IOU Venezuela: the Chavez government issues bonds to keep current on payments. But faltering economy stirs fears of a credit crisis or worse. (Finance).

When professor Silvana Pezzella finally received her years-overdue social benefits payment in bonds instead of cash last January, a stockbroker gave her about 75% of face value for the bonds. "I'm interested in having cash money, not bonds," says Pezzella, who teaches economics at Caracas's Central University.

Pezzella can count herself fortunate. As the nearly bankrupt Venezuelan government has increasingly resorted to using bonds to meet its obligations, the value of those Vebonos has dropped to 65%. It is part of an economic swoon that has seen the bolivar lose nearly half its value against the dollar since January, inflation soar beyond 30% and unemployment affect more than a quarter of the population.

A weak bolivar helped non-traditional exports surge nearly 20% during the first half of the year, but that did not salvage an economy expected to contract at least 5% this year. Venezuela's economy became more precarious when more than US$2 billion disappeared from the government's economic stabilization fund to pay salaries.

Meanwhile, the government of President Hugo Chavez is pumping up public spending to put the economy on artificial respiration. The money has gone to current expenses and has expanded the budget deficit to between 3% and 5% of the gross domestic product (GDP). In August, the National Assembly agreed to cover part of the shortfall by raising bank-transfer and value-added taxes.

Coup rumblings. But in a nation that exports primarily petroleum and imports nearly everything else, there are limits to that strategy. The growing economic recession and rising inflation have shrunk purchasing power. Aida Madrid, a graduate student in psychology walked out of a Caracas store recently carrying a liter of mineral water that had jumped 200 bolivars in price (about $0.15) from the week before. In order to pay rising costs, Madrid has had to take a second job, working nights in a hospital. "My wage is the same as in 2000," she says, "but expenses have quadrupled."

Both Chavez and the opposition have used the imploding economy as a political howitzer. Chavez accuses the business community of trying to stage an "economic coup" by deliberately shuttering its businesses and has threatened to pass a decree permitting workers to take control of factories.

Business leaders call that communism and say Chavez is sabotaging the economy in order to have an excuse to stage an auto-golpe, or self-coup. "More than 70% of production is paralyzed," says Carlos Fernandez, president of the Federation of Chambers of Commerce. "And the damage which [Chavez] has done in three and a half years will take a long time to repair."

The business community blames Chavez for the economic debacle. To obtain a "just price" for oil, he has cut production by about one quarter since 1999, throwing thousands of people out of work. Although Chavez's actions have rarely matched his fiery anti-capitalist rhetoric, the radical statements have been enough to drive away foreign investment, which dropped 65% in the first half of the year compared to the same period a year ago.

The nation's constant social and political confrontation has further undermined confidence. Juan Francisco Clerico, president of the Venezuelan Construction Chamber of Commerce, says his industry no longer has any private business. Public construction has dropped by 30% from last year and the government is four months behind on its payments for those projects, he says.

Clerico recently agreed to accept payments in government bonds. "I know that the banks don't want more bonds," he says. "But they'll have to accept the bonds or take my old, broken equipment."

The government's desperation to sell bonds has collided with the Central Bank's tight-money, low-inflation fiscal policy that has not increased liquidity out of fear that the money will just be turned into dollars. "The economy is in stagnation, and this vicious circle just increases the stagnation," says Aurelio Concheso, president of the Caracas economic think tank Cedice. "The only way to break out is by producing confidence through a coherent program."

Economics professor Pezzella calls the situation Venezuela's "worst crisis" in memory. "The government is using an economic model which doesn't permit private investment, but the government isn't investing either," she says, "so there's nothing to drive the economy."

RELATED ARTICLE: Central Bank Siege

As the crisis in Venezuela deteriorates at the end of 2002, Diego Luis Castellano, president of the Central Bank in Venezuela, fights to preserve the country's financial stability. Worse yet, the growing conflict between the government's goals and the austere policies of the Central Bank puts the financial institution's independence to the test. Mike Ceaser, LATIN TRADE correspondent in Venezuela, speaks with two of Castellano's close collaborators, Central Bank directors Domingo F. Maza Zavala and Bernardo Ferran.

How serious is Venezuela's fiscal situation?

Maza: Very serious. First, because the tendency of public spending is to grow, and fast. In 2002 the budget approved by the National Assembly was 26 billion bolivars. However, it later proposed a 7% budget cut and an increase of income through taxes. What was achieved by this? The deficit has decreased a bit, but it has not disappeared. The budget forecasted for 2003 will reach 36 billion bolivars, an increase of almost 50%. Part of that is to pay public debt service. Part is for municipalities and states. Another part is for contractual obligations that cannot be ignored.

How will the government obtain the funds?

