I. COMMERCIAL OVERVIEW / EXECUTIVE SUMMARY Overview of the Import Market U.S.-Venezuelan trade is expected to grow substantially over the long term, despite sharp declines in U.S. exports to Venezuela in 1993 and 1994. Reforms begun in 1989 form a basis for movement away from a petroleum-based, statist economy toward one that is diversified and market-driven. Tariffs fell sharply, to a maximum of 20 percent (with some exceptions), and free exchange of currency was established. Driven by the reforms and economic expansion, imports grew rapidly during 1990, 1991 and 1992 (see appendix A 3). The President, Rafael Caldera, suspended certain constitutional guarantees and decreed exchange and price controls on June 27, 1994. As the new currency control mechanism was being designed and put in place during July, foreign currency was generally not available to importers. Foreign firms saw a halt in purchase orders from Venezuelan buyers. While it is clear that the emergency measures are having a disruptive effect on the market, the duration of these "temporary" controls, and their full impact were not known when this report was completed. U.S. businesses, particularly new-to-market exporters, are advised to seek updated information from a US&FCS district office or from the Commercial Office in Caracas. Imports shrank in 1993 and 1994. 1995 promises to be difficult as the new Government deals with formidable economic policy challenges. Oil income, the main source of government funding, will probably not recover significantly from 1993 lows. A five- quarter economic recession deepened with the closure of the country's second largest bank in January 1994, and an ensuing industry-wide financial crisis. Many importers have seen their financing dry up: trade credit lines have been pared, and local interest rates remain prohibitive. Government spending has been reduced. New taxes, commonly acknowledged to be necessary if the government is to reduce its dependence on dwindling oil income, have increased the cost of imported goods. Among the new taxes are an import wholesale tax of 10%, a bank transaction tax of 0.75% on all bank debits (including check and credit card payments), a luxury tax of up to 20% on many expensive items, and increased stamp taxes on many government services. The country posted a trade surplus of $3.2 billion in 1993, in large part due to shrinking imports. The U.S. has traditionally been Venezuela's most important trading partner, receiving about 57 percent of Venezuela's total exports and accounting for about 42 percent of its imports in 1993. Venezuela's imports in 1993 totaled about $11.0 billion and were composed mainly of electrical machinery and equipment, transportation equipment (cars, trucks, parts), chemicals, minerals and mineral products, wheat and feed grains. Principal imports from the United States included telecommunications equipment, oil and gasfield equipment, auto parts, cars and trucks, computers, chemicals, wheat, corn, machine parts, valves and controls. Commercial Environment Venezuela's rich natural resources give it an impressive foundation for growth over the long-term. Petroleum, natural gas, hydroelectric power, iron ore, coal, and bauxite are among the country's major natural resources. Transportation, communications, and power generation and distribution are also relatively well developed. Since early 1992, Venezuela has endured a series of political and economic crises that have shaken business confidence within the country and have led to increasing caution by international investors. Although new investments and marketing initiatives have suffered greatly since mid-1993, business efforts launched during the 1989-92 boom have largely continued to thrive. The Caldera Administration took office in February 1994, facing a fiscal deficit which could reach as high as 8 percent of GDP for 1994 if new tax and fiscal policies are not successful. The financial sector has been rocked by the failure of the country's second largest bank in early 1994, and subsequent government assistance and intervention in eight other financial institutions. The economic situation has been further aggravated by a run on the Bolivar in late April. After losing an estimated $2 billion in international reserves in the first four months of the year, the government suspended its crawling peg exchange rate system on May 4 and tried alternative exchange systems, but the dollar drain continued. On June 27, 1994, in the face of the continuing crisis, Caldera announced a temporary emergency economic program. Key actions of that date included suspension of constitutional guarantees (private property, expropriation, protection from arrest without warrants, and freedom to travel); exchange controls, and price controls on nearly 200 commodities. A fixed exchange rate regime of US$1 = B170 was implemented on July 11, 1994 reportedly as a "temporary" measure. Through its first six months in office, the Caldera administration has sent mixed signals on further reforms. Constitutional economic guarantees were suspended, reinstated, and then suspended again. In February, a Value-Added Tax (VAT) was repealed at the retail level, shortly after being introduced by the preceding government. Privatization efforts have been reinvigorated following an earlier their suspension; and a new law allows for public works and services to be contracted out to the private sector. Although the economy is expected to continue to contract in 1994, its final performance will depend on several factors, including how the government handles the severe problems of the banking sector and the fiscal deficit. Doubts exist about whether new taxes and tax reforms will provide enough