How long could Venezuela's slump last?

Recession has hit Venezuela, South America's top oil exporter, after declining output and low prices for crude, plus a collapse in manufacturing and imports, brought an end to five years of economic good times. Some questions and answers about the downturn and its impact on President Hugo Chavez's socialist revolution.

Why did GDP fall an unexpected 4.5 per cent in the third quarter?

Oil production nosedived this year, with GDP in the sector down a shocking 9.5 per cent in the third quarter after a drop of 4.2 per cent in the second quarter. Economists and the government underestimated the decline, which reflects lower production more than international prices. The government blames lower output on OPEC cuts but the nationalization of companies in the Lake Maracaibo oil region probably played a part too, with some docks barely working.

Manufacturing and commerce took big blows, in part because Mr. Chavez slashed spending and strictly limited access to foreign exchange when oil prices dropped to about $30 (U.S.) a barrel in January, chilling demand and the supply of imported goods at the same time. Car factories were particularly hard hit, with some production grinding to halt because of a lack of parts.

The public sector actually expanded, reflecting Mr. Chavez's model of state-led growth. Construction and telecoms also grew, the latter due to fast-growing mobile and fixed line networks.

How long could the recession last?

Venezuela has entered recession when many other countries are edging out of it, and many economists say the downturn will last for several months at least. Finance Minster Ali Rodriguez predicts recovery by the first quarter of next year. Mr. Chavez's pro-cyclical cutbacks are at odds with the big stimulus packages that have softened many countries' recessions.

Some economists say Venezuela needs to spend hard to dig itself out of the crisis and after a relatively frugal 2009, Mr. Chavez can be expected to do just that. With many analysts predicting oil prices of around $70 per barrel next year, well above the budget estimate of $40, he will increase off-budget outlays ahead of legislative elections in September.

Venezuela also has healthy foreign reserves and has issued $11-billion in foreign bonds this year.

Mr. Chavez himself argues that traditional GDP methodology under-represents growth in the public sector and his policies of subsidies, price controls and free health services aimed at protecting the poor among Venezuela's 28 million people.

What does this mean for Mr. Chavez's popularity

A decade after first winning power, Mr. Chavez is still a popular president. But it remains to be seen whether a burst of spending now will revive the economy in time to bring back the good-times feeling he has counted on in recent elections.

The sputtering economy, combined with irregular water and electricity supplies, have hurt him, bringing support down to around 50 per cent from a peak of around 60 per cent early this year after he won a referendum allowing him to run for office as often as he likes.

Mr. Chavez could see his massive parliamentary majority heavily shaved in September if the economy stays weak, inflation remains high, and problems with services are compounded by shortages of consumer goods - a perennial problem in heavily regulated Venezuela.

However, few believe he will actually lose control of parliament.

Will Venezuela devalue its overvalued currency?

Mr. Chavez is opposed to devaluing partly because of fears it will stoke already high inflation. Most economists and many in the cabinet agree that it is unavoidable at some point, as the overvalued rate is costly to the government and makes it hard for local industry to compete with imports.

Mr. Chavez reintroduced controls on foreign exchange during political turmoil in 2003 to prevent capital flight. The local bolivar is also fixed against the U.S. dollar.

The restrictions on taking money out of the country helped Venezuela preserve its foreign reserves, but the wide gulf between the official 2.15 rate and the parallel rate - currently around 5.5 to the U.S. dollar - causes many of the distortions and opportunities for corruption that are prevalent in the economy.

Inflation

Another hardy perennial in Venezuela is rampant inflation - double digit price rises have been the norm for as long as most Venezuelans can remember. In Mr. Chavez's boom years, it was not much of an issue - large minimum wage hikes and increases for public workers softened the blow. But recession combined with high inflation - 26.7 per cent was the annualized rate in October - could really upset people next year. Prices are likely to keep rising rapidly. Government spending next year may increase money supply and its usual anti-inflation measures - price controls and regulation - often backfire by reducing supply of goods.

Source: theglobeandmail.com/