is the government’s payroll. There are 1.3 million government employees. Another is social programs. A central plank of President Chávez’s “Bolivarian revolution” is to provide aid to the poorest sections of society. This includes mobilizing the army to sell food at subsidized prices to the poor, and building cheap housing. But these programs have done little to alleviate poverty, and much to encourage corruption.
“You cannot imagine the amount of corruption,” says Oscar García, chairman and chief executive of Banco Venezolano de Crédito. “Capital flight last year was $9 billion. A lot of it was theft by government people. This year it will be worse. There are no controls.”
Unemployment was officially 12% last year and will be at least 14% this year – the true figure, says Teodoro Petkoff, editor of daily newspaper Tal Cual, is already close to 20%. And it is the poorest sections of society, with no access to inflation-proof investments, whose income will be most eroded as inflation this year heads for more than 30%, after reaching 12.5% last year.
According to José Toro, the problem is one of management. “Nothing destroys value like bad management,” he says. “This government has been destroying value at an amazing rate.”
If that’s the case, it must be said that this government is not the first to squander Venezuela’s oil wealth. Corruption and bad management are nothing new, and Venezuelans were getting poorer by the year throughout the 1990s, long before Chávez came along. Indeed, fighting corruption was one of the few coherent promises of his first election campaign. But matters have certainly got worse under Chávez.
One reason is that irresponsible spending has drained money away from productive investment. Another drain has been depletion of revenues through over-generous tax cuts. For example, government projects to foster agriculture or the arts, typically involve granting exemptions from income tax or value added tax. More than 80 laws have been passed granting such exemptions.
The new cabinet formed after the April coup is attempting to tackle the problem. Finance Minister Tobías Nóbrega has announced plans to increase value added tax to 15.5% from 14.5%, and the financial transcations tax to 1.0% from 0.75%. He expects the move to cut the primary budget defict this year (before interest payments) to 1.9% of GDP, from 2.7%, or about $3 billion. The increases are subject to approval from the National Assembly.
More structural changes are also needed. One example is the absurdly high base levels at which corporations and individuals become liable for tax. Individuals only have to make an income tax declaration if they earn more than 1,000 tax units a year, currently equal to Bs 14,800,000, or about $14,800. The first 774 tax units are exempt. Businesses are liable for VAT only if they have annual sales of more than 4000 tax units. In practice, a middle class worker earning the equivalent of $60,000 a year will pay only about $5,000 in tax. At the national tax office, SENIAT, there are just 600,000 registered taxpayers, including individuals and corporations. Income tax earns the federal government the equivalent of just 0.02% of GDP a year, says Andrés Santeliz, a member of the National Assembly’s economic and financial advisory committee, compared with 2% of GDP in Brazil and more than 3% of GDP in Chile.
Even with such a small tax base, evasion is a problem. SENIAT says evasion amounted to Bs7 trillion last year, including income tax, VAT and customs duties. Prosecuting evaders is a tortuous and lengthy business, and fines are frozen while court cases drag on, often for years.
Reform of the tax laws is therefore a high priority. Santeliz says the first step should be to lower the basic income tax exemption to 400 units from 774. He also says the plethora of other tax exemptions should be taken out of the law and made subject to individual regulations. That way, at least, they could be given a limited duration.
On the spending side, the government has little leeway for investment. About a fifth of the national budget is spent on payroll for the public sector. About a third of the budget goes on debt service. Payments this year are expected to total $6 billion. The government will need to raise about $4 billion to meet its obligations. It hopes to raise it from multilateral agencies such as the IMF and from bond markets. Oscar García, at Venezolano de Crédito, says private banks will probably step in, provided the price is right. “Human beings are the only animals that make the same mistake twice,” he says. “Bankers do it 50 times. If the commissions are big enough, Venezuela will raise the money it needs.”
Some 20% of the federal tax take is transferred by law to the states and municipalities. About 15% of royalties from oil and mining operations are transferred to the states in which those activities take place. And 15% of VAT revenues are earmarked for a decentralization fund for the regions. Taken together, it leaves little room for discretionary spending. Federal government investment last year was less than 1% of GDP, according to Santeliz.
Tax reform, if it came in 2002, would have little practical impact before next year at the earliest. “But it would be important immediately as a signal to capital markets” that Venezuela was prepared to put its fiscal house in order, says Alejandro Grisanti, head of research at Santander Central Hispano in Caracas.
