In the 19 months since he was elected president of Venezuela, Hugo Chávez has turned his country upside down, helped drive up international oil prices to their highest point in a decade and made powerful enemies at home and abroad. Washington is angered by his anti-Americanism and his dalliances with Muammar Khadafi of Libya and Iraq's Saddam Hussein. The approval of a new constitution in a referendum and his triumph in July's "relegitimization" election give Chávez great power. Instead of getting down to straightening out the economy, though, he keeps shaking business confidence already dazed by his anti-capitalist tirades and last year's 7% collapse in GDP.
Venezuela and Colombia, its neighbor to the west, have become two of the most difficult places to do business in Latin America. Colombia is struggling with a severe recession, a deadlocked political system and a bitter drug-financed civil conflict that has dislocated the entire country's political, social and economic systems. Indeed, every other country in the Andean region (see page 32) is facing considerable economic and political disarray.
Each country's problems are unique and each has taken a different approach to solving its difficulties. While Colombia's President Andrés Pastrana (see interview page 30) and his economic team are taking a conventional approach, backed by President Bill Clinton and supported by big business, Chávez is often described as a dangerous populist, a caudillo in the worst Latin tradition.
Of course, Chávez sees things differently. He says he has come to drain a "disgusting immoral swamp" left by decades of corrupt leaders and misguided economic policies. His eyes narrow as he denounces the "neo-liberal fundamentalists" who would "give privileges to a minority and poverty to all the rest. Society has become full of explosive forces that are accumulating and accumulating."
In his view, the state has a duty to intervene to avoid a social explosion and lead the creation of a new, diversified industrial base that can create jobs. He continues, "Did the US or England grow rich with neo-liberalism? No, of course not. They grew with a strong state, a solid state that drives and develops the economy. That is the duty of the state."
One of his great ambitions is to break the country's 86-yearaddiction to oil, which he sees as one of the roots of all evil in Venezuela. Although he is a champion of OPEC's unity and wants to keep oil prices high, he declares that, "We have to get rid of the oil model. We have to break this chain." Chávez believes that easy oil wealth has corrupted generations of his people, depopulated the interior and prevented the development of agriculture and manufacturing industry. "Oil has destroyed Venezuela," he says.
Ernesto Martínez, a vice president at Moody's Investor Services, says Chávez has a point: "This is the only economy in the region that still gets 70% of its export earnings and fiscal revenues from a single commodity. But [Venezuela's] living standards have been declining for 20 years." Real incomes are the same as 40 years ago.
Promises and Procrastination
Chávez wants to keep oil prices at a "just" level of $22 to $28 per barrel to fund his dreams of a new Venezuela, a country that would be a curious blend of Castroism, German-style stakeholder capitalism and old-fashioned economic nationalism. He is opening up the telecommunications system and some basic industries to foreign capital, but keeping oil firmly under state control. Chávez envisages the state taking a leading role in creating new industries, either alone or as a joint venture partner, with private companies. In spite of this "vision" and promises to turn his attention to economic issues, the president keeps procrastinating. Now he has called an "economic constituent assembly" in which all Venezuelans can give their views on the country's future economic strategy. Theoretically, Venezuela should have little difficulty in moving into growth, with oil prices three times what they were in late 1998. The trouble is, country's disaffected business leaders do not trust Chávez, so growth is stagnant outside the oil industry. Still, he claims he is trying to improve relations with the business world. "There are some very dynamic and very creative businessmen," he says. "They have to be motivated and encouraged. " In his long victory speech after the July "relegitimization" elections, Chávez said, "I call on the Venezuelan business class, all of those who doubt or fear me, to stop. We must save the Venezuelan economy. There is no room for doubt."
However, most members of Venezuela's corporate elite still loathe Chávez and his followers as much as when he first burst upon the scene eight years ago during his abortive coup d'état. One businessman recalls recently driving past a knot of the president's supporters, all of whom wore Chávez-style red berets. "I was in my Lexus and when they saw me, they began drawing their fingers across their throats. This never used to happen before in Caracas," he says.
As result, the business community and the financial markets are growing restive. Growth at 3% this year is weak, coming after last year's slump. Public spending this year is up over 20% and the government is running a budget deficit of 3% of GDP - high given strong oil prices. In fact, the oil bonanza has barely roused the economy because billions of dollars in flight capital are leaving the country.
