ROUNDTABLE: Venezuelan Ministry of Finance

On February 13, the Minister of Finance of Venezuela, Tobías Nóbrega, together with Alejandro Dopazo, Director of the National Office of Public Credit, and Ministry of Finance Advisor Luis Dávila, met with a panel of financial analysts at the Institutional Investor offices in New York.

*This Sponsored Roundtable was prepared by the Special Projects department of Institutional Investor.

The participating analysts were Tulio Vera, Managing Director, Global EM Debt Strategist, Merrill Lynch; Lacey Gallagher, Director, Emerging Markets Research, Credit Suisse First Boston; David Sekiguchi, Head of Emerging Markets Strategy, Deutsche Bank; Eduardo Cortes, Managing Director at Global Investment Advisors; and Jaime Valdivia, Director of Research at Emerging Sovereign Group. Ernest McCrary of Institutional Investor served as moderator.

MODERATOR: A great deal is riding on economic recovery in Venezuela, including the likelihood of President Hugo Chávez remaining in office. Although there have been projections for a strong rebound in 2004, driven by the oil industry and public spending, how are you addressing the fiscal issues that continue to fuel investor uncertainty? NÓBREGA: To understand our financial strategies, it’s important to be aware of the close connection in Venezuela between political conditions and economic conditions.

Certainly during 2002 and 2003 our fiscal policies had to adjust to the country’s political conflict. Our efforts since last year to implement temporary exchange controls, however, have helped us create a fundamental distinction between politics and economics. We have just made an adjustment in our nominal exchange rate, so that the value of the bolivar to the dollar has risen nearly 20 percent since the start of 2004. When we say temporary it doesn’t mean that we will keep these controls in place for another year or two years. Hopefully we will not have to do it for much longer; we are striving through the controls to achieve flexibility rather than freezing the exchange rate.

The fact that we have been able to implement the exchange agreement between the Central Bank and the Ministry of Finance is a very clear sign that our economy is gaining more autonomy. Political conflicts are being addressed through a political channel, the National Electoral Council, as they are in any democratic country with ups and downs.

The oil industry is also starting to operate with more independence from government. Oil is without a doubt the most dynamic sector of the economy, representing 30 percent of the GDP in a good year. Whereas when Alí Rodríguez, who

is president of the state oil firm, Petróleos de Venezuela (PDVSA), was in Parliament a few years ago he might have nullified certain oil contracts, today the government guarantees the validity of private sector

contracts and property rights for investors. Rodríguez, in fact, is guaranteeing contracts with companies from China, Norway, France and the US. We expect a recovery in the oil sector not only because prices are rising and we will be able to keep the level of production similar to that of last year, but also because we have been able to reduce the impact of political conflict on the oil industry and deal with costs and expenses in a more transparent way. PDVSA has a budget to invest up to $5 billion in internal exploration and refineries this year without incurring debt. To that we can we can add capital from the domestic private sector and a group of public programs, plus foreign investment that will bring the total amount invested in the oil industry for the year to about $10 billion.

VALDIVIA: What are your plans for dealing with debt expiration in the capital markets?

NÓBREGA: We will be developing strategies depending on the problems that arise. At the end of 2002, Venezuela’s public finances suffered from a concentration of short-term expirations. As is widely known, we conducted an exchange of the internal debt with the resignation of the bonds in bolivars. At that time we had free convertibility of our currency combined with strong political tensions. We were able to extend the expirations to 2004, 2005, and 2006. Our presence in the international markets was cut off for a time because we had stopped payment of our oil debt, so we had to to wait until June 2003 to establish the exchange rate control that allowed us to return to the markets.

That activity has increased the value of our external debt, and though it can weigh on us, the rating agencies upgraded our debt last year. Our challenge now is to postpone one more time the expirations scheduled for 2004 and 2005. We will have expirations of the equivalent $1.75-$2 billion coming up this year. How much of the total will be addressed through a swap and how much through a new financial plan will depend largely on how much of our debt is positioned

in the public financial institutions, which now hold just over 25 percent of our debt. An operation such as we conducted in 2002 would be easier now that we have exchange controls, but we don’t want to do it in such a way that would be perceived as a non-voluntary operation.

