ARCAYA & ASOCIADOS
02 August 2007
Consumer price inflation slowed to 0.5% month-on-month in July, the government reported yesterday, down from 1.8% in June. Annual inflation fell to 17.2%, down from 19.4% in June. Although President Hugo Chavez claimed that anti-inflation measures such as rises in the interest rate and reserve requirements are proving effective, most private analysts attributed the fall in inflation to a one-off cut in value-added tax, from 11% to 9%, implemented last month. The central bank has raised the interest rate on both consumer lending and savings accounts, although in the latter case interest rates remain below inflation, discouraging savers. Despite the government's expressed commitment to reducing inflation to single digits over an unspecified period, laxity in monetary and fiscal policy will combine with contradictions in the government's development strategy to undercut the long-term sustainability of current growth figures and progress in reducing inflation and unemployment.
Government spending and the liquidity-driven consumption boom have been stoking inflation, which stood at 17.2% year on year in July. The central bank raised savings rates and reserve requirements in mid-July, but Duch measures will not be enough.
* The volatile Caracas stockmarket has been behaving erratically during the most recent bout of emerging-market selling. The IBC index is down for theyear, having reached a nadir below 40,000 in late June. It traded at 42,100 atend-July.
* The bolívar fell to its lowest level in five months in unregulated trading in late July, hitting Bs4,375:US$1.
* Along with that of other emerging-market Eurobonds, the spread on the government benchmark due 2027 widened sharply over the past six weeks, gaining nearly 100bps and reaching nearly 400bps as of late July.
Public spending has been the main driving force behind a consumption boom and strong economic growth in Venezuela over the past three years.
Government outlays doubled over the past two years. A six-fold increase in petroleum prices since President Hugo Chávez came to power in 1999 has provided the bulk of the funds for public spending. Moreover, Venezuela's efforts to put the energy industry under greater state control have boosted government income by some US$5.8bn per year, measuring over 10% of the country’s GDP. The funds are coming mainly from tax and royalty increases phased in since 2004, and the seizure in May of four joint-ventures with foreign oil companies in the Orinoco Belt.
However, runaway economic growth, averaging 12% per year over the past three years, has unleashed one of the highest inflation rates among the world’s large and medium-sized economies. Public spending is likely to remain robust in nearby years, even if petroleum prices were to decline. (At end-July, petroleum prices reached fresh records in New York.) The consumer price index (CPI) rose 1.8% month on month in June but the increase dipped to 0.5% in July. This brought year-on-year inflation to 17.2% from 19.4% in June. The government’s inflation forecast is presently for 14% in 2007, up from 12% forecast previously. This may prove overly optimistic, however, given recent consumption and import trends, even though the central bank is committed to preventing consumer prices from accelerating beyond the 17% rate posted in 2006.
Import prices are likely to continue to climb. The bolívar, which is pegged by the government at an official rate of Bs2,150:US$1, is trading on the unregulated market at its lowest level since March. It hit Bs4,375:US$1 in late July. Most importers are forced to buy dollars on the grey market, since official currency sales are insufficient to meet demand. The central bank has taken some steps in July to curb domestic liquidity, by raising the savings rates to 8% from 6.5%, and imposing stricter reserve requirements on banks.
However, the rise in the savings rate, which remains negative in inflationadjusted terms, will not even be enough to compensate savers for real losses stemming from the increase in the rate of inflation in the first half of the year.
Meanwhile, heightened volatility in international financial markets seen inthe second half of July has been felt in domestic financial markets as well.
The IBC index of the Caracas bourse has been flat, trading below its level at the start of the year. It picked up at the end of July when international equito markets bounced back after a bout of selloff, but still traded below 42,000.
The yield spread over comparable US Treasuries on the eurobond market widened to nearly 400 basis points (bps), before narrowing modestly by the end of the month.