Cablegate: Inflation Going Up, Up, and Away in the Brv

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DE RUEHCV #2831/01 2582121
ZNR UUUUU ZZH
R 152121Z SEP 06
FM AMEMBASSY CARACAS
TO RUEHC/SECSTATE WASHDC 6360
INFO RUEHBO/AMEMBASSY BOGOTA 7008
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RUEHSG/AMEMBASSY SANTIAGO 3777
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E.O. 12958: N/A
TAGS: EFIN ECON PGOV VE
SUBJECT: INFLATION GOING UP, UP, AND AWAY IN THE BRV

REF: A. CARACAS 02718

B. CARACAS 02825

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SUMMARY
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1. (SBU) Inflation rose 2.2 percent in August, reaching a
total of 10.4 percent for 2006 and implying an annual rate
exceeding 15 percent. The BRV is now incapable of meeting
its inflation target for 2006 of 10 percent and recent
statements by Chavez and senior BRV officials demonstrate
that the BRV has become increasingly concerned about the
effect inflation is having on public support for the
Bolivarian Revolution. At the same time, the government
shows no signs of slowing spending (one of the principal
causes of inflation) as it tries to buy support for the
December elections.

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NUMBERS
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2. (U) Official inflation rose 2.2 percent in August and
shows a worrying trend for the remainder of 2006. Food and
drinks showed the largest increase (4.3 percent) and there
were also significant increases in the cost of transportation
(2.8 percent), housing (2.4 percent) and hotels and
restaurants (1.9 percent). The price of foodstuffs between
August 2005 and August of 2006 has increased 26.7 percent and
during this time the overall Consumer Price Index (CPI) rate
has increased 14.9 percent.

3. (U) Inflation is particularly damaging for the poorest
segments of society. Venezuela,s 2 million impoverished
households (31.5 percent of all households), or about 9
million people spend half of their income on foodstuffs and
the increase in prices hits them the hardest. The current
basic basket of goods and services for a family of five costs
1,789,768 bolivars (USD 832) a month, which economists
estimate only 20 percent of Venezuelans can afford. An
increase in the minimum wage this month (from approximately
USD 216 per month to USD 238 per month) will do little to
alleviate the burden as increases in salaries are not keeping
up with inflation.

4. (SBU) Official inflation numbers are also misleading. A
recent canvassing of business leaders at a VENAMCHAM meeting
implies that actual inflation is running at significantly
higher levels than stated. (Note: As high as 20-22 percent.
End note.) In addition, price-controlled goods (which rose
1.5 percent in August) are distorting the market and hide
real inflation. As an example, white sugar is supposed to
sell for 1200 bolivars a kilogram (56 cents). Widespread
sugar shortages last month left shelves bare as the import
cost exceeded the controlled sale price. (Note: Venezuela's
domestic sugar production is insufficient to meet demand, and
approximately 60-70 percent of the annual crop alone goes to
carbonated beverages. End note.) Since the government
bought 60,000 tons of sugar from Brazil, it has returned to
supermarket shelves, but is on sale for approximately 3000
bolivars per kilo. In the basket of goods used to judge
inflation, the price of sugar has not changed (masking a 150
percent real increase). In the government subsidized Mercal
markets, a kilo of sugar (when available) costs 750 bolivars.

5. (U) There is also a gap between increases in the CPI, on
which this report is based, and changes in the wholesale
price index (WPI) that demonstrates costs for suppliers and
manufacturers. After growing significantly faster than CPI
in 2004 and 2005, WPI is growing at an annualized rate of
12.2 percent (or 2.7 points lower than CPI).

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CAUSES
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6. (SBU) Inflation in Venezuela is a result of a variety of
factors as predicted by orthodox economics. Liquidity (the
amount of money in the economy) has increased 60 percent
since August 2005, and since 1998 has increased by over 730
percent. Santander, an economic consultancy, estimates that
the amount of excess liquidity in Venezuela exceeds USD 19
billion. Oil revenues entering the economy are increasing
liquidity, as is government spending. Government
expenditures have increased 95 percent in dollar terms since
1999 (see reftel A). In addition the government is creating
incredible amounts of money. A noted economist observes that
as PDVSA repatriates a dollar, the Central Bank (BCV)
converts that dollar into bolivars for PDVSA and then has
been transferring another dollar (USD 10.7 billion since
September 2005) in &excess reserves8 to the National
Development Fund (FONDEN), thus creating a dollar out of thin
air.

7. (SBU) Increased government spending and currency controls
are also causing large increases in consumption, which fuels
inflation as demand outpaces supply. The over-valued
exchange rate (estimates range from 20 to 25 percent) makes
imports cheaper, but also encourages short term consumption
(as everyone expects the BCV to devalue at some point in the
future). People are also discounting the future (due to
political and economic instability) in other ways and more
than one analyst has commented that long term planning in the
BRV means 3 months.

8. (SBU) Despite the fact that inflation is running at least
at 15 percent annually, the nominal interest rates for
savings accounts is below 10 percent. For Venezuelans, there
is a huge disincentive to save money as interest rates below
inflation mean that their money loses value every day it is
in their account. (Comment: The BRV is probably hesitant to
raise interest rates as it wants to avoid slowing the economy
or raising the burden for the already debt-laden public. End
comment.)