Oscar García Mendoza, president of Banco Venezolano de Crédito, a solid, medium-sized Caracas bank, says, "When the price of oil falls, exchange controls will come. He will look for scapegoats, for us, the oligarchs." The government is empowered to order the central bank to impose controls whenever the external accounts come under stress. Charges García Mendoza, "Chávez lacks absolutely any understanding about how the economy works. There is no clear economic policy."
Crisis of Confidence
Over the border in Colombia, the financial system is a shambles, urban unemployment has hit a record 20% and the country is grappling with political stalemate, all exacerbated by the drug trade and guerrilla insurgencies.
Yet the dapper, upper-class Pastrana is sticking to economic orthodoxy. He vows to move ahead with "economic reforms [that] are not popular. What we are doing benefits the country and this is our commitment." Unfortunately, Colombia's economy has gone from bad to worse during the first two years of his mandate. Commentators complain that Pastrana, the son of a former president, lacks sound political judgment. He has bungled relations with Congress, controlled by the opposition Liberal Party, which blocked his economic reforms.
Confidence has fallen, and with it Pastrana's popularity. A poll in July showed that three-quarters of Colombians say the situation in the country has worsened; only 20% say Pastrana is doing a good job as president. Jaime Velásquez, vice president at Bancolombia, the country's biggest bank, says the government needs to encourage the creation of "more jobs, to renew confidence in the market, instead of people taking their money to the US." Bank lending in Colombia is down by 6%, even though the central bank has increased liquidity.
Given the weak confidence in both countries, it is not surprising to find the financial systems in Colombia and Venezuela unable and unwilling. In neither country can bankers find enough sound risks; nor do many companies want to borrow. Consumer demand is flaccid, in spite of falling interest rates. Instead, a large proportion of banks are buying government securities rather than lending to the private sector. Extreme conservatism may well be the only way to survive the deadly combination of political uncertainty and economic volatility. Last year, bank lending fell 6.5% in Venezuela. At the end of 1999, Venezuelan banks held over half their assets in government securities.
Both Venezuela and Colombia need to finance a large part of their budget deficits locally because access to the international markets is neither cheap or easy. Colombia lost its investment-grade rating in 1999 and government officials admit it will be years before the country gets it back. Standard and Poor's rates Colombia a BB with negative outlook. Venezuela gets a B, one of the lowest ratings in the region.
Colombia, though, is probably far closer to turning the corner than Venezuela. In July, Pastrana gave up antagonizing the opposition and reshuffled his cabinet, giving the finance ministry to Juan Manuel Santos, a leading Liberal. Pastrana and the Colombian business community are pinning their hopes on Santos, who has the makings of a tough finance minister.
"We have to deliver," declares Santos. "We have to act with realism [and] adjust in the very short term or we are going to have problems in the long run." He adds, "We can take advantage of the crisis and have a larger reform rather than [the planned] incremental reform. The Liberal Party has said that it will support the reforms."
Pastrana hopes Santos has the political clout to get economic reforms through Congress. Santos wants to put the public finances on a stronger footing, raising taxes and redirecting spending to social areas, without compromising budget deficit targets agreed with the International Monetary Fund. He says, "We have to make a larger social investment to give the economy a push and to protect the weakest in the reform process."
If all goes well, the economy could resume rapid growth in two years. Government forecasters say Colombia should grow by around 3% this year, after contracting by 5% in 1999, its first recession since the 1930s. In 2002, growth should rise to 4.8%, the highest rate since 1995. However, one of the keys to growth is to rebuild confidence and encourage banks to lend. Both Colombia and Venezuela still have a lot of work ahead in recasting the banking system.
In Colombia, bankers recognize that they have failed to bring down high operating costs fast enough. In the mid-1990s, loans were growing at 40% a year, three times faster than GDP growth. Lending was profitable because inflation and spreads were high. Small and inefficient banks could prosper in this environment.
Of course, once the party stopped, the easy profits ended and the banking system went into crisis. Non-performing loans as a proportion of total bank portfolios were 14% last year, up from 6% in 1996. Colombia has spent about 6% of GDP to recapitalize private and public banks, through a government agency known as Fogafin. Half the money was spent on cleaning up state banks and about 1.5% of GDP went to the private banks. One reason few private banks have resorted to Fogafin is that the terms are so onerous. The government is financing its rescue mission with a 0.2% tax on financial operations.