VALDIVIA: How much are you planning to issue in international capital markets?

NÓBREGA: We are evaluating it around $1 billion. We are introducing to the Finance Commission some $1 billion in financing from programs and projects by way of the investment allocated for 2004. We are going to raise resources not for refinancing purposes but for investment.

GALLAGHER: How much of your debt is in bank or government obligations?

NÓBREGA: The impact of bank debts on our internal debt is an issue that has caused tension from various sectors. But we have seen contraction of the debt. As of year-end 2003, following two years of recession, the national debt represented about 43 percent of GDP, down from about 49 percent of GDP in 1996, which was a record high. The balance of banking obligations within our debt is at a historic minimum but could grow up to five times the size of the activity of the banks. The banks have had very high liquidity requirements.

It would seem that this is not a problem we cannot solve by economic recovery, but if the economy can grow significantly in the next two to three years and the adjustment measures start to become more flexible, we should see the balance of bank obligations go down to no more than 10 percent to 15 percent.

VERA: There has been a great deal of debate recently over the fiscal sector capturing some of the Central Bank reserves. Are there plans to replace the reserves?

NÓBREGA: The issue of the accumulation of reserves that President Chávez has proposed is one of the fundamental issues of monetary programming. We accumulate reserves excessively, whether our exchange rate is flexible or not. There are no plans to reform or even modify the Central Bank policies, but we are discussing ways of resolving the problem with them. Many of the measures we took last year to postpone bond expirations have helped use the international reserves. What is happening is that we place a bond internationally, it is acquired by Central Bank, and the dollars go into circulation

Part of the $5 billion that PDVSA has to invest will have to be bought on the international markets, so not all of those dollars will go to the Central Bank. We’re projecting a strong year for oil investments which should undercut some of the injection of capital into the reserves. Also helping to level off the commercial account this year will be some of the smaller components of the balance of payments, such as more authorizations for traveling expenses and more buying over the Internet.

GALLAGHER: The method that Venezuela uses to calculate Central Bank profits after devaluation is an ongoing concern to the investment community. There are methodologies that could show it as anywhere from one percent to three percent of the national public debt and possibly more depending on the reserves, so how will you calculate the profits?

NÓBREGA: The national budget has 1.5 billion bolivars in Central Bank profits, but they already generated half of this product as of the second semester of 2003, meaning that this much becomes effective in the first semester of 2004. For the rest

of the first semester of 2004, the exchange rate adjusts to 1,920 bolivars to the dollar with a tendency toward growth of liquidity. I believe that we will surpass that 1.5 billion bolivar projection by at least 25 percent more.

MODERATOR: In light of a complicated scenario that includes having to calculate Central Bank profits based on devaluation of the bolivar, how will you address the amount of new financing and refinancing that Venezuela will need in the current fiscal year?

DOPAZO: At the beginning of every year we have a meeting of analysts estimating financing needs, and, at the end, saying this will be a year of fiscal crisis in Venezuela. As in all other countries, our budget ends up being a political exercise rather than an economic one. But Venezuela has its own dynamic of very optimistic objectives in terms of revenue and expenses which end up being different from what had been budgeted.

As a result underperformance is standard, yet history indicates that we close each fiscal accounting periods at manageable levels. I am not arguing that this is the best policy, but that is the reality.

To put some perspective on the numbers for this year, however, the principal expenditures for 2004 should amount to around 50 trillion bolivars. The 2003 budget had a headline number of expenditures of 40 trillion bolivars, which implies a nominal increment of spending of 20 percent below inflation. The 2004 budget represents a real contraction in spending.