9. (SBU) The government is also holding large amounts of
demand deposits in private sector banks (see reftel A).
Banks are using government deposits to make loans, increasing
the money supply further. (Note: Estimates are that for every
1 dollar of government deposits, banks create 3 dollars in
additional liquidity. End note). The recent decrease in
interest rates from 10 to 6 percent on government
certificates of deposit (CDs) has meant that banks can no
longer profit from arbitrage (paying Venezuelans 6-8 percent
interest on savings accounts and then using those funds to
buy CDs at 10 percent). Instead banks will now try to
increase their loan and credit card portfolios, which will
cause an increase in consumer spending.

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HISTORICAL PRECEDENT
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10. (U) Venezuela, like many Latin American countries, has
had a recurring problem with inflation. During the past two
decades, inflation has ranged from 8.8 to almost 100 percent
a year. Spikes in inflation have been historically
associated with increases in oil prices, but are also
contingent on monetary policy. The mid 1990s were
characterized by modest oil prices, yet very high inflation
as successive governments were unable to break the cycle
where deficit spending resulted in a devaluation, which in
turn caused more inflation and necessitated more deficit
spending.

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GOVERNMENT RESPONSE
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11. (U) During his weekly television program, &Alo
Presidente,8 on September 3 Chavez played the role of
Economics Professor in Chief for the BRV. With a series of
graphs and charts behind him, Chavez explained to the
Venezuelan public the historical precedents for the current
state of the Venezuelan economy and how the BRV deserved much
credit for current economic growth and "price stability."
Chavez demonstrated the growth in the minimum wage as
compared to the growth in inflation and said that in the
early 1990s inflation outpaced wages. According to his
chart, since 1998 the minimum wage has increased quicker than
inflation (Note: though overall wages are about 20 percent
less in real terms than in 1998). Chavez then discussed
inflation with Minister of Planning and Development Jorge
Giordani, who outlined the 28 percent increase in food costs
and the shortages of tomatoes, peppers, and onions. Chavez
made it very clear that the BRV must lower inflation, for
example by increasing domestic production of tomatoes, and
admitted that it was important to import goods to prevent
shortages and price increases.

12. (U) The Committee for the Administration of Foreign
Currency (CADIVI) has increased its authorizations in the
past month and in August authorized USD 2.3 billion in
conversions. The increases come at a time when it is under
criticism from both the opposition and the National Assembly
for helping fuel the fires of inflation by preventing money
from leaving the system and imports from entering the market
(importers need CADIVI to get dollars to buy goods to
import). (Note: An increase in imports may temporarily
alleviate inflation as supply catches up with demand, though
does nothing to deal with the longer term issues of
de-industrialization occurring in Venezuela. End note.)

13. (SBU) The BRV is also attempting to reduce the money
supply in the economy. The USD 1 billion, dollar-denominated
&bonos de sur8 issuance planned by Venezuela (USD 500
million) and Argentina (USD 500 million) would reduce the
supply of bolivars. The issuance has been delayed as
contacts note that Argentina does not need additional
financing this year. Nonetheless, Finance Committee Chairman
Rodrigo Cabezas has announced that the BRV will issue bonds
(per Chavez,s insistence) before October 15.

14. (SBU) The past week saw announcements that PDVSA may a)
issue USD 3.5 billion in dollar-denominated bonds on the
local market (see reftel B) and b) will send USD 4-6 billion
in excess dollar profits to be held in escrow in a special
Treasury account. While both of these actions would reduce
liquidity, the director of a local economic consultancy is
doubtful they will occur as the debt issuance has been
criticized as unnecessary (why take on debt when PDVSA is
making huge profits from high oil prices). The treasury
account is supposed to be inviolate, but the BRV has a long
history of raiding supposedly inviolate accounts (such as
foreign reserves at the BCV). In a normal country such
inflation-fighting measures would fall under the purview of
the Central Bank rather than the state oil company.

15. (SBU) Other measures the BRV is floating for controlling
inflation are reducing the Value Added Tax (IVA), enacting
more price controls, increasing imports, and punishing price
gougers. These actions, while unlikely to do much to combat
systemic inflation or help the economy, could bring some
short-term relief or have a public relations benefit, and so
are likely to occur in the run up to December. Contacts in
the retail sector worry that Chavez will force a
confrontation with some supermarkets and start shutting them
down in November. This would be damaging for the private
sector and for the supply of foodstuffs, but in the weeks
leading up to the election, could provide a boogeyman for the
public to blame for inflation and shortages.

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CONCLUSION
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16. (SBU) The BRV seems preoccupied with inflation and at the
same time incapable of stopping it, which places it in league
with the majority of modern Venezuelan governments. During
his Alo Presidente presentation, Chavez's economic
explanations were open and he fully admitted to a flaw in the
BRV's economic policies. Many analysts have labeled
inflation the "Achilles heel" of the BRV and note that
inflation tends to hurt the poorest segments (Chavez's base)
of society the most.

17. (SBU) Proven orthodox measures to slow inflation include
decreasing public spending, raising interest rates and
draining liquidity. Rather than taking these difficult
steps, it seems likely the BRV will continue its stopgap
measures that further distort the economy and slowly emaciate
the private sector, while at the same time touting solutions
that mislead the public as to the true nature and causes of
inflation. Embassy contacts estimate that the BRV can
continue its spending binge for 1-2 years before the
imbalances and deficits catch up, which combined with lower
oil prices will result in economic upheaval, as has been the
case in Venezuela,s series of boom and bust cycles ever
since the 1970s.
WHITAKER

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