Update on the Venezuelan Economy

After nearly six years of record economic growth, the Venezuelan economy went into recession in the first quarter of 2009, shrinking by 3.3 percent that year. A number of analysts see this as the end of an “oil boom” and the beginning of a long period of recession and stagnation.

For example, in June, Morgan Stanley drastically cut its forecast for GDP growth in Venezuela to negative 6.2 percent in 2010 and negative 1.2 percent for 2011. And the IMF projects that the Venezuelan economy will contract by 2.6 percent for 2010 and grow by less than 1.4 percent annually over the next five years[1] – i.e. negative per capita GDP growth.

However, the most prominent forecasts for the Venezuelan economy have been wrong in the past, often by enormous margins. This was especially true for Venezuela’s most recent economic expansion, where the IMF underestimated Venezuela’s growth for the four consecutive years 2004, 2005, 2006, and 2007, by 10.6, 6.8, 5.4, and 4.7 percentage points, respectively.

This update looks at the most recent data on the Venezuelan economy, in an attempt to evaluate its prospects in the foreseeable future.

We find that the Venezuelan economy is most likely already in recovery, and that the 2009 recession has probably ended. This is based on seasonally adjusted quarterly data, which show that the Venezuelan economy grew by an estimated 5.2 percent in the second quarter of 2010, on an annualized basis.

If the Venezuelan economy is indeed recovering, the question remains whether this recovery will accelerate and be sustainable. It appears that this will depend primarily on government policy.

A number of analysts have argued that the Venezuelan economy will remain mired in recession or stagnation, and/or is doomed to long term decline. In this paper, we consider these possibilities and arguments.

One possibility is that the government has created an unfavorable investment climate, and that this will severely limit the country’s growth and development. Private capital formation as a percentage of GDP had declined significantly, even before the 2009 recession. The question is whether this necessarily means that the Venezuelan economy, which grew very rapidly in the last expansion from 2003-2008, is likely to face significant constraints on its future growth due to negative investor sentiment.

The answer to this question is, most likely, no. As can be seen in Figure 3, private capital formation rebounded very rapidly as the economic recovery began in 2003, despite intense hostility toward the government on the part of the most powerful business interests. This indicates that many domestic investors, when there are profitable opportunities to invest within the country, will take advantage of them.

The government can also compensate for the current fall-off in private investment by increasing public investment. This was done successfully in 2008, as can be seen in Figure 3. As the recent electricity crisis has shown, Venezuela has a great need for public investment in infrastructure. The government can also invest in residential construction, transportation, hospitals, and other public needs. All of this can compensate for weak private investment, as necessary. And as can be seen in Table 2, private consumption follows the growth of the economy. Eventually, if it becomes clear that the government is committed to maintaining economic growth, we would expect private investment to increase, as it did from 2003-2006.

The government can increase and maintain economic growth so long as it does not face a foreign exchange crisis. It is important to understand that this is the binding constraint on countries that do not have “hard” currencies (as compared to the U.S., which can pay for its imports in dollars).

Venezuela is not in danger of a foreign exchange crisis. Its official reserves at the Central Bank are currently at US$28 billion. This is a reasonably high level of reserves, however: approximately half of imports for 2008 and over two-thirds for the reduced imports of 2009. (The most widely used benchmark is that international reserves should be sufficient to cover three months of imports.)[2]

Over the past year,[3] Venezuela’s current account surplus was US$19.8 billion, or about 6.3 percent of GDP, which is sizeable.

Furthermore, in the case of a collapse of oil prices, the government has considerable borrowing capacity. This was demonstrated in April with a $20 billion credit from China.[4] Venezuela’s total central government public debt is just 18.4 percent of GDP; and its foreign public debt is 10.8 percent of GDP.[5] Even if we add in the debt of PDVSA, the state-owned oil company – about 6 percent of GDP – this is a low foreign and domestic public debt burden, which gives the government plenty of room to borrow if there are unforeseen external shocks.