revenue to fill the fiscal gap. International petroleum prices, currently unfavorable from the Venezuelan perspective (although improving), are of key importance. The Central Bank pursued contradictory monetary policies in the first half of 1994. It engaged in massive zero coupon bond sales to soak up excess liquidity, while injecting billions of dollars into insolvent banks. The net effect was a 4.5 percent real drop in the money supply, assisted by significant capital flight. At the same time, a severe contraction of productive activity has led to the current abundance of funds in financial markets. Inflation surged due to sharp devaluation of the bolivar, fiscal undiscipline, political uncertainty, and lack of a coherent economic policy. Venezuela's overall current account is expected to show its third consecutive deficit in 1994. INDUSTRIAL COMPOSITION: The petroleum industry, in 1993, accounted for roughly 23 percent of Venezuela's GDP, 74 percent of its export earnings, and an estimated 61 percent of central government revenues. The petrochemical, mining (iron ore, bauxite, coal, and gold), aluminum, iron and steel, cement, forestry, and manufacturing sectors are also important. Venezuela and the United States Commercial relations between the two countries are highly developed. The United States is the dominant trading partner, accounting for 57% of Venezuelan exports and 42% of Venezuelan imports. Current commercial concerns include improvement in intellectual property rights policy, opening of all industry sectors to private investment, better enforcement of commercial laws, and reversing a recent proliferation of non-tariff trade barriers. Venezuelans have a particular affinity for U.S. goods and brand names, strengthened by their proximity to the United States. A large number of U.S. television cable and network channels are received through ubiquitous satellite dishes and local cable services, keeping a wide range of consumers up-to-date on U.S. products. The upper and upper-middle classes (around 5% of the population) have so far shown themselves to be recession--and exchange rate--proof consumers. Many Venezuelans have received higher education in the United States, and carry their preferences for high-quality U.S. goods into the companies where they work. Major Business Opportunities Opportunities exist for both U.S. exporters and investors. The current Venezuelan Government has announced its intention to initially emphasize the tourism and agribusiness industries in its privatization efforts. The question of reform to permit private investment in the two largest state controlled conglomerates, Petroleos de Venezuela, S.A. (PDVSA) and CVG, is under study. This could expand opportunities in these industries which need foreign capital to increase output. Privatization in the electrical power, financial and transportation sectors are pending. In 1993, telecommunications equipment topped U.S. exports to Venezuela, surpassing oilfield equipment for the first time ever. The telecommunications industry is expected to grow well through the year 2000. Investment in infrastructure, housing, and medical care are priorities for the present administration; related products such as construction equipment and medical equipment are expected to perform well. Security and safety equipment is another growth industry. Major Roadblocks to Doing Business For export sales: o Temporary exchange controls, imposed on June 27, 1994, may restrict access of Venezuelan buyers to means of repayment, or could delay completion of contracts. o New taxes on financial transactions, imports and wholesales, which add over 10% to the landed cost of all imports and over 20% on certain luxury items. o A growing regime of "quality standards" affecting manufactured goods, agricultural commodities and processed foods, often arbitrarily enforced. o High real domestic borrowing rates, and a scarcity of foreign currency and trade credits. o Less than world class intellectual property laws and enforcement. For investment: o Laws limiting investment in some sectors: radio, television, Spanish-language press, law, medicine, many areas of consulting, and so-called "basic industries." o Antiquated, unclear or cumbersome laws in areas like mining and telecommunications. o A labor law which strongly favors labor in benefits guarantees and which makes firing or laying off workers, for whatever reason, extremely expensive. Local and Third Country Competition The United States has remained Venezuela's dominant trading partner for many years. For the last five years, the U.S. share of total Venezuelan imports has remained between 40 and 50 percent. A few countries have gained significant market share in recent years. Colombia profited from its free trade agreement with Venezuela, showing a big increase in exports to Venezuela from 1991 to 1992, and other Andean Pact countries also showed growth. In 1993, the only major trading partner showing significant gains in exports to Venezuela was Japan, which sold goods worth $815 million, 60 percent over 1992, and 206 percent over 1991. Most of this gain was in cars and car parts, a sector where the United States has traditionally been very strong. Japan has also gained a foothold in the hydrocarbons industry-- traditionally a U.S. preserve--through joint ventures and attractive financing packages. Some pressure has come from increased domestic production where the Venezuelan Government has encouraged "non-traditional" industries. Other Pacific Rim and European countries have also been aggressive in the Venezuelan market. European and Japanese companies bid aggressively for major projects. Canada has a high profile in the mining and environmental sectors.