June 27, 2007
It is boom time in Venezuela. Many of the hillside slums encircling Caracas now have satellite dishes on their corrugated iron roofs. Wealth is reaching all levels of society and it is being spent with gusto.
Endemic consumption and vibrant economic growth have been triggered by public spending on a huge scale, doubling over the past two years owing to a sixfold rise in the price of oil since President Hugo Chávez came to power in 1999.
But this effervescent economy - averaging about 12 per cent growth in the past three years - has unleashed one of the highest inflation rates in the world. And as growth slows, which some fear it is doing, inflation could continue to rise.
Armando León, a director of the central bank, admits that he is more optimistic than most economists. He argues that Venezuela is only at the beginning of a growth cycle he expects to last another five to six years.
"Inflation continues to be a problem," he says, particularly because it is much higher than Venezuela's trade partners. At almost 20 per cent, it is close to double the next highest rate in Latin America. Although the central bank forecasts inflation will fall to 12 per cent by Christmas, Mr León warns that if government spending spirals, this goal could be derailed. "It's a very delicate game," he says.
Efraín Velázquez, the president of the National Economic Council, which advises the government, says current fiscal policy is unsustainable. The problem, he says, is the government's reliance on oil income to finance an array of subsidies, grants, generous social programmes, ambitious infrastructure projects and rising public-sector wages.
As oil revenues are received in dollars abroad, they have to be converted into local currency to be spent in Venezuela. This has resulted in a huge injection of new bolivars: the amount of money in circulation has multiplied by six times since 2003, escalating inflation.
This has also caused a steady depreciation of the parallel "black market" rate of the bolivar. The parallel rate is now about twice the bolivar's official value of 2,150 to the dollar.
Although an expansive fiscal policy has successfully boosted growth, it has also generated serious imbalances between supply and demand. Production has failed to keep pace with consumption, which has been encouraged further by negative real interest rates. In equal measure, this has discouraged the savings and investment needed to stimulate production. Imports have tripled in the past three years.
With too much money chasing too few goods, not only inflation but shortages of basic goods have been increasing, including milk, eggs, beans, beef and cooking oil. These goods are available sporadically and often generate long queues. Scarcity has been made more acute by price controls, which producers say make it impossible to sell at a profit.
Mr Chávez has reacted by threatening to expropriate businesses if shortages persist, worsening an already poor investment climate.
Mr Velázquez says the -fundamental solution lies in moving to reduce the government's reliance on oil earnings abroad for domestic spending.
"They need a more conservative and more organised fiscal policy," he argues, as well as prescribing a gradual lifting of exchange controls and a better environment for private investment.
"They are prioritising short-term benefits over more sustainable objectives in the medium term," says Mr Velázquez, arguing that the government's strategy is "inconsistent" in its attempt to achieve the impossible: growth without inflation.
The government shows few signs of taking such advice seriously. So far its anti-inflation strategy this year, which has included cuts in VAT and issuing $9bn in bonds to soak up excess liquidity, has had only short-lived success, attacking the effects rather than the causes of inflation.
With Venezuela's largest fiscal deficit in a decade, as well as declining international reserves, many analysts fear the worst: by next year, a forced devaluation.
Milton Guzmán, chief economist at Banco Santander's subsidiary in Caracas, says although the bolivar will continue to depreciate this year, government finances are still relatively sound.
"With such a gap between the official and parallel exchange rate, there are clear expectations of an imminent devaluation but I don't see one happening any time soon," he says.