VENEZUELA: STRUGGLING WITH DECLINING OIL REVENUES

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88T00768R000400510001-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 27
• Document Creation Date: December 27, 2016
• Document Release Date: March 25, 2011
• Sequence Number: 1
• Publication Date: December 1, 1986
• Content Type: REPORT

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Intelligence 25X1
Declining Oil Revenues
Venezuela: Struggling With
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ALA 86-10051
December 1986
363
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Directorate of
Intelligence
Declining Oil Revenues
Venezuela: Struggling With
An Intelligence Assessment
This paper was prepared b Office
of African and Latin American Analysis, with
contributions from
Office of Leadership Analysis. It was
coordinated with the Directorate of Operations.
Comments and queries are welcome and may be
directed to the Chief, South America Division
Secret
ALA 86-10051
December 1986
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Venezuela: Struggling With
Declining Oil Revenues
Key Judgments The unexpected depth of the oil market collapse in 1986 has set back
Information available President Jaime Lusinchi's efforts to stabilize the Venezuelan economy. In
as of 15 November 1986 response to the steep decline in oil revenues, Lusinchi has urgently
was used in this report.
introduced new adjustment measures aimed at checking the economy's
slide and bolstering the nation's debt service capacity. The President's
efforts, however, are unlikely to provide more than temporary relief to an
economy suffering from overdependence on oil revenues and an excess of
government intervention. In our view, the Venezuelan economy is likely to
remain in recession at least through the 1988 presidential election-a
situation that could result in a defeat for President Lusinchi's conservative,
pro-US Ortodoxo faction of the ruling Democratic Action party. According
to US Embassy and press reporting, Lusinchi is already under attack from
his political opponents for his management of the economy. Continued
recession is also likely to negatively affect US interests by depressing
demand for US products and by limiting Venezuela's capacity to provide
economic assistance in the Caribbean Basin.
We expect Lusinchi to succeed in protecting the nation's capacity to meet
its servicing obligations on the external public debt. International bankers
are likely to acquiesce in Venezuela's request that most of the principal due
through 1990 be rescheduled-providing Venezuela insurance against the
risk that oil prices might descend again to $10 per barrel. To conserve
foreign exchange, Lusinchi has imposed new restrictions on imports and
has devalued the Bolivar. These measures, and Venezuela's relatively large
foreign exchange reserves, should allow Caracas to meet its external
payments obligations over the next three years, even if oil revenues remain
depressed. 25X1
We believe, however, that success will continue to elude Lusinchi in his ef-
forts to extricate the economy from a recession that has persisted for more
than eight years. The economy's problems extend far beyond a temporary
inadequacy of foreign exchange. According to the US Embassy, the
principal impediments to growth are deficient institutions and policies that
over several decades have resulted in a pervasive presence of the state in
the economy-a presence that Lusinchi has not aggressively attacked. His
failure to liberalize the economy, his abrupt policy reversals on such issues
as the external private debt, and the uncertainty over oil revenues rule out,
in our view, a significant revival of private investment in the medium term.
Because the oil revenue shortfall also constrains government and consumer
Secret
ALA 86-10051
December 1986
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spending, we see no plausible engine to pull the economy out of its
doldrums. A growing danger is the possibility that Lusinchi, out of
frustration, will try to spend Venezuela out of recession. We concur in the
IMF judgment that such a strategy would provide only a transitory
stimulus to the economy-while risking a sharp increase in inflation that
would handicap future efforts to generate self-sustained economic growth.
The moribund economy has become the principal issue in domestic politics
and may play a determining role in presidential succession. With cam-
paigning for the 1988 election already under way, COPEI, the Christian
democratic opposition, has made modest gains in public opinion polls by
stridently assailing Lusinchi's economic management. COPEI's chances to
seize the presidency will continue to improve as the economy deteriorates,
but we believe COPEI will fall short in the 1988 election-unless
Democratic Action, the ruling social democrats, splits over the selection of
a candidate. Within Democratic Action, Lusinchi's Ortodoxo faction is
being challenged by maverick ex-President Carlos Andres Perez, who also
hopes to capitalize on Lusinchi's problems with the economy. Although
Perez is fighting an uphill battle against the party machine, his chances are
boosted by his immense following among party rank and file and by the
Ortodoxos' inability to settle upon a candidate to succeed the popular
Lusinchi, who cannot seek a consecutive term in 1988. Perez's bitter
relations with the Ortodoxos suggests the possibility that-if his bid falls
short-he might refuse to endorse the party's nominee or might even
accept a third-party nomination.
The economic crisis poses no threat to the stability of democratic govern-
ment over the medium term, in our judgment. Public acceptance of
Venezuela's political institutions remains strong and the radical left is
almost nonexistent. Labor peace is virtually assured by the intimate
relationship between Democratic Action and the Confederation of Venezu-
elan Workers-the nation's dominant labor organization. Over the longer
term, however, the inability of the economy to generate sufficient jobs for
the nation's rapidly expanding labor force could become a destabilizing
US interests will be adversely affected by Venezuela's continuing foreign
exchange crisis and economic recession. Over the medium term, US
exports to Venezuela will continue to be limited by Venezuelan trade
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restrictions and chronic recession, while US creditors-who hold about
one-third of Venezuela's $35 billion external debt-are almost certain to
experience continued difficulties in collecting principal and interest pay-
ments from Venezuelan borrowers, especially in the private sector. Venezu-
elan economic assistance to fledgling democracies in the Caribbean
Basin-usually coincident with US interests-has been trimmed substan-
tially from precrisis levels and is unlikely to recover soon. US-Venezuelan
bilateral relations will probably be strained if the US increases its trade
barriers to Venezuelan oil, steel, and aluminum exports-or if the failing
Venezuelan economy contributes to the election of Perez, whom we believe
would once again use the presidency to project himself internationally as a
spokesman for Third World causes.