Maza: Petroleum contributes 40% [of the public budget]. The other 60% must be generated by taxpayers. But there is no tax policy in place because they believe petroleum pays for it all. It is estimated that tax evasion reaches 60%. If there were no fiscal evasion there would be no fiscal deficit.

The government will increase its debt to help finance itself?

Maza: If there were a positive image of Venezuelan politics, of the existing regime, of the behavior of the country as such, the doors to international markets would be open to the state.

Ferran: Especially because we have a perfect payment history. External debt is approximately 20% of GDP. Internal debt is close to 9%. The total is approximately 30%. It is less than other countries, which should indicate that we can take on more debt. We have another asset, which is the safety net of oil prices.

How has the financial situation affected the behavior of Chavez's government?

Maza: It hasn't helped. The political message is a bit contradictory and there is no clear definition of the political economy. If there were a political message within normal democratic terms, if there were a profile of the political economy geared towards a social economy, a market economy, confidence in investors, security, property guarantees and protected opportunities, Venezuela would be different. Some of the government's measures are tinged with neoliberalism. Even so, the message, the words, are just the opposite. It does not instill confidence.

Why aren't investors buying Venezuelan debt?

Ferran: Because investors are observing a tense political situation. But the economic potential in the country is considerable. We have reserves in oil, natural gas, iron, nickel, asphalt, etc. Venezuelans living abroad have between US$80 billion and $100 billon. If they were to bring back only 20% of that, the situation would be different. The country's potential is tremendous.

So what will happen?

Maza: There is no private investment. Public investment is not enough. Consumption has fallen, Unemployment has increased. The informal sector is very wide, exceeding more than 50% of the productive sector.

The difficulty in issuing bonds has led to a clash between the government and the Central Bank. Will the bank do something to help the government?

Ferran: The Central Bank is guided by the law and its final objective, which is the wellbeing of the population. The Central Bank cannot directly assist the government.

Has the Central Bank been able to maintain its independence?

Ferran: Even you have said there is a conflict.

Maza: We are an autonomous state institution. We are not part of the government. We have to cooperate so the state can accomplish its goals, which are macroeconomic stability, to propel economic growth and social well-being. There is an obligation called economic coordination, but that does not mean there cannot be a discrepancy that could lead to a conflict.

Does monetary policy limiting currency circulation harm growth?

Maza: No. The financial system has in recent times been a good buyer of public debt. Private sector credit for production is contracted. Another option, the purchasing of foreign currency, is limited by orders of the Central Bank. So the financial system has been buying public credit and already has a significant portfolio. More than 20% of the financial system's purse is composed of public debt. It is a risk if the government interrupts payment. The other risk is that the service on the debt also accumulates. There is no clear guarantee that the government can properly look after service on the debt.

Are there plans to reduce the banks's obligatory adjustments?

Maza: It's an idea, a simple idea. If what is reduced in adjustment terms is applied to public debt titles, then the Central Bank's autonomy could be compromised because it could be interpreted as directly financing the goverment. However, if there is a voluntary agreement between the government and the financial system ... I don't know how the Central Bank would enter this accord, because the Central Bank would only reduce adjustments for monetary policy reasons, and not to ease financing for the government:

So it seems that ...

Maza: Also, because if we decide to increase liquidity there could be an increase in demand for foreign currency. We don't want that.

How far will the bolivar drop?

Maza: No one knows, not even where it is headed this year.

Is the Central Bank willing to intervene in the foreign currency market?

Maza: Yes, when the movements can be interpreted as a speculative upsurge, when we understand that they are sporadic, manipulated movements that are trying to take advantage of the exchange rate.

If President Chavez continues with the same rhetoric until 2006, what prospects does the country have?

Maza: If political discourse continues, if political conflict continues, if social pressure continues, if uncertainty regarding the social and political crisis continues, naturally the impact on the economy will be very serious.

Ferran: No one can predict that, even if President Chavez remains in power, there will be no reconcilliation, an agreement between distinct sectors. If this happens, if the waters became less turbulent, that would make a big contribution to the economy. Aside from the political conflict, there is a process for institutional change. For example, social security is a very important element for a new situation in the country, because it could lead to a good financial, economic and social atmosphere in the country.

Where does the problem lay? In the government? The opposition? Both?

Maza: In both. That is my personal opinion. I do not speak for anyone else. If the opposition presented a clear, positive alternative, proposed a solution to the country's problems and acted accordingly, that would notably contribute toward improving the political climate, independent of whether or not Chavez remains in the government. But the opposition does not offer anything, it is empty. That deepens the crisis.

Are we now in danger of falling into another crisis?

Maza: The financial system has strengthened. Emergency mechanisms have strengthened, and there is better capitalization. The Superintendency of Banks has applied norms of prudence and strengthening of the system's bases.

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