This is the first year in which the budget projections seem to be realistic and consistent with long-term goals. Starting in 2005 the budget plan will project the numbers within a long-term policy, based on a deficit that would be around three-quarters of a point of the GDP and two points of the GDP in nominal terms. Our total financing needs for this year are going to be between $6 billion and $6.25 billion. How will that be financed? The average financing from multilateral and bilateral investment that Venezuela receives per year is approximately $1 billion. In domestic terms, assuming a 100 percent roll over of the maturities and a net collocation of internal debt, we would be talking about between $3.5 billion and $3.75 billion. By introducing much more debt we can add $1.5 billion. These projections include share holdings considered in dollars.

MODERATOR: With Venezuela’s inflation running as high as 26 percent to 27 percent, to what extent do you factor inflation in your budget and exchange calculations? And what is the likelihood of an inflation decline?

NÓBREGA: In 2003 we had a depreciation of 45 percent on average, and inflation was 27 percent. For 2004 we will have an adjustment of the exchange rate by 20 percent and perhaps an inflation rate that is somewhat higher. But we do not foresee a significant jump in inflation, above all when the movement of the exchange rate starts to drain those pressures of liquidity that exist in the government.

Considering that our unemployment rate is about 16 percent to 17 percent, it would be absurd to create erroneous expectations of what we can lower. The worst thing we could do would be to announce restrictive monetary policies and a fight against inflation simultaneously.

SEKIGUCHI: Looking at the oil industry, Venezuela has issued some ambitious objectives for future output. How much of this activity is coming from PDVSA versus how much from the private sector? And are there any long term agreements with China, given the huge needs for oil imports there?

DÁVILA: PDVSA’s goal is to be producing 4.7 million barrels per day within five years. This is quite a challenge. To increase capacity to that level, from the current production capacity over 3.7 million barrels per day, the oil sector will require an investment program around $39 billion. This year the oil investments will be close to $5.2 billion. Some of this investment will be part of PDVSA’s participation in the Orinoco Joint Ventures. Hamaca project completion is in line for this year. The Ministry of Energy and Mines is considering further expansions of this Orinoco Joint Ventures, and PDVSA’s own developments. These investments aim to generate more local economic activity, especially through extra heavy crude oil processing rather than invest outside the country for similar activity. PDVSA is working in the direction to add value to the oil sector, in this respect PDVSA is evaluating technologies to move from just upgrade activities for extra heavy crude oil to more complex refining facilities.

There is a plan to boost gas production to supply domestic market, to export as liquefied natural gas, and support PDVSA’s crude oil production activities. This investment program in gas will require a wide participation of the private sector domestic and international. Mariscal Sucre LNG project is in the business development stage with Mitsubishi and Shell as participants up to now. A lot of private companies are interested in medium and light crude oil developments through joint ventures with PDVSA, however PDVSA will develop on its own the Tomoporo field given the level of investment and development already done by PDVSA during the last years. A billion barrels of reserves have been considered for this field and the next challenge is to finance it, in order to attain in the first phase 250,000 barrels per day of new high quality crude. PDVSA has signed some agreements with China, and talks are ongoing about strategic joint ventures with the Chinese, not only in Venezuela but also in China.

CORTES: How much development do you see in the private sector outside of oil over the next few years?

NÓBREGA: We have seen expansion in real estate activity that is likely to be very important in the year ahead, along with plans for some large public works and infrastructure projects. We have three subway systems under construction in three of our biggest cities, as well as a number of new roads, so the construction industry is experiencing a time of growth. Another critical segment of our economy is the agricultural sector. Those who paid close attention to the debate over the use of mechanisms in Central Bank discounts know that the problem started with the need to lower the cost of agricultural credits. In the end we found a workable solution. Throughout 2004 the bank will gradually increase the percentage of agricultural credits in its portfolio to 16 percent, up from 12 percent at the end of 2003. Last year a committee was created to monitor the adjustment; the bank has made agricultural adjustments since the 1960s but never before has there been a committee to follow up on transactions between the Central Bank and the private sector.