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Key Judgments
The Setting
Oil Collapse Provokes New Crisis
The Political Equation
Stabilization Renewed
Tight External Constraints-Two Scenarios
The Outlook for the Domestic Economy
Implications
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Venezuela: Struggling With
Declining Oil Revenues
Introduction
The sudden collapse of oil prices in the first quarter of
1986 has deepened Venezuela's economic crisis-
frustrating President Lusinchi's efforts to engineer
economic recovery, raising new doubts about the
nation's capacity to service its external debt, and
jeopardizing the most important US trading relation-
ship in South America. The stalled economy has
become the major-almost the only-political issue in
Venezuela. COPEI, the Christian democratic opposi-
tion party, has used Lusinchi's economic problems to
stage a modest comeback in public opinion polls,
raising the prospect that it may be able to mount a
serious bid for the presidency and for control of
Congress in the 1988 election. The main challenge to
Lusinchi and his Ortodoxo wing of the ruling Demo-
cratic Action (AD) party comes from ex-President
Carlos Andres Perez, who heads the party's populist
wing. Perez and the populists hope to capitalize on
Lusinchi's often fumbling economic management to
seize the AD's presidential nomination. If Perez suc-
ceeds in winning control of the party and the govern-
ment, he can be expected to use the presidency to
project himself internationally as a spokesman on
Third World issues, increasing tensions in Venezuela's
traditionally harmonious relations with the United
States.
This paper examines the implications of the oil reve-
nue shortfall for Venezuela's debt service capacity,
assesses the economy's growth prospects in light of its
foreign exchange constraints and the government's
probable policy initiatives, and suggests some implica-
tions of these developments for Venezuela's presiden-
tial succession and for US interests.
The Setting
When Lusinchi took office in February 1984, the
precarious state of the economy commanded his im-
mediate attention. Over the two previous years, nonoil
GDP had declined by 4 percent, the official unem-
ployment rate had almost doubled, the public sector
had posted fiscal deficits averaging 10 percent of
GDP, net international reserves had plunged $8 bil-
lion, and negotiations with international lenders to
reschedule $28 billion in external public debt ap-
peared hopelessly stalled. To marshal support for
stabilization, the President forged a "social pact" with
business and labor in which each agreed to make key
concessions in exchange for measures protecting inter-
ests vital to their constituents. Business leaders ac-
cepted government mandates placing a temporary
freeze on layoffs, extending price controls, and requir-
ing firms to provide workers free lunches and com-
muting allowances. In exchange the government
promised the private sector a preferential exchange
rate to service foreign debt, and labor leadership
pledged to exercise wage restraint. With the "social
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pact" achieved, Lusinchi turned to implement a com-
prehensive stabilization program-giving priority to
correcting the balance of payments and fiscal deficits.
He further devalued the bolivar and expanded tough
controls on imports and access to foreign exchange.
The government also placed stern limits on public-
sector expenditures and scheduled certain money-
losing entities for dismantling. In addition, debt nego-
tiations with international bankers began in earnest.
Successes. By the end of 1985 the administration
could show important results. According to the Cen-
tral Bank:
? The current account of the balance of payments
recorded surpluses in 1984 and 1985 totaling more
than $7 billion-allowing a $3 billion net reduction
in the external public debt and a $3.7 billion
increase in the Central Bank's international
reserves.
? Interest arrearages on the external public debt were
paid and $21.2 billion in public debt to international
bank creditors was rescheduled, the first multiyear
rescheduling agreement without an accompanying
IMF program.
? Inflation was held to only 16 percent in 1984 and
9 percent in 1985 through the exercise of fiscal
restraint, price controls, and a hard line against
requests for government-mandated wage increases.
Failures. Success, however, eluded Lusinchi in his
efforts to revive the nonoil economy from a recession
that started in 1978, four years before Venezuela's oil
revenues began their precipitous decline. At yearend
1985, real output in the nonoil economy was far below
that of 1982 and only 65 percent of manufacturing
capacity was in use. Of even greater concern to the
administration, unemployment remained stubbornly
high-12.7 percent, according to official estimates,
but over 20 percent, according to the Confederation of
Venezuelan Workers (CTV), after adjusting for the
severely underemployed. Administration spokesmen
gave public assurances, however, that the successes
achieved during these first two years in stabilizing the
balance of payments and the fiscal accounts had set
Oil Collapse Provokes New Crisis
The dramatic slide in petroleum prices that began in
January 1986 has erased important gains achieved by
the Lusinchi administration and accentuated its fail-
ures. In 1986 petroleum revenues will fall by at least
$5 billion-or 40 percent-from the $13 billion
earned in 1985. With oil market analysts forecasting
only marginal improvement in market conditions
through 1988, Venezuela's oil revenue prospects re-
main bleak. Consequently, the Planning Ministry's
sanguine projection last year that the current account
balance would post a cumulative $9 billion surplus
through 1988 and that economic growth would aver-
age 3 percent per year is no longer plausible. Instead,
the Embassy and independent Venezuelan analysts
are now projecting that the current account will be
barely in surplus and economic growth will be closer
to zero percent over the 1986-88 period. The current
account's deteriorating prospects have raised fears
that Venezuela could experience problems meeting its
debt service obligations in the 1987-89 period.
The oil revenue shortfall also adversely affects the
government's budget. At the current exchange rate of
7.50 bolivars/dollar, each $1 billion decline in oil
revenues causes the tax payments of Petroleos de
Venezuela (PDVSA), the state-owned oil monopoly, to
fall by about 5.5 billion bolivars. Consequently, the
IMF projects that the $5 billion shortfall in petroleum
revenues expected in 1986 will produce a public-sector
fiscal deficit equal to about 9 percent of GDP this
year, and the oil revenue shortfall expected in 1987
will produce a fiscal deficit almost as large. According
to the Embassy, financing these deficits will probably
exhaust the public-sector financial reserves accumu-
lated in 1984 and 1985-reserves the administration
had hoped to use to finance an economic recovery
program over the second half of Lusinchi's term.