Venezuela’s inflation rate is another often mentioned problem, which is generally reported as “the highest in Latin America.” Figure 3 shows monthly year-over-year inflation at 30.9 percent. This is high inflation, although there are no signs that it is accelerating: inflation over the last three months is running at an annualized rate of 26 percent, and core inflation has been declining since last September. So long as it does not accelerate, Venezuela’s inflation is not by itself necessarily a significant impediment to future economic growth, and can be lowered gradually.[6] It is also worth emphasizing that the predicted surge in inflation following the devaluation did not happen – sources quoted by the media were in the range of 40-60 percent annual inflation for this year.[7] In fact, the 26 percent inflation over the last three months is lower than inflation for the three months prior to the January devaluation.

The main impact of inflation has been an indirect effect, through its influence on the real exchange rate. The nominal exchange rate was fixed at 2.15 from March 2005 until January of 2010. With the exchange rate fixed and inflation averaging about 20 percent annually over the last seven years, the bolivar appreciated rapidly in real terms.[8] This has made imports increasingly cheap and non-oil exports increasingly expensive, in real terms. During the expansion, manufacturing basically held its own at about 16 percent of GDP; the fastest growing sectors were non-tradables such as finance and insurance, communications, and construction.[9]

The devaluations have reversed a good part of the real appreciation of the currency over the last 5 years, but not all of it. If Venezuela wants to diversify its economy away from oil – which it has not done over the last decade – it will most likely need a more competitive exchange rate.

Nonetheless, for the narrow question at hand here – whether the Venezuelan economy can resume and sustain strong economic growth – the exchange rate is unlikely to be determinative. It will affect the sectoral mix of economic growth, tilting it toward non-tradables as during the previous expansion. But the pace of economic growth is more likely to be determined by the government’s other macroeconomic policies, most importantly public spending.

But because of Venezuela’s position as an oil exporter – and one sitting on 500 billion barrels of oil, perhaps the largest reserves in the world – it is very unlikely to run into foreign exchange constraints. Therefore its growth, especially in the near future, will depend overwhelmingly on the government’s commitment to maintaining adequate levels of aggregate demand. (In that respect, its immediate situation is similar to that of the United States, the Eurozone economies, and many other economies whose recovery is currently weak and uncertain.)

The prior economic expansion was an important one for Venezuela. Poverty was reduced by 47 percent and extreme poverty by 70 percent. Real social spending per person tripled, and there were greatly expanded public programs in health care and education; unemployment fell by half and there were large gains in employment.[10] According to a recent report by the UN Economic Commission on Latin America, Venezuela had the sharpest reduction in inequality in the Americas during this expansion. The fall in the Gini coefficient from 50.0 to 41.2 from 2002-2008 gave Venezuela the least unequal distribution of income in Latin America.[11]

If the government maintains adequate levels of aggregate demand – including a commitment to strong counter-cyclical policies as necessary – the Venezuelan economy will grow, and the progress in employment, living standards, poverty reduction, and income equality that were seen during the previous expansion will continue. Of course this is not guaranteed – it depends on whether the government is willing to make, and maintain, this commitment to growth. The government will also have to make sure that sufficient foreign exchange is made available for imports that are inputs to production. If these commitments are met, then economic growth, as well as the accompanying social progress, can continue for years, regardless of inefficiencies, development strategies (or lack thereof), or other economic problems. Although there are a number of analysts who are predicting that the Venezuelan economy is on the verge of inevitable (and long-anticipated) ruin, there is nothing in the recent data – or that of the last decade – to indicate that this is true.

Notes

[1] International Monetary Fund 1999 – 2010.

[2] See Wijnholds and Kapteyn (2001) for a review of the literature on the adequacy of reserves.

[3] This Q1 2009 to Q1 2010.

[4] Molinski and Lyons 2010.

[5] Oficinal Nacional de Crédito Público 2010.

[6] See Weisbrot, Ray and Sandoval (2009, p. 19) for more on inflation.

[7] See for example Forero 2010 and Jaramillo 2010.

[8] See Weisbrot, Ray and Sandoval.

[9] Ibid.

[10] Weisbrot, Ray and Sandoval 2009.

[11] United Nations Economic Commission for Latin America and the Caribbean 2010, Chapter 2.

This is the executive summary of the report titled “Update on the Venezuelan Economy” by the Center for Economic and Policy Research (CEPR) in Washington, D.C. You may download the full report in PDF or Flash, or by visiting the CEPR website. Mark Weisbrot is Co-Director and an Economist and Rebecca Ray is a Research Assistant at CEPR.