III. ECONOMIC TRENDS Major Trends and Outlook Since early 1992, the Venezuelan economy has suffered from political concerns and economic policy uncertainties. As a result, in 1993, after three years of solid economic growth, the economy went into recession. Another, more severe contraction is expected in 1994. Final performance, however, will depend on several factors, including how the government handles the severe problems of the banking sector and the fiscal deficit. The behavior of international petroleum prices will also affect results in 1994 and beyond. A number of concerns surround President Caldera's economic policies. Chief among them is the fiscal situation. Doubts exist whether recent new taxes and tax reforms can offset potential revenues lost through an elimination of the Value-Added Tax (VAT) through the retail level. The fiscal deficit reached the equivalent of 3.6% for the consolidated public sector in 1993 and could climb to 8.0% in 1994. The Central Bank operated a tight monetary policy in 1993, but inflation remained stubbornly high at 45 percent for the year. The need to give substantial financial aid to troubled banks reduced the effectiveness of monetary policy in 1994, and inflation accelerated; it may climb to 80 percent in 1994. Price controls wee imposed on many items in late June in an attempt to control inflation. Venezuela's trade account improved in 1993, but its capital account surplus shrank. Capital flight in the first six months of 1994 prompted the government to impose exchange controls to preserve the country's international reserves. For U.S. exporters, Venezuela remains a significant market. It ranks behind Mexico and Brazil as the third largest in Latin America. Although 1994 will be a difficult year for trade with Venezuela, the long-term outlook for the export of U.S. goods and services into Venezuela remains positive. During 1993, U.S. exports to Venezuela were $4.6 billion. Principal Growth Sectors The Venezuelan Government has emphasized the link between economic development and social goals. Thus projects which contribute to the well-being of the population are likely to receive a bigger piece of Government funds: hospital and health system modernization, improved prisons, highways, water distribution, and housing have all been identified as priority areas for purchasing and construction. Much will depend on the availability of financing from multilateral institutions, and the successful implementation of the new Concessions Law for Public Works and Services. The new law represents a significant improvement over the old Concessions Law, allowing greater access by foreign companies to many infrastructure and services concessions, and reducing multi-tiered approval requirements. Joint ventures in the hydrocarbons sector may start to bring much needed cash to the mining, petroleum and gas industries. Venezuela has a significant import component in most basic agricultural commodities. Wheat imports will continue to be the single most important, not only for growing domestic consumption, but for production of products for export, particularly pasta. Domestic vegetable oils count for only 10 percent of requirements, and previous experience has shown that imports will resist economic downturns better than most commodities. Other important imports are feeds for poultry and other animals. The continued growth of High Value Product imports will depend on economic performance. Government Role in the Economy The Government of Venezuela owns and operates an extensive portion of the country's domestic product. In 1992, Government- owned sectors produced goods and services valued at $ 16.4 billion, nearly 28% of the country's Gross Domestic Product (GDP). About 65% of the government's output was produced by the state-owned petroleum company Petroleos de Venezuela S.A. (PDVSA) and its principal subsidiaries. Other principal areas of government production include public transportation, electricity generation and financial services, that combined contributed about 8 percent of GDP to government coffers in 1992. The Government also operates extensive mining and industrial manufacturing interests which generated about 5 percent of GDP in the same year. In October 1990, the Government of Venezuela embarked on a privatization program that aimed to substantially reduce the government's role in many industrial, manufacturing and service industries, largely outside of the petroleum sector. In 1991, the program generated about $2.3 billion when a host of government-owned firms were sold, including part of the state telephone company, CANTV, and the largest state airline, Viasa. In 1992, sales slowed for political reasons and privatization revenues fell to a small fraction of the 1991-'92 figure. President Caldera is attempting to reinvigorate the program in 1994 with the announcement of planned sales of a national airline, Aeropostal, the Enelbar and Enelven-Enelco power generation companies, additional offerings of the government's holding in the national telecommunications company CANTV, and other interests. While the failure of the Aeropostal privatization attempt in May 1994 was viewed as a major setback to the program and an embarrassment to the Government, it may make the Government more realistic with the terms of future privatizations. The government expects to generate approximately $500 million in privatization revenues during 1994. Balance of Payments