The Political Equation
Lusinchi is under intense political pressure to limit the
short-term impact of declining oil revenue and to
restore economic growth before the 1988 election.
According to the Embassy, COPEI is using the
nation's economic difficulties to rail against the ad-
ministration's policies. Although COPEI has yet to
the stage for economic recovery in 1986.
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Petroleum-Based Economic Development
The Venezuelan experience again demonstrates that
abundant foreign exchange earnings alone are insuffi-
cient to generate self-sustained economic growth.
According to the US Embassy, the institutions and
policies necessary for economic development are lack-
ing or deficient in Venezuela. Instead, excessive stat-
ism and frequent policymakingfip-flops have dis-
couraged investment, have encouraged the dissipation
of oil revenues on consumer goods imports, and have
induced the flight of capital to more secure invest-
ment havens abroad.
The surge in oil revenues following the 1973 Arab oil
embargo sparked visions among politicians and social
planners of transforming Venezuela into a modern
industrial democracy. Over the next 10 years, $117
billion in oil receipts-augmented by more than $40
billion in medium- and long-term loans from interna-
tional lenders-were used to finance a sweeping effort
to diversify the industrial base; to expand the govern-
ment's commitments in housing, education, and other
social programs; and to fund an ambitious foreign aid
program. Initially, the strategy of government-
managed investment of the oil dividend appeared to
work. By 1978 the ratio of investment to GDP was
among the highest in the developing world, real
output in the domestic economy was expanding at an
8 percent annual clip, and per capita consumption
was the highest in Latin America.
Achieving self-sustained growth, however, proved to
be an elusive goal. Instead, in 1979 the economy
entered a period of long-term stagnation and decline
from which it has not recovered. The stagnation
phase, 1979-82, was especially disturbing to advo-
cates of state-managed development because even by
using the record oil revenues of 1980 and 1981 to
fund an ambitious program of public-sector invest-
ment projects, economic recovery was not achieved.
According to the Embassy, recoveryfailed to materi-
alize because the fiscal stimulus injected by the
government was offset by sharply declining private
investment. Private investors, made skittish by irreso-
lute and misguided economic policy making, cut real
outlays for plant and equipment by two-thirds over
the 1978-82 period. Outright economic decline began
in 1983, when declining petroleum prices necessitated
retrenchments in public outlays and destroyed re-
maining private-investor confidence. For the 1978-85
period as a whole, real output in the nonoil economy
declined 6 percent, and per capita output fell 24
percent.
The same factors that discouraged investment were
inducements to increased consumption and capital
flight. Over the 1973-82 period, the influx of oil
dollars and a greatly overvalued currency triggered
sharp increases in consumer goods imports. Accord-
ing to official data, most of the 37 percent increase in
per capita consumption in this period is attributable
to increased imports-not increases in domestically
produced consumer goods. Subsequently, in the 1982-
85 period, when oil revenues began their downward
slide, imports and consumption levels descended in
tandem, further underscoring the oil revenu%on-
sumption relationship.
Capital flight absorbed a growing share of Venezue-
la's foreign exchange earnings through 1983. Accord-
ing to the Embassy and a major money center bank,
capital flight took more than $30 billion out of the
country by 1985. Embassy analysis shows that capi-
tal flight from Venezuela was so strong that, when
netted against the external debt, it converts Venezue-
la into a net creditor nation-that is, Venezuela's
foreign-currency-denominated assets currently ex-
ceed its liabilities to foreigners.
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Figure 2
Venezuela: Economic Trends, 1980-86
Percent change over
previous December
a Projected.
b Fiscal year equals calendar year.
LI
-15 1980 81 82 83 84 85 868
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formulate its own program for economic recovery-
and is unlikely to do so until the party resolves a
leadership struggle between party General Secretary
Fernandez and party founder Rafael Caldera-its
assault on Lusinchi's policies has boosted the party's
standing in public opinion polls from the extremely
low levels recorded at the close of the failed presi-
dency of Luis Herrera Campins in 1984.
The most serious challenge to Lusinchi, however,
comes from within his own party. According to
Embassy reporting and press accounts, the populist
wing of Democratic Action has strongly criticized the
administration for adopting an economic adjustment
program that critics believe too closely resembles
those the IMF has imposed on other debtor nations.
For example, in a widely reported press conference in
September 1985, former Planning Minister Luis
Matos Azocar-who had earlier resigned in disagree-
ment with administration policy-charged that while
business interests were granted key concessions, such
as a preferential exchange rate to service their exter-
nal debt, workers have been saddled with sharp
increases in the prices of basics and reduced job
opportunities. Matos also advocated linking debt ser-
vice to export earnings and faulted the administration
for running up huge budgetary surpluses, instead of
providing fiscal stimulus to the stalled economy.
Matos and other critics from AD's left wing have
pressed for the removal of Finance Minister Manuel
Azpurua and Venezuelan Investment Fund head
Hector Hurtado-principal architects of the adminis-
tration's economic strategy-on the grounds that they
are too conservative. The ruling party's leftist and
populist backbenchers, many of whom agree with
Matos, are reported by the Embassy to support the
candidacy of populist ex-President Carlos Andres
Perez for the party's 1988 presidential nomination.