Fernando Uribe, president of Corporación Financiera Colombiana, said in a press interview, "The cost of this help has been excessively high because the credits are very hard to pay. We will see more mergers and acquisitions or liquidation of financial institutions."
Banks in Colombia lost $444 million in the first half of this year, down from a $547.2 million loss in the same period last year, although in nominal terms the losses were almost flat. Public banks lost the most, with $96.9 million, up from $15.7 million the year before. A few banks, such as BanColombia, the biggest private bank, have raised fresh equity capital, boosted loan loss provisions and are returning to profit.
Colombia needs a strong banking system to resume sustainable growth and business needs to regain confidence. Velásquez says a breakthrough in peace talks with the guerrillas would help: "Peace would generate very good news. Announcement of a cease-fire would raise confidence and help economic recovery."
It is obvious why. Extortion and kidnapping on an industrial scale are transferring millions of dollars a year to guerrillas and common criminals. There were more than 3,000 reported kidnappings last year, three times more than in 1994. A businessman says, "Fear of violence makes us afraid to pursue profits, to spend, to invest." In April, the Farc, Colombia's largest guerrilla group, said it would levy a 10% tax on individuals and companies with assets of more than $1 million and threatened to abduct those who did not comply.
To gain international support in combating the guerillas, Pastrana has cultivated relations with the US, damaged during the presidency of Ernesto Samper. The recently approved $ 1.3 billion in US aid to combat the drug trafficking that finances the guerrillas could help bring peace, although it could lead to more violence.
An upsurge in guerrilla violence could further discourage investment, especially in energy and oil. Repeated guerrilla attacks on its oil pipeline forced Occidental Petroleum to declare force majeure in August, suspending oil production and shipment for two weeks. Guerrillas are attacking electricity pylons now.
Although Venezuela does not have a guerrilla problem it suffers from a violent crime wave caused by unemployment and a rise in drug smuggling. Foreign companies in Venezuela say criminal violence is their biggest problem.
Venezuela's banks got into trouble before Colombia's and they are recovering sooner as well. The regulators revamped the system after it crashed in 1993-1994 following the collapse of Banco Latino, but banks are still weak. Standard and Poor's states that the gradual recovery is due to the entry of foreign banks, which now hold over half the banking assets, tighter bank supervision and prompt liquidation of problem assets during the crisis.
As in Colombia, banks have high operating costs and overdue loans could reach 7% of total loans by year end. Luckily, Venezuelan banks are well-provisioned and highly capitalized, with ratios of 16%. Still, the government is pushing banks to consolidate to increase efficiency, reduce spreads and thereby revive the economy.
Weaker banks are looking around for suitors. Indeed, the bank supervisory agency expects the number of banks to fall by half in the next two years. Venezuela has 84 banks, compared with over 100 five years ago. Consolidation is gaining momentum. In July, Banco Mercantil, the second largest bank, swallowed Interbank in a deal that moved it into top position with combined assets of more than $4 billion. In June, Spain's Banco Santander Central Hispano, which controls Banco de Venezuela, began talks to buy Banco Caracas. In May, Banco Unión merged with Banesco in a stock deal.
Still, the collapse in April of Cavendes, a small bank, raised concern about the quality of bank regulation. The bank's owner, Luis Vallenilla, a businessman turned politician, is close to Chávez and the opposition claims Cavendes received preferential treatment. In a recent report on Venezuela, S&P commented that the way Cavendes was shut down "casts a shadow of doubt" over the effectiveness of regulation.
Official disregard for regulations is increasing. In May, PDVSA, the national oil company, withdrew 390 billion bolívares ($573.5 million) from the domestic banking system as part of a government-inspired ploy to punish currency speculators. The authorities achieved their immediate objective but damaged the managed exchange rate's credibility.
In August, José Rojas ordered the nominally independent central bank to transfer almost $3 billion from its reserves to the treasury to finance government spending. The government says it will spend $2.2 billion on social projects and use $640 million to pay down its debts to the central bank.
