US embassy cable - 05CARACAS669

C O N F I D E N T I A L  CARACAS 000669 
 
SIPDIS 
 
 
TREASURY FOR OASIA - SIGNORELLI 
NSC FOR SHANNON AND BARTON 
SOUTHCOM ALSO FOR POLAD 
 
E.O. 12958: DECL: 03/04/2015 
TAGS: ECON, EFIN, PGOV, VE 
SUBJECT: VENEZUELA DEVALUES TO KEEP THE SPENDING MACHINE 
RUNNING 
 
REF: CARACAS 578 
 
Classified By: Economic Counselor Richard M. Sanders.  Reason:  1.4(b) 
and (d). 
 
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Summary 
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1.  (C)  The GOV has announced announced the devaluation of 
the bolivar from 1920 to 2150 bolivars per dollar.  The rise 
will mean that the GOV will have more local currency at hand 
to continue its highly aggressive spending policies, which 
have proven to be so politically popular.  With high oil 
prices underpinning the economy, the impact on internal 
prices of the decision is, for the time being, likely to be 
tolerable, and the GOV should be able to keep to its goal of 
goal of 15 pct inflation for 2005.  It is, however, already 
looking at some price increases at the highly popular 
state-run (and subsidized) discount food chain, Mercal.  End 
summary. 
 
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New Rate Announced 
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2.  (U)  On March 2, the Central Bank and the Finance 
Ministry announced that the exchange rate, currently fixed at 
1920 bolivars per dollar, would be changed to 2150 bolivars 
per dollar, a 10.7 pct devaluation.  (Venezuela has had a 
fixed exchange rate since February 6, 2003, when it was 
imposed during the general strike which had shut down exports 
of Venezuela's principal foreign exchange earner, petroleum. 
Initially fixed at 1600 bolivars per dollar, the rate was 
changed to 1920 bolivars per dollar on February 9, 2004.) 
The quasi-legal parallel rate, which had been heading upward 
in recent days in expectation of an announcement, now stands 
at 2857 bolivars per dollar, 24.8 pct higher than the 
official rate, a relatively narrow spread.   Finance Minister 
Nelson Merentes suggested that the impact of the devaluation 
on inflation would be minimal, while Vice President Jose 
Vicente Rangel would spoke in general terms of "highly 
satisfactory compensating effects" that the decision would 
bring. 
 
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One Economist's View 
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3.  (C)  Alejandro Grisanti, formerly chief economist for 
Spanish-owned Banco de Venezuela, now an independent 
consultant, told econcouns that the devaluation was driven by 
the GOV's desire for more cash to maintain its highly 
expansionary spending policies.  He said that the devaluation 
would allow it to expend an additional 8.8 trillion bolivars 
(USD 4.5 billion).  (Note:  the GOV would access the money in 
two ways, by being able to convert dollar earnings from state 
oil corporation PDVSA at the new rate, and by pressing the 
Central Bank to remit to it more bolivars as earnings on the 
foreign exchange it holds.  End note.)  Admittedly, Grisanti 
went on, this would result in a jump in inflation of as much 
as 3 pct.  Nonetheless, he thought that from a purely 
political calculus, the GOV had made the right decision. 
Having to cut back on its welfare programs, which are 
concentrated in the lowest income sectors, would probably be 
more damaging to its popularity than inflation, which is 
diffused among the whole population.  Unemployment, although 
dropping, remains high, and for many these welfare programs, 
(such as "scholarships" for presumed high school or college 
studies) are their only form of income.  Even if inflation 
means the recipients buy less, these transfer payments are 
still much better than nothing for them. 
 
4.  (C)  Grisanti suggested that the timing of the 
announcement had been affected by the relatively low 
inflation numbers which the year to date has brought.  Even 
with the price hikes which will be generated by the 
devaluation, inflation may well yet come under the 15 pct 
which Planning Minister Jorge Giordani has predicted. 
Grisanti thought the next devaluation might not come until 
the end of the year.  He saw inflation continuing on its 
downward trend, reserves staying strong, and the GOV able to 
maintain high levels of spending through 2006, all sustained 
 
 
by high oil prices.  This is a classic Venezuelan story, he 
added, with the final chapter being a brutal adjustment "when 
the model stops working" once oil prices finally drop. 
 
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A Key Price Rise in the Works Anyway 
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5.  (U)  Even ahead of the devaluation, news stories in major 
Caracas dailies suggested that prices would rise at the 
massive state-run "Mercal" chain of stores which sell staple 
foodstuffs at deep discounts.  (The Mercal program, aimed at 
low income Venezuelans, is one of the GOV's most popular 
programs, see reftel.)  Mercal President Jorge Luis Rodriguez 
bemoaned increases in costs which the (highly subsidized) 
chain most face ) in transportation, services, and salaries. 
 He said that he hoped that any price increase would be below 
the predicted 15 pct inflation, and thus would conserve the 
purchasing power of its customers.  Any generalized price 
increase will require approval by President Chavez. 
(Comment:  Bolivars obtained by devaluation may instead go to 
further subsidies to keep Mercal prices down, but, given that 
much of Mercal's inventory is imported, the devaluation will 
further aggravate its fiscal situation.  End comment.) 
 
 
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Comment:  A Devaluation Foretold 
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6.  (C)  The GOV's 2005 budget had explicitly assumed an 
exchange rate of 2150 bolivars per dollar, so this 
devaluation is not a surprise.  It had initially been 
expected at the beginning of the New Year's (the traditional 
time for such announcements, during the many periods in which 
Venezuela has had a fixed exchange rate), but the GOV held 
off, many analysts believed, to keep prices down for a few 
months in order to assure that the 15 pct inflation target 
would be met this year.  Inflation, while relatively high in 
January (1.9 pct,) came in very low in February (0.17 pct) 
making this strategy workable.  We agree with Grisanti's 
suggestion that maintaining the various social "missions" has 
become more important to the Chavez government's popularity 
than avoiding a bump in inflation ) on a downward track 
anyway.  We expect that this expansive fiscal and with it 
monetary policy will continue as long as oil revenue remains 
abundant. 
Brownfield 
 
 
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      2005CARACA00669 - CONFIDENTIAL