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The charismatic Perez, who presided over the nation
in the halcyon days of the nation's oil bonanza, is
openly casting himself as a proven manager of the
economy and a votegetter. Perez's quest for the
presidency is made difficult by the strong control the
Ortodoxos and labor leaders exert over the nomina-
tion process. According to the Embassy, Perez's prob-
lems with the Ortodoxos and labor leadership stem
from his highly personalistic style in a party where the
exercise of power is traditionally collegial. According
to the Embassy, party and labor leaders believe that
Perez would again freeze them out of decisionmaking,
as he did during his 1974-79 presidency when he often
turned, instead, to advisers from outside the party. In
addition, Perez's constant sniping from the sidelines
has engendered a deep animosity between Perez and
the President that, according to the Embassy
has frequently flared into heat-
ed exchanges over economic strategy in meetings of
the party's executive committee. To gain the party's
nomination, Perez must persuade a majority of the
30,000 to 45,000 party stalwarts who will choose the
party's candidate that only by turning to him can AD
avoid being turned out of power-and government
sinecures. According to the Embassy, Perez's pros-
pects for success are improved by the Ortodoxos'
inability to find an attractive alternative. After much
indecision, the Ortodoxo leadership of the party is
now advancing-without enthusiasm-the candidacy
of the lackluster former Minister of Interior Octavio
Lepage. Despite being anointed by party leadership,
Lepage continues to lag far behind Perez in public
opinion polls.
The resurgent candidacy of Perez and COPEI's gains
in recent public opinion polls have added a note of
urgency to Lusinchi's efforts to revive the economy
and have constrained the administration's policymak-
ing options. The administration has chosen to rely on
an economic strategy largely grounded in traditional
Venezuelan statism and nationalism, in the Embassy's
view, largely because innovative economic adjustment
measures would almost certainly provoke intense criti-
cism from entrenched economic and political inter-
ests. For example, recommendations by independent
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The Confederation of Venezuelan Workers (CTV) is
Venezuela's dominant labor organization and plays a
key role in setting the nation's agenda. According to
US Embassy analysis, the CTV's prominence in
national affairs is rooted in its firm command over
the labor movement and in its unique ties to Demo-
cratic Action (AD), Venezuela's dominant political
party. The CTV-AD bond evolved out of a common
struggle against dictatorship in the 1940s, and mani-
fests itself today as a comfortable power-sharing
arrangement. The mainspring of the arrangement is a
network of leadership interlocks between the two
organizations. Democratic Action party members
hold almost 60 percent of the federation's leadership
posts, while labor leaders are represented on AD 's
National Executive Committee, the Cogollito (the
party's informal board of directors), and in AD's
congressional delegation. This relationship allows the
CTV to define its objectives in broad political, eco-
nomic, and social terms, rather than in narrow trade
unionism. In exchange, the CTV supports AD by
mobilizing its grassroots components in support of
party candidates and programs. In contrast, COPEI,
the Christian democratic opposition, receives little
labor support and has negligible influence over the
labor movement.
The CTV's influence within the party and the Lusin-
chi administration has been repeatedly demonstrated.
In party affairs, labor was key to the selection of
In exchange for labor's support,
Lusinchi agreed to name CTV leader Manuel Pen-
alver to the party's secretary generalship. In national
affairs, labor lobbied successfully for food and trans-
portation subsidies in 1984 to soften the impact of the
President's austerity program on the working class.
At the same time, labor pressure was instrumental in
administration decisions to freeze prices on a long list
of consumer basics and to reject the IMF s recom-
mendation to devalue the currency further. The
CTV's influence was also felt in Caracas's negotia-
tions with its creditor banks last year. Labor's strong-
ly voiced objections to the terms of a tentative deal
with bankers resulted in a six-month delay, during
which the administration placated labor by negotiat-
ing minor revisions in the text of the agreement and
acquiesced in labor demands for a WPA-type public
works program.
The CTV-AD relationship also helps ensure social
peace when AD is in power. The hierarchical CTV
controls the process by which the more than I million
members of CTV-affiliated unions select their leaders
and requires that all important decisions of local and
state affiliates be approved by the CTV. Because
labor leadership is a partner in government, there
have been fevfr open manifestations of labor discon-
tent-despite a shard drop in real wages and a 50-
percent increase in the number of the unemployed.
Lusinchi as AD 's standard bearer in 1983
Venezuelan economists and the IMF calling for a
liberalization of the economy have been ignored in
favor of a further elaboration of controls over prices,
wages, interest rates, imports, exports, and foreign
exchange. On the external debt issue, Lusinchi, while
recognizing the need to reach a settlement with
foreign creditors, has played to public opinion by
adopting a dilatory and often confrontational ap-
proach with international bankers. As a consequence
of Caracas's statist and often stubborn approach to
economic management, investors and international
lenders have demonstrated a reluctance to make new
commitments to Venezuela, according to Embassy
Stabilization Renewed
According to the IMF, the administration under-
stands that the oil'price decline is unlikely to be
transitory and that policies should be developed in the
expectation of a continued scarcity of foreign ex-
change. Accordingly, the administration implemented
a package of stabilization measures in the third
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quarter of 1986 that seeks to conserve foreign ex-
change by:
? Rescheduling most of the officially recognized pri-
vate foreign debt. Foreign creditors will be required
to extend the grace period on principal repayment
for most of the $6.9 billion in net external private
debt, instead of receiving repayment over the 1986-
91 period as originally promised.
? Imposing new restrictions on imports of consumer
goods and agricultural commodities.
Mandating that public-sector entities purchase do-
mestic products, if possible.
The stabilization package also includes measures de-
signed to bolster the government's fiscal accounts. To
increase revenues, Lusinchi proposed a modernization
of the tax system and announced-without specifics-
that the "unnecessary assets" of public enterprises
will be sold. The central government's revenues re-
ceived a one-time-only boost by the administration's
decision to renege on its earlier promise to provide the
private sector with subsidized dollars to service its
external debt. This decision allowed the treasury to
seize the assets of a special fund in the Central Bank
that had been set up to cover the costs to the Central
Bank of such subsidies. To cut the central govern-
ment's expenditures, the President announced new
austerity measures for government agencies.