Yet Chávez and his economic team sometimes sound like hard line disciples of economic orthodoxy. For example, Chávez is an inflation hawk. "Inflation is a cancer" because it hurts the poor more than the rich, he says. He does not like having a budget deficit either. Last year he acted decisively to stop the budget deficit from widening to 7.3% of GDP and cut the gap to 2.6% of GDP. He says "this was not conservative, but rational." He ordered a cut in military spending and on all superfluous items, and the confiscation of government cell phones and credit cards. He fired 500 bodyguards. He brought in value-added tax and tightened up collection of import duties to help balance the books.
'Fangs Stuck in the Throat'
He cut interest rates, hoping to discourage financial speculation. Chávez thunders: "In 1998, interest rates were at 80%. It was like having a vampire, with its fangs stuck in the throat of the nation, especially the poor. It caused the failure of small companies and farms and bankrupted the middle class."
He opposes devaluing the bolívar, even though it has appreciated by 48% against the dollar in five years. This is because ordinary Venezuelans rely on imports for so many basic consumer goods. Chávez appears indifferent to the scale of capital fleeing Venezuela. Economists reckon that 70% to 80% of this year's $9 billion forecast oil windfall will leave the country as soon as it arrives, adding to the roughly $20 billion Venezuelans hold outside the country. Chávez says, "Exchange rate stability gives the country stability. There is no threat that can make us devalue. Let the speculative money go somewhere else, it destroys countries. As it goes, [direct investment] will come."
However, García Mendoza, the banker, like most other business leaders, is far from convinced. "I have lived through seven oil crises," he recalls. "Whenever the [revenues] increase, the government spends more and the people are happy and then all goes bad, because there has been no investment in industry."
This seems to be the case now. The banks are not lending and companies are not borrowing or raising capital. Not even households, squeezed by low wages, can afford to spend on much beyond the bare necessities. However, foreign direct investment is picking up, with $3 billion likely to enter the country this year, up from $2.7 billion in 1999. In June, the US power group AES spent $1.66 billion to take control of Electricidad de Caracas, (EDC) the city's power utility. Pechiney, the French aluminum company, beat out three international competitors to become a joint venture partner with a government company in a bauxite mine that languished for years. Pechiney plans to invest $200 million to $300 million in the project.
Assets are so cheap right now that a number of Venezuelan companies have begun share buybacks to avoid the same fate as EDC, which lost its independence in the takeover battle with AES.
Collapsing asset prices in Colombia are drawing in foreign investors as well. Violy McCausland and Simón Araújo, of New York boutique Violy, Byorum&Partners, which has advised on several mergers and acquisitions in Colombia, commented in the Colombian media that they forecast a $1 billion capital inflow this year. This is a modest amount by the region's standards, but is three times more than last year's foreign investment. While this is good news, it is a lot less than the $2.60 billion average annual investment flows that Colombia received over the last five years.
Colombia and Venezuela need foreign investment to resume growth. Twenty-five years ago, Colombia's domestic savings rate averaged 21%, falling to just 15% last year. But Moody's Martínez says the investment flowing to these countries does not necessarily indicate a high degree of confidence because "utilities are defensive investments." International companies invest in troubled countries all around the world, he argues, especially when acquisition prices are depressed. Much worse than this, he argues, is the tendency for "the sellers take the money out of the country."
Nobody is expecting either country to find its way out of trouble easily or quickly. A quick-fix solution, such as a devaluation or supply-side shock, is unlikely to work without major structural reforms. Colombia is lucky to have a strong business culture and a sophisticated economic team, but faces an uncertain political future as it moves against the drug lords and their guerrilla allies.
Venezuela, with its abundance of oil, could start laying the foundations for a new economic system that relies less on what Chávez likes to call "devil's excrement." However, neither Chávez nor his economic team inspires much trust among the business elite or foreign companies. He needs to win their support if he wants them to work with his Fifth Republic to create entire new industries from scratch.
But what will happen, investors wonder, when oil prices drop, Venezuela's shaky finances crash and Chávez has his back against the wall. Will the president, fighting for his political survival, bay for the blood of the oligarchs, or will reality intrude and force Chávez to save the economy with sensible policies?
| Back in the Black (trade balance)
|| Heading Down (consumer price inflation) |
| Hard Times (average annual growth rates)