One important signal has already been sent, in the form of the devaluation of the bolivar in February. According to Grisanti, the devaluation could even secure a return to overseas financial markets for Venezuelan borrowers. “The devaluation was received as a positive signal,” he says. “It’s a strong indication of the country’s willingness to pay. If the president accepts the political risk of a devaluation, it follows that he will also allow the country to pay its debts.”
Indeed President Chávez took most observers by surprise with the devaluation, as he had been a strong supporter of the former controled system in which the currency anchor was the country’s principal defense against inflation, and had even threatened to introduce capital controls rather than devalue. But this system became untenable when oil prices fell last year, because the government had committed itself to spending programs it could no longer afford. Grisanti says devaluation has been Venezuela’s classic response to a drop in oil prices over the past 20 years, pointing to earlier, much bigger, devaluations in 1983, 1989, and 1994 to 1996.
Perhaps it was past experience that led many Venezuelans to see it coming. As the bolivar became increasingly overvalued during last year, many believed that a crash was around the corner. That’s the main explanation behind the boom in auto sales last year. Car sales rocketed to 216,000 units during the year, up from 145,000 in 2000. With the devaluation, sales came crashing back down again. Sales in April were just over half what they’d been a year earlier, and were falling by a third month-on-month. It’s the same story with household electrical goods and other big-ticket imported items.
Less Flight
The devaluation may also have brought a reduction in capital flight. Venezuela commonly has a current account surplus combined with a capital account deficit because much of the oil wealth is transferred back overseas in private dollar investments. About $3 billion or $4 billion commonly leaves the country in a year. Last year the net figure was $9 billion ($11 billion in capital flight, minus $2 billion that entered the country). Again, Venezuelans with money were sending their capital out of the country for fear of devaluation, says Grisanti. The amount of money leaving the country fell off sharply after the devaluation – but that, says Grisanti, may simply be because March and April are the months in which Venezuelans pay their taxes. He expects figures for June to show that capital flight has picked up again.
The devaluation will have another, more pernicious impact. As Grisanti explains, any devaluation of the bolivar results in a movement of resources away from importers to exporters: one benefits, the other loses. Because the main exporter in Venezuela is the government, through PDVSA, the transfer is from the non-oil economy to the government. “It has exactly the same effect as raising taxes,” Grisanti says. “The devaluation will transfer about $5 billion a year from the private sector to the public sector.”
Although the economy should benefit in the longer run from the devaluation, as it should increase the competitiveness of locally produced goods on the domestic and export markets, many in the private sector are angry that it took place precipitately, and has led to a less predictable economic environment. Nor do they see it as a sign that Chávez has embraced economic orthodoxy. “The devaluation was entirely forced on the government,” says Andrés Duarte, a private port operator and commodities trader. “They found themselves with too much debt and not enough bolivars.”
In addition to tax reform, the new planning and finance ministers installed after the April coup are proposing to change laws that earmark revenues for the regions, forcing state and municipal governments to raise cash as well as take more direct responsibility for spending it. Proposals would also better target spending at those sectors most in need of it, such as health and education.
One crucial reform would overhaul the notorious FIEM, or macroeconomic stabilization investment fund. This rainy day fund, designed to iron out the effects of volatility in the oil price, is supposed to receive all oil revenue in excess of $9 a barrel. With the price for Venezuelan oil in the second quarter hovering around $20 a barrel, a gigantic amount of money should be entering the fund. But President Chávez stopped making contributions last year, and the part of the fund reserved for the federal government has run almost dry. The proposal is to change the nature of the fund (and its name) so that contributions and withdrawals are made on a more realistic scale. The fund will be used to correct on a monthly basis any difference between revenues and expenditure as planned in the national budget and what actually occurs.
None of this will be enough to stave off a substantial budget deficit this year. The National Assembly’s advisory committee believes at least $4 billion in external financing will be needed. Santeliz at the National Assembly’s economic and financial advisory committee says the government will also try to tap capital markets in Europe, Asia and the US in 2002 and 2003.
Nor will it be enough to avoid a contraction in GDP, already down by 4.2% during the first quarter. Estimates of the economy’s performance during the full year range from flat to a contraction of 6%. Most expect a contraction of 3% overall, including a 5% shrinkage in the non-oil economy. That has major implications for employment, as the oil industry employs just 0.5% of the labor force. The economic problems facing Venezuela this year will pose a severe test not only to the new cabinet, but also to the durability of the Chávez government. w