Although the new measures may help somewhat to
stabilize the nation's fiscal and external accounts, the
administration has avoided some of the more difficult
steps recommended by the IMF to restructure the
economy along more market-oriented lines and reduce
the public-sector fiscal deficit. Such recommendations
included progressive elimination of quantative restric-
tions on imports, ending the practice of export licens-
ing, relaxation of price and interest rate controls,
eased regulation of labor markets, increased prices for
goods (especially electricity and refined petroleum
products) produced by state enterprises, and a sharp
devaluation of the bolivar. According to the IMF, a
liberalization of the economy and devaluation are
essential to a more rational allocation of resources,
and to encourage the private investment the economy
needs to stimulate economic growth. Embassy reports
indicate, however, that ruling party leaders believe
adoption of the IMF's recommendations would sub-
ject them to charges from their labor allies and their
political opponents that they have compromised the
nation's sovereignty and have sold out to business
interests.
Tight External Constraints-Two Scenarios
The new measures may prove insufficient to enable
Venezuela to meet its debt service obligations and to
pay for necessary imports over the 1986-88 period. To
assess the external balance problem-and identify
corrective measures likely to be taken by the govern-
ment-we have projected Venezuela's financing gaps
under two sets of assumptions regarding future oil
prices.' In the first case, exports are assumed to
average $14 per barrel in 1986, $16 per barrel in
1987, and $18 per barrel in 1988. In the second case,
exports are assumed to average $13 per barrel in
1986, but dip to $10 per barrel in 1987 before
rebounding to $12 per barrel in 1988. In both cases,
petroleum exports are assumed to average 1.50 mil-
lion barrels per day in 1986 and 1987, increasing to
1.55 million barrels per day in 1988. In addition, the
two scenarios assume that the economy does not grow;
the interest rate applicable to the external debt is 9
percent; and fiscal, monetary, trade, and exchange
rate policy remain unchanged over the period through
1988.
The Upside. In the first case, Venezuela's financing
gaps are probably manageable without additional
stabilization measures. The 1986 current account
balance posts a deficit of $0.8 billion, which, when
added to debt amortization requirements, yields a
financing gap of $2.5 billion. This gap can be covered
by drawing from the $15.5 billion in international
reserves that were held by the Central Bank and- the
Venezuelan Investment Fund at the beginning of
, A financing gap is created when the sum of the current account in
the balance of payments and scheduled debt amortization is
negative and must be covered by drawing down existing interna-
tional financial reserves, attracting new capital from abroad, or
taking corrective actions such as rescheduling debt or cutting
25X1
25X1
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Table 1
Venezuela: Estimated
1986-88 Financial Gaps:
High-Oil-Revenue Scenario
Merchandise exports
9.2
10.5
12.1
Oil
7.7
8.8
10.2
Nonoil
1.5
1.7
1.9
Merchandise imports
7.0
7.3
7.7
Nonfactor services (net)
- 1.6
-1.5
-1.4
Interest and dividends
-1.3
-1.5
-1.7
Debits
-2.7
-2.5
-2.4
Transfers (net)
-0.1
-0.1
-0.1
Balance on current account
-0.8
0.1
1.2
Scheduled debt amortization
1.7
1.5
1.8
Public
1.4
1.5
1.8
the external accounts.
1986. Over the next two years, increasing petroleum
revenues swing the current account into modest sur-
plus, producing financial gaps of $1.4 billion in 1987
and $0.6 billion in 1988. For the 1986-88 period as a
whole, the cumulative financial gap of $4.5 billion
could be covered by drawing from international re-
serves, leaving a cushion of over $11 billion to cover
other contingencies, such as increased imports if
growth resumes. In our judgment, this scenario re-
quires no additional measures-such as a further
rescheduling of the external public debt-to stabilize
the nation's liquid reserves.
Table 2
Venezuela: Estimated.
1986-88 Financial Gaps:
Low-Oil-Revenue Scenario
Merchandise exports
8.6
7.3
8.8
Oil
7.1
5.5
6.8
Nonoil
1.5
1.8
2.0
Merchandise imports
7.0
7.0
7.0
Nonfactor services (net)
- 1.6
- 1.4
- 1.3
Interest and dividends
-1.3
-1.7
-1.8
Credits
1.4
0.8
0.6
Debits
-2.7
-2.5
-2.4
Transfers (net)
-0.1
-0.1
-0.1
Balance on current account
- 1.4
-2.9
- 1.4
Scheduled debt amortization
1.7
1.5
1.8
Bridging Gaps. The low-oil-revenue scenario would
require the government to implement tough measures
to shore up the nation's external accounts and protect
its capacity to service debt. The options open to the
government include followup debt reschedulings, de-
valuation, loans from international creditors, and
debt-to-equity conversions. We believe that the poten-
tial benefits from these sources-in conjunction with
reserve drawdowns-would suffice to cover the fi-
nancing gaps of the low-oil-revenue scenario. The
accompanying reserve drawdowns, however, would
probably have to be substantial-perhaps even includ-
ing partial liquidation of the Central Bank's $3.4 25X1
billion in gold holdings-requiring that Caracas
learns to live with reserve levels much lower than
those with which it has traditionally felt comfortable.
The Downside. Under the more pessimistic assump-
tions of the second case, financing gaps exhaust the
nation's liquid foreign exchange reserves by 1989-
unless additional stabilization measures are taken.
