Economics Update (April-June 1998)

Venezuela: The Trouble With Oil
by Wendy Gutierrez, economic analyst

V enezuela's natural petroleum wealth has been a blessing and a curse since its discovery. Oil has been Venezuela's main export for more than 70 years and has accounted for around 25 percent of the country's GDP (gross domestic product) since the 1970s. During the 1970s, the country experienced oil booms that made Venezuelans' per capita income one of the highest in Latin America.

Those same oil booms, however, also encouraged the government to raise and maintain spending at a high level, thereby diminishing the windfall gains and creating potential fiscal imbalances when oil prices fell. Venezuela's stellar 10 percent real GDP growth rate in 1975 withered to 3.5 percent by the end of the decade, accompanied by a fiscal deficit of 14 percent of GDP. Negative oil shocks hurt the country even further: shocks in the 1980s nearly depleted Venezuela's foreign exchange reserves. Oil accounts for almost 80 percent of all exports in the country, and the government has been unable to break the linkage between oil price changes and changes in the country's overall economic performance.

"[The Venezuelan stock market] lost almost all of its gains during the month of January alone as troubles in the oil market were first felt."

Oil Troubles in 1998

Last November, the Organization of Petroleum Exporting Countries (OPEC) increased its production quotas by 10 percent. At the same time, the Asian financial crisis caused petroleum demand in that area to drop; Asia had been the fastest-growing market for oil-producing countries in the past few years. These events, combined with the mild winter in North America and Europe, caused oil prices to drop dramatically in early 1998, hitting a 10-year low in March.

Since oil accounts for two-thirds of Venezuela's government revenues, the administration of President Rafael Caldera was forced to revise the country's 1998 budget. Earlier this year, the $23 billion budget was reduced by 10 percent — $1.3 billion in government spending cuts and $1 billion in cuts by the state petroleum company. An additional budget cut followed in late April. The oil price estimate in the budget has been revised numerous times, from an original $15.50 per barrel to the most recent price of under $11 per barrel in mid-May. The administration will be hard-pressed to find suitable areas to cut since the budget is already tight. In the past, the Venezuelan government has found it difficult to keep within its spending limits and has typically underestimated its annual funding needs by 15 to 30 percent.

Venezuela's stock market is also suffering. A number of studies have shown — and its performance this year confirms — that the Venezuelan market has a strong positive correlation to petroleum prices, even after attempts to diversify the economy by revitalizing its steel and aluminum sectors. Although the stock market closed 1997 up 23 percent for the year, the market has been one of the worst performers in the region in 1998. It lost almost all its 1997 gains during the month of January alone as troubles in the oil market were first felt. As of mid-April, Venezuelan equity values had dropped nearly 16 percent for the year.

Venezuela's Fiscal Balance Is Linked to Oil Prices
(1997 fiscal balance estimated)

Source: International Monetary Fund

A Currency Under Pressure

In addition, the current oil price decline has put pressure on the country's currency, the bolivar. The central bank raised interest rates on certificates of deposit in efforts to protect the bolivar. It also increased the monthly depreciation of the currency from 1.16 percent to 1.28 percent. The currency depreciation for 1998 therefore will approximate 15 percent. Nonetheless, considering the 25 percent inflation rate targeted this year, the bolivar is likely to appreciate in real terms. This condition will be difficult to sustain if low oil prices linger and will encourage further import growth at a time when the budget calls for fewer imports.

Because of concerns over oil prices and currency stability, Venezuela has experienced an increase in private short-term capital outflows: $1.2 billion left the country from December 1997 through January 1998. Higher short-term capital outflows, lower oil export revenues and growing imports have lowered the country's level of international reserves by over $1 billion. Reserves stood at $15.7 billion as of March 1998 — an amount considered healthy — but are expected to fall further by year's end. The reserve loss and capital flight are mild compared to the negative oil shock of 1982. At that time reserves dropped by $8.2 billion, and $6.5 billion in private capital left the country.

Being so reliant on oil for its revenues, Venezuela has experienced a roller-coaster ride associated with global oil prices. And it is unlikely that Venezuela's boom-bust cycles associated with the oil sector will end in the near future. However, the creation of an oil stabilization fund, still being discussed by the government, would be a positive step. The fund would accumulate excess oil revenue in bumper years that would be used when the commodity's price falls, thereby mitigating the effect of volatile prices on government budgets. While a full diversification of the country's exports is a more appropriate response, the fund would serve as a buffer from the unpredictability of oil revenues and would help alleviate the symptoms of Venezuela's oil dependency.

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