A little local difficulty?

Venezuela, the richest country in the Americas in petroleum and with huge reserves of other natural resources, such as high-grade bauxite, has investors wary on two counts: leading presidential candidate Hugo Chávez Frias and the lowest world oil prices for more than a decade.

Chávez, a former army lieutenant who led an unsuccessful coup attempt in 1992 and who is the populist candidate leading in the polls for presidential elections scheduled for December, "has created a lot of uncertainty", says an international monetary source in Washington, who in the next breath identifies oil prices as the second culprit.

Picking a page from Latin American political campaign manuals for the 1980s, Chávez says he wants less of the budget to be used to service foreign debt and has suggested that Venezuela's privatizations of recent years be reconsidered. Oil, which at $18 billion accounted for almost 80% of Venezuela's exports in 1997, has fallen about 30% in price this year, forcing finance minister Freddy Rojas Parra to make two budget cuts early in 1998. In addition to dominating exports, oil provides more than half of the country's fiscal revenues.

Pared to the bone

"There will be a brutal fall of $5 billion in oil-export revenues for this year," says planning minister Teodoro Petkoff. Yet when asked if yet more paring of state expenditures might be necessary, the minister, whose spartan office has a marvellous view of downtown Caracas but a bare concrete floor and missing ceiling tiles, says: "There is nothing else to cut."

Petkoff declined to estimate how much Venezuela will need to raise on international capital markets in 1998. Market sources suggest an additional $1 billion to $2 billion, including some $500 million which the country is negotiating to obtain from the Inter-American Development Bank. "That is a wide range, $1 to $2 billion, but the range reflects the uncertainty on oil prices," says an analyst for a New York bond trader.

Venezuela's scheduled debt-service payments total about $4.2 billion on foreign debt and $1.8 billion on domestic debt in 1998, according to banking sources. In late June, the government announced that it had negotiated a "shadow agreement" with the International Monetary Fund. "This provides comfort to financial markets so Venezuela will get good terms," says a central bank source in Caracas. The informal agreement, which does not include obtaining monies from the IMF, provides for staff monitoring by the fund of the Venezuelan economy. "It could be changed to a formal agreement to get financing," says one banker.

Petkoff says the Venezuelan congress "in a matter of weeks" will vote on a proposal to increase value-added tax to 18% from 16.5%. The new rate will damp consumption and increase the tax base, he says. The minister expects inflation to fall to 30% in 1998 from 37.8% last year.

Discouragement of consumption is important in Venezuela because the bolivar is overvalued, according to analysts and bankers in Caracas. Petkoff notes that the central bank is following a policy of devaluing the bolivar by 1.28% a month. Some analysts predict that the currency, about Bol 546 to the US dollar in late June, will drop to about Bol 600 by the end of this year, implying a devaluation of about 17% for 1998. The exchange rate closed at about Bol 500 to the dollar at the end of 1997. Oscar García Mendoza, president of Banco Venezolano de Crédito, reckons that the bolivar should be Bol 676 to the dollar.

"Imports are going up because of an overvalued currency," says Gonzalo Pacanins, an analyst at Darby Overseas Investments in Washington. "You see a lot of Venezuelans still travelling abroad because it's cheap."

Is there more fat to cut?

According to James Barrineau, emerging-markets strategist for Salomon Smith Barney in New York, "the government has a limited ability to cut the budget from here". Large parts of the budget such as the payroll and debt-service payments could not be touched in any year, much less an election one.

However, a former World Bank official in Washington is sceptical that Venezuela is doing enough. "I don't think that they have been nearly as successful as Mexico in that Mexico had a similar situation, although the Mexican economy is not as dependent upon oil," says Richard Frank, managing partner of Darby Overseas Investments. "As I look at what is going on in Venezuela, they've got some reduction in government spending but it doesn't look like it is enough to offset the lower revenues."

Yet Venezuela rates high marks from international monetary sources in Washington, who ask not to be identified, as well as from the IADB, for its handling of the economy this year. "I think that they are doing well and they've taken the right steps," says Jorge Lamas, coordinator for Venezuela at the IADB. "They have tightened fiscal and monetary policy."

Venezuela, which has cut about $2.4 billion from its budget in two steps this year after oil prices began their plunge, is taking the difficult decisions in an election year, notes Lamas. In many countries, he points out, an election year causes the government to loosen the purse strings - "so I think the [Venezuelan] government is not playing politics". Venezuela entered the year projecting an average oil price of $15.50 per barrel, a figure subsequently lowered to $13. But now oil is close to the $12 level. Each $1-per-barrel drop in world oil prices costs Venezuela about $800 million in lost export revenues.

When oil prices are high everyone wants to invest in Venezuela, says Alejandro Grisanti, a consultant at the IADB, but when prices go into a down cycle, investors want to pull out. That happened early this year when between $4 billion and $5 billion flowed out of the country. However "the huge capital outflows we had in the beginning of the year have been controlled and reversed," says Grisanti. The country's foreign-exchange reserves now are a little less than $16 billion, up from $14.5 billion two months ago, he says. The figures dovetail with those given by planning minister Petkoff. Grisanti says the capital outflows were reversed by high interest rates, about 20% in real terms.