For 1986, the current account registers a deficit of
$1.4 billion, creating a financing gap of $3.1 billion
after the addition of scheduled debt amortization
payments. Although the 1986 gap could be covered by
drawing down international reserves, gaps of $4.4
billion in 1987 and $3.2 billion in 1988 would exhaust
To protect against the advent of a low-oil-revenue
scenario, Caracas appears almost certain to, first,
devalue the bolivar sharply and, second, secure a
followup rescheduling of most principal due on the
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Table 3
Venezuela: Sources of Additional Foreign
Exchange Savings and Inflows, 1987-88
Reschedule external public debt to bank
creditors
2.3
Reschedule bond debt and debt to official
creditors
1.1
Nonproject loans from multilateral
development banks
public-sector debt in 1987 and 1988-steps that offer
about $4 billion in foreign exchange savings. Caracas
has already initiated the rescheduling process. In
September, Venezuelan debt negotiator Jorge Mar-
cano gave Venezuela's bank advisory committee the
government's proposal for a rescheduling of $21.2
billion in public debt owed to international bank
creditors-debt that was initially rescheduled in Feb-
ruary 1986. banks will
probably grant aracas's request to defer most princi-
pal repayments due over the next four years, including
$2.3 billion in principal payments due in 1987 and
1988. In addition, bankers are likely to grant Caracas
some form of interest rate relief, perhaps, as in the
case of Mexico, reducing the spread over LIBOR to
0.8125 percentage point from the current 1.125 per-
centage points. Such a reduction in the spread over
LIBOR would save Caracas about $65 million per
year in interest payments.
The administration is also likely to devalue the con-
trolled exchange rate significantly from the current
7.50 bolivars per dollar, according to the Embassy.
The dual exchange rate system, with a free-market
rate floating above the controlled rate, is likely to be
continued, however. Depending on its magnitude, we
believe that a devaluation could reasonably be expect-
ed to yield $750 million per year in foreign exchange
savings-mostly from reduced imports and from the
reduced capital outflows that result from such prac-
tices as underinvoicing and overinvoicing.
Loans from international creditors offer only limited
potential for balance-of-payments support. Central
Bank president Hernan Anzola has indicated that the
administration will continue to seek loans from multi-
lateral development banks to augment the $750 mil-
lion already secured from the Inter-American Devel-
opment Bank. But, because such loans are usually
granted for projects that would not otherwise be
undertaken and because they usually have disburse-
ment schedules linked to progress on the project, they
are not likely to provide significant balance-of-
payments assistance in the short term. According to
the US Treasury, most of the Inter-American Devel-
opment Bank commitments that Caracas has already
secured will be disbursed after 1988. Neither are
World Bank loans likely to be forthcoming in the near
term. Venezuela has only recently been reinstated to
borrower status-after its per capita income declined
sufficiently to meet the Bank's criteria for need. Nor
is borrowing from foreign commercial banks a likely
source of significant financing.
a full-fledged return to world credit markets requires
that Caracas first regularize payments on the external
private debt. Finally, allowing foreign creditors to
convert debt-to-equity holdings in domestic corpora-
tions is not likely to become a source of significant
savings in the near term. Although such conversions
have attracted the interest of Venezuelan officials
because of Chile's successful use of such swaps to
reduce its debt burden, they are likely to remain
minuscule in Venezuela until the government clarifies
its recent revisions of the foreign investment code.
Other measures, such as borrowing from the IMF,
would be undertaken only in the event of an acute
emergency. The administration does not want to
subject itself to the firestorm of protest from across
the political spectrum that government acceptance of
IMF performance requirements would almost certain-
ly bring. The administration is also likely to be
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Reform: The Missed Opportunity
Taking charge of an economy in crisis, Lusinchi was
presented with an opportunity to restructure Venezue-
la's economic institutions along more market-orient-
ed lines. Although he has taken important steps to
liberalize the foreign investment code and has halted
the growth of the state-enterprise sector-actually
scaling back or folding up certain money-losing enti-
ties-we believe there is no chance that he will
abandon the managed-economy approach that presi-
dents of both parties have followed for almost three
decades.
The reform issue became the center of a national
debate during the first two years of the Lusinchi
administration. The National Council of Industry
and the Roriama Group-an informal club of
wealthy businessmen, most of whom are associated
with AD-called for a reduction in the state enter-
prise sector, an end to price controls, liberalization of
the trade regime, and a rational exchange rate policy.
In the media, the influential journalists Carlos Ran-
gel and Marcel Granier spearheaded an attack on the
philosophy and practice of statism. In the Cabinet,
reform was-and continues to be-advocated by
Minister of the Presidency Carmelo Lauria, who told
the Embassy that a "180-degree turn in economic
policy" is necessary for a resumption of economic
development. In addition, the IMF has urged-un-
successfully-that Caracas make structural reforms,
arguing that, while the government's measures may
succeed in achieving a short-term stabilization of the
balance of payments and the fiscal accounts, they do
not remove important impediments to long-term de-
velopment.
extremely reluctant to seek a rescheduling of the
nonrestructured debt. This debt was not included in
the $21.2 billion rescheduling with foreign bank credi-
tors because it largely consists of central government
bonds and debt to official creditors. Rescheduling the
$1.1 billion due on this debt in 1987 and 1988 would
require a Paris Club agreement with official creditors,
which in turn would require an IMF agreement.
According to the Embassy, however, there is little
support for sweeping economic reforms within the
ruling party or among other power groups. The
Cogollito-the ruling party's innermost circle where
policy with broad political implications is formulat-
ed-is unsympathetic toward the reform movement.
Such reforms would threaten important constituen-
cies of the party that have become dependent on the
statist practices followed for more than 25 years. For
example, labor leaders believe that state ownership of
the basic industries, mandated wage levels, and price
controls are essential to labor's well-being. In addi-
tion, the ruling party's Ortodoxo leadership probably
fears that the medium-term dislocations that sweep-
ing structural reforms would produce would give
Carlos Andres Perez another opening to launch at-
tacks on the government for dismantling the statist
system that Perez himself helped construct and still
supports. Neither has COPEI advocated economic
reform. With campaigning already in full swing, the
Christian democratic opposition would instead be
likely to attack any such proposals advanced by the
administration. Finally, influential entrepreneurial
groups oppose relaxation of important parts of the
controls regime, according to the Embassy. Some-
such as the Mendoza group from which Finance
Minister Azpurua comes-have prospered behind
trade barriers and have benefited from the govern-
ment's indirect subsidization of critical inputs such
as credit and energy.
