Record-High Oil Prices Drive Venezuelan Growth to 10.3% in 2006

The Numbers Breakdown

The Venezuelan economy has carried the strength shown in the first three quarters over into the fourth trimester of the year. Indeed, total GDP expanded 11.8% year-on-year (y/y) in the last quarter, outpacing the revised figures of the previous quarters. Most industries performed very well in the fourth quarter of the year, with the notable exception of the oil sector—oil GDP shrank 3.7% y/y in this period. Such low growth comes as a result of a 17.8% y/y decline in private-sector oil activity, which was attributed to maintenance work in crude oil-processing plants in the Orinoco Belt. Meanwhile, public-sector oil production showed a barely positive result in its gross value added of 0.5% y/y.

In 2006, the non-oil sector grew by a remarkable 11.7% y/y amid a very expansive continuing fiscal policy; this achievement was trumpeted loudly since 2006 was an election year. The sectors that showed above-average growth in this period were construction (32.1%), commerce and retail sales (19.9%), and communications (23.2%). All these sectors—mostly services—benefited from a solid expansion in aggregated domestic demand. Manufacturing industries registered an overall increase of 10.4% y/y, propelled by dynamic growth in the food and beverages sector; furthermore, production of plastics and rubber, vehicles, machinery and equipment expanded markedly faster in the fourth quarter of 2006, up 28.9% y/y, 25.3% y/y, and 22.4% y/y respectively. These sectors continue to benefit from the increasing monetary liquidity, the expansion of consumer credit, negative real interest rates, the minimum-wage increases (a 15% increase as of 1 February 2006 and a 10% rise as of 1 September 2006), as well as the intensified extravagance in public spending (see Venezuela: 4 January 2007: Primary Fiscal Balance Continues to Worsen in Venezuela). In the meantime, government spending has also driven up activity in the construction sector; public-sector construction activity rose 39.4% in the last quarter of 2006. A 36.1% increase in residential buildings construction was observed in the fourth quarter, while construction of non-residential structures expanded 40.3% in the same period. Within the non-residential category, investments in highways, infrastructure, irrigation systems, and security and defence, among others, were funded by the National Development Fund (Fonden).

Private domestic demand again remained the key driver of economic growth as private consumption expenditure, up 21.4% y/y, was still fuelled by lower unemployment, and sustained liquidity. Gross fixed capital formation increased by 39.8% y/y, but the breakdown figures to distinguish between public and private investment, yet again, remained unspecified. Meanwhile, public-sector consumption grew 7.4% y/y in real terms.

The Central Bank data release did not show the figures for real imports and real exports in the fourth quarter of 2006. Nonetheless, the 48.7% expansion in the volume of sales of imported goods signals a very strong increase in real imports during 2006. Moreover, results from the balance of payments indicate a 36.2% nominal increase of goods purchased abroad. Imports have grown at such a pace because of booming domestic demand, the relaxation of foreign-exchange controls, price controls, and an overvalued currency. Import growth reduces the potential rate of expansion of the overall economy, as it implies some constraints in domestic output growth. Meanwhile, the non-oil exporting sector continues to have little incentive to increase exports, not only because of a strong domestic demand but also because of the imposition of troublesome foreign capital controls and the overvalued currency.

Outlook and Implications

Thus, fourth-quarter GDP figures have repeated the same growth pattern of the previous quarter: that is, strong domestic demand and a sluggish oil and export sector. We do not expect this pattern to change during 2007 or the first half of 2008, should current conditions prevail. The government will continue to struggle with increasing oil-output capacity in the short term, as contract renegotiations for the Orinoco extra-heavy oil belt bring uncertainty regarding much-needed further investment in that sector.

In the current economic boom Venezuela has already shown signs of an overheating economy. Inflation accelerated in the last quarter of 2006, driving government authorities to take action: in early 2007, a series of new policies—short-term patches—are to be implemented in order to regain control of prices. Furthermore, President Hugo Chávez's decision to take away the autonomy of the central bank, a move already anticipated following the 2005 reform, should bring higher discretionary spending, thus raising the risk for inflation to spiral out of control as Chávez stubbornly intends to keep the exchange rate untouched in the short and medium term. Government authorities estimate 2007's average inflation to be in the 10-12% range, whereas Global Insight expects inflation to reach 19.2% in 2007.

Energy prices are set to remain high in 2007 and 2008. Yet, our energy service forecasts a decline in the West Texas Intermediate (WTI) oil price; an average above US$57.7/barrel is expected in 2007—down 12.7% from the 2006 average—and US$61.4/barrel should be reached in 2008. Global Insight forecasts 7.7% y/y GDP growth for 2007, reasoning that, through government spending, fiscal incentives will continue to carry the economy in the next few quarters. Nevertheless, the government will find it increasingly difficult to keep the economy growing at its current rates by the end of 2007. Furthermore, the increasing intervention of the government in the economy does little to attract much-needed private investment. Thus, we expect economic growth to start decelerating progressively in the next few quarters. Meanwhile, the long-term sustainability of the current expansion will depend heavily upon the government's ability to boost oil-output capacity and upon oil prices. It is far from clear if oil prices will continue to decline as the early January 2007 prices show, but Venezuela is doing what little it can to head off a price crash that would derail its oil-dependent economy. In the scenario of a pronounced international oil-price decline, the government would rapidly lose its ability to sustain the economy by itself through public spending.