Venezuela's balance of payments position improved slightly in 1993. The merchandise trade surplus increased to $3.2 billion, primarily because of a reduction in imports due to the economic contraction. Petroleum exports dropped in value terms because of a decline in prices while volume remained almost the same. The current account deficit declined from $3.4 billion in 1992 to $1.8 billion in 1993. Non-traditional exports increased about 20% in 1993 from 1992 levels because of a slow down in domestic demand and increased regional integration, reaching $3.3 billion for the year. While still positive, the capital account surplus shrunk in 1993. The capital account recorded a surplus of $1.3 billion in 1993 which follows that of $2.8 billion in 1992. Political events triggered a net short-term capital outflow of $939 million in 1992; high real interest rates reversed the outflow in 1993, but the Banco Latino collapse and concerns about President Caldera's exchange rate policies led to increased capital flight in the first half of 1994. Venezuela's international reserve position remained strong at year-end 1993 but has deteriorated rapidly since then. Central Bank reserves stood at about $12.7 billion at the end of 1993, which is equivalent to about 14 months of imports and compares with the year-end 1992 level of $13.0 billion. International reserves were $9 billion at the end of May 1994, approximately half of which were operational (liquid) reserves. Trade and Investment Barriers Intellectual Property Rights: There have been recent improvements made by Venezuela in the protection of intellectual property rights, through its new copyright legislation and Andean Pact agreements. Nonetheless, IPR protection remains weak in some areas. Continued progress in IPR protection and enforcement are critical. Standards Certifications and Phytosanitary Requirements: Although intended to protect consumers, Venezuela applies discretionary and arbitrary standards which are acting as protectionist non-tariff barriers to imports. The Venezuelan Commission of Industrial Standards (COVENIN) requires certification from COVENIN-approved laboratories for imports of almost 300 agricultural and industrial goods. Many of these goods are kept from entering Venezuela by a newly-created bureaucracy governing product certification. Phytosanitary standards have also been applied arbitrarily to food imports. Sectoral Investment Restrictions: Decree 2095 restricts foreign capital to a maximum of 19.9% in enterprises engaged in radio, television, the Spanish language press, and professional services subject to licensing legislation (e.g. attorneys, architecture and engineering, medical professions, veterinary practice, economists, business administration /management, and accounting). Basic industries, that is those designated as basic by the President in the Council of Ministers, may be reserved to "mixed companies," i.e., those with a maximum of 49 percent foreign capital. Major Local and Third Country Competitors Proximity and familiarity have made the U.S. the traditional favored source of most imports into Venezuela. In recent years strong competition has come from a number of countries expanding into the Latin American market. Except as noted below, domestic production of most goods is underdeveloped. Telecommunications: U.S. management of the national telephone company CANTV, and CANTV's monopoly of basic phone service until the year 2000, puts foreign competition at a disadvantage. Some companies, particularly Siemens, Ericsson and Alcatel all compete strongly, and Japanese names are well known. Automotive: U.S. Models, either imports or locally assembled, remain popular. The big three U.S. assemblers are active in Venezuela. There is no local manufacture. Inexpensive models from Korea (Hyundai) and Eastern Europe (Skoda, Lada) have gained in popularity, as have Japanese four-wheel drives, particularly Toyota. Computers/Peripherals: Asian makers, such as Acer, and Samsung, are gaining market share. Medical equipment: For all types of electromedical equipment, Japanese and German suppliers are preferred. Tools: The U.S. is the preferred source of power tools. For non-powered tools, strong competition is coming from the Brazil, Mexico, Italy and Germany. Machine tools are sourced increasingly in the European Community and Japan. Major Infrastructure Projects Underway Venezuela has introduced ambitious legislation to attract foreign investment in public works and services, notably through a new Concessions Law. Recent exchange controls and the general perception of instability have largely negated the effect of the law for the near term. With the scarcity of financing, much will depend on funding from multilateral or bilateral sources. Caracas Metropolitan Aquaduct System: An estimated $200 million will be needed to refurbish the dilapidated system. Reportedly, funding will come from the United Kingdom. The project will be managed by Bywater of the United Kingdom. Road Projects: 17 separate road and highway projects are to be tendered under the new concessions law. Some of these completions of projects already begun; others rehabilitation or maintenance. The estimated cost will exceed $ 1 Billion, for roads totalling 681 miles. Rail Construction: The Ministry of Transport and telecommunications has resumed construction of railways to connect major urban and industrial centers with each other and with ports.