The Outlook for the Domestic Economy
Although Lusinchi appears to have sufficient maneu-
vering room to stabilize the external accounts and to
pay interest on the external debt, we doubt that he
will achieve his most important objective-engineer-
ing an economic recovery. The essential problem he
faces, in our judgment, is that of continuing weak
demand from consumers and private enterprise for
domestically produced goods and services.
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Investment Outlays. The outlays of private firms for
new plant and equipment have been depressed for
seven years and are unlikely to recover before Lusin-
chi leaves office. According to the Embassy and
independent Venezuelan analysts, investor confidence
has been sapped by heavyhanded price controls, per-
vasive concern over the availability of foreign ex-
change to finance imports, and uncertainty created by
sudden changes in economic policy-such as the
decision to renege on an earlier promise to provide
subsidized dollars to service the external private debt.
Moreover, press and Embassy reporting indicate that
there is growing friction and distrust between the
administration and key business groups-especially
with FEDECAMERAS, the umbrella organization
that represents the private business sector. For exam-
ple, on several occasions Lusinchi has bitterly assailed
private businessmen for demanding that the govern-
ment grant them access to subsidized dollars to
service the private foreign debt while refusing to
repatriate dollars from accounts abroad to finance
investment in Venezuela. In response, private-
sector spokesmen have publicly charged that the
administration itself makes investment unattractive
by failing to create an appropriate business climate.
FEDECAMERAS has been especially critical of the
administration for not consulting with the private
sector prior to making decisions on key issues-such
as a proposed revision of the tax code. Recent surveys
of private investment plans indicate that no near-term
revival of outlays on plant and equipment is likely. In
our judgment, the Lusinchi administration has missed
its opportunity to gain the confidence of private
investors and must formulate policy in the knowledge
that private investment will remain depressed through
Foreign direct investment is unlikely to provide a
significant stimulus to economic activity, in our judg-
ment. Because of rigid Venezuelan adherence to
Andean Pact Decision 24,2 there has been little
foreign investment since 1973. Although the revisions
of the foreign investment code announced in Septem-
ber-relaxing restrictions on profit remittances and
foreign ownership-may eventually encourage more
' Under this provision, to foster domestically owned enterprises, the
five Andean Pact signatories-Bolivia, Colombia, Ecuador, Peru,
foreign investment, in the near term, the same factors
that discourage domestic investors are likely to offset
the positive effects of such revisions.
Consumer Outlays. Household demand for goods and
services is weak and is unlikely to rebound in the
medium term. Family incomes have been hard hit by
the economic crisis. Real wages fell by 22 percent
between 1981 and 1984, according to the IMF, and
have probably declined another 4 to 6 percent in the
last two years. A resurgence of real wages would
require either a significant rebound of oil revenues-
unlikely, according to most petroleum market observ-
ers--or a significant increase in productivity in the
nonoil economy-also unlikely in the medium term, in
our judgment.
Public-Sector Outlays. The government lacks suffi-
cient revenues to fund a significant noninflationary
increase in public-sector outlays, in our judgment. In
past years, oil revenues funded about two-thirds of the
central government's expenditures, including an am-
bitious investment program in state-owned enterprises
and public works. At present, however, the oil revenue
shortfall sharply limits the government's ability to
apply fiscal stimulus to the economy in the form of
increased outlays on investment projects because re-
duced oil revenues mean reduced tax payments to the
central government from PDVSA, the state-owned oil
monopoly. Although the 1987 budget bill calls for a
4-percent increase in central government expendi-
tures, inflation-adjusted net domestic expenditures in
1987 will probably fall 4 to 8 percent from 1986
Inflation. Embassy and independent analysts are
concerned that Lusinchi, out of frustration with the
stalled economy, may try to spend his way out of the
recession. According to the Embassy, labor and ruling
party leaders have told Lusinchi that maintaining
expenditures at current levels or higher is essential if
the economy is to recover before the 1988 election.
But, because the government is experiencing a short-
fall of tax revenues, increases in expenditures can only
be financed through deficit spending. In a determined
effort to meet 1986 budget demands, the government
already is drawing down the accumulated reserves of
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various public-sector entities-PDVSA, the social se-
cilrity system, and the commercial bank insurance
fund-to finance a deficit of unexpected magnitude.
These funds will be exhausted next year, however,
necessitating a search for new revenue sources to
cover continuing deficits. According to press and
Embassy reports, the administration is considering
legislation that would permit direct sales of large
amounts of Treasury debt to the Central Bank. If, as
independent Venezuelan analysts fear, these deficits
require large bond sales to the Central Bank, the
monetary base will be sharply augmented, creating
the raw material for inflation. According to the IMF,
increased inflation would trigger a resurgence of
capital flight and further depress the investment
climate while giving only a weak and transitory
stimulus to the economy.
Implications
Domestic Politics. The deteriorating economy is like-
ly to remain the salient issue in domestic politics
through the 1988 election-with COPEI, Carlos
Andres Perez, and the radical left opportunistically
seizing on the administration's management failures.
Despite the economic crisis, however, Democratic
Action's hold on the reins of power will be difficult to
break. Recent public opinion polls indicate that AD's
popular standing has declined only marginally from
the high level recorded when Lusinchi took office
almost three years ago. This suggests that public
discontent over the economy will have to increase
significantly to enable COPEI to seize control of the
Congress. If, however, COPEI can unify behind a
strong candidate, such as the young, dynamic
Eduardo Fernandez, and articulate a well-conceived
program for economic recovery, the Christian demo-
crats would have a modest chance at winning the
presidency. Such a scenario is especially plausible if
the nomination of a weak candidate, such as Octavio
Lepage, produces a split in Democratic Action-as
occurred in 1968. In our judgment, however, the
nomination of the charismatic Carlos Andres Perez
by AD would almost preclude a COPEI victory
In his quest for the nomination, Perez will remind
voters and party leaders of Venezuela's economic
achievements during his stewardship in the mid-
1970s, according to the Embassy.
We estimate Perez's chances
for obtaining the nomination at less than 50-50, but
his prospects are likely to improve, if-as we expect-
the economy continues to decline.
Although the economic crisis will continue to fuel
intense politicking, it is not likely to provoke destabi-
lizing political and social unrest. According to the
Embassy, the Venezuelan electorate is basically con-
servative and retains confidence in the nation's demo-
cratic institutions. Since the onset of the economic
crisis in 1982, there have been few manifestations of
social unrest and the number of Venezuelans who
identify with the parties of the left has increased only
marginally, according to public opinion polls. Labor
peace is virtually assured through the end of Lusin-
chi's term because of labor leadership's traditional
conservatism and its strong ties to the ruling party.
Labor's rank and file, although battered by the
recession, is firmly controlled by the CTV's leadership
and is unlikely to engage in more than sporadic,
unsanctioned protests. Leftist political parties are
small, fragmented, and incapable of mounting large-
scale protests. The left, however, is likely to continue
to exploit student discontent over such economic
issues as the current financial plight of the universi-
ties. Student on-campus protests will probably spill
into the streets on occasion.
Regional Assistance. The external payments crisis is
causing Venezuela to scale back its commitment to
foreign assistance programs in the Caribbean Basin.
In the late 1970s and early 1980s Venezuela bur-
nished its image as an exporter of democracy and a
promoter of regional stability by making large contri-
butions to regional development banks, by providing
oil on concessionary terms to smaller nations of the
region through the San Jose Accord with Mexico, and
by extending other forms of bilateral aid to more than
10 regional nations. But in 1985, for the first time,
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Caracas trimmed its outstanding net credits for for-
eign assistance. In 1986, the government cited declin-
ing oil revenues as the reason for withdrawing an offer
to lend Guatemala $50 million and for drastically
reducing its commitment to the Caribbean Develop-
ment Bank.' We believe that depressed oil prices and
the continuing economic recession will result in fur-
ther reductions in foreign assistance, so that the freed
resources may be allocated to domestic needs.
US Interests. The impact of Venezuela's economic
decline will continue to be negative for US interests.
Once the largest market for US exports in South
America, Venezuela has been forced by the reduced
availability of foreign exchange to cut imports from
the United States by almost 50 percent since 1982. In
our judgment, there are no prospects of regaining this
lost market in the medium term. Instead, the adminis-
tration's latest trade restrictions and the gradual
phasing out of the preferential foreign exchange rate
for consumer goods imports will further limit US
export opportunities.
US banks are also likely to feel Venezuela's foreign
exchange pinch. Although we believe that Venezuela
will remain current on its public debt interest obliga-
tions, further reschedulings of principal repayments
are almost assured. On the private debt, US lenders
will probably have to accept growing arrearages and
writeoffs, because the elimination of the special ex-
change rate for repaying principal on the foreign
private debt will have a sharply negative effect on
many firms, producing bankruptcy in some cases,
according to independent analysts. A possible benefit
to US investors in the long run may result from the
growing Venezuelan recognition that foreign direct
investment is an important source of risk capital and
technology transfer.
Frictions over trade issues may grow. Concerned over
its almost total dependence on oil for foreign ex-
change earnings, Caracas is seeking to increase its
' Although Caracas did offer Haiti oil deliveries on San Jose
Accord terms this year, the current slack oil markets and the recent
requirement that 50 percent of San Jose Accord benefits be in the
form of nonconvertible bolivars sharply limits the costs to Venezue-
exports of nontraditional products. Within the past
year, the government has announced ambitious ex-
pansion plans for its state-owned steel and aluminum
industries. But Caracas is concerned that the industri-
al nations, particularly the United States, will close
their markets to such products. Still fresh in Caracas's
memory is its dispute'over steel exports to the United
States in 1985-a confrontation that was resolved
only after Caracas and the US Department of Com-
merce negotiated a "voluntary restraint agreement."
As the foreign exchange bind tightens, Venezuelans
will probably renew complaints that their friendship is
taken for granted and that-unlike Mexico-Venezu-
ela is rarely accorded preferential treatment in eco-
nomic matters. These frustrations are likely to intensi-
fy Caracas's efforts to secure non-US outlets for its
products.
If the Ortodoxos fail to retain control of the govern-
ment, the tone of US-Venezuelan relations is likely to
change-especially if the new president is Carlos
Andres Perez. Although not an ideologue of the left
nor personally anti-US, the opportunistic Perez is,
nevertheless, often critical of US actions. For exam-
ple, his public statements about the Sandinistas are
often at variance with US policy objectives-and with
what he tells US officials privately.
we believe that Perez would use the
presidency and Venezuela's economic and moral au-
thority in the region to project himself as a Third
World leader.
Notwithstanding the modestly negative implications
of Venezuela's economic crisis for medium-term US
interests, we believe that US-Venezuelan ties will
remain strong over the long run. The strength of
Venezuela's democratic institutions, its commitment
to regional stability, and the complementarity of the
two economies create the basis for a fundamentally
congruent relationship. We believe that the Venezue-
lan president who takes office in 1989 will use the
framework of this relationship for solutions to the
daunting economic problems he is almost certain to
face. He will have opportunities to strengthen the
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economy and US-Venezuelan ties. According to oil
market analysts, oil prices are likely to rebound in the
early 1990s, bolstering Venezuela's external accounts
and US trade opportunities with Venezuela. In our
judgment, however, the most important opportunities
would be to implement economic reforms. Both Vene-
zuelan and US interests would be served by an
aggressive dismantling of the statist economic regime
that we believe inhibits Venezuela's return to sus-
tained economic growth.
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Secret
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