Global Insight Perspective

Significance

GDP growth figures for the first quarter of 2005, while respectable at 7.94%, reveal worrisome signs in the oil sector - oil activity grew just 1% year-on-year, and state-owned oil company PDVSA continues to struggle to increase oil output at a time when oil prices have reached record highs.

Implications

First-quarter GDP figures for 2005 repeat last year's growth pattern, with domestic demand booming thanks to out-of-control public spending and certain macro-economic stability, while inflation decelerates due to widespread price controls. Meanwhile, oil activity has remained sluggish at best, and such a pattern will be very difficult to sustain in the longer term, even if oil prices remain relatively high.

Outlook

We expect economic growth to continue decelerating throughout 2005 as it becomes increasingly difficult for the government to sustain the current pace of public spending, though the economy will still grow 6% for the year as a whole thanks to stubbornly high oil prices. However, the economy could be heading towards a new recession in the medium term due to lack of investments in key activities - especially oil - and increasing dependency on oil prices.

Broad-Based Expansion in Non-Oil Sector

According to preliminary figures from the central bank, the economy expanded 7.94% year-on-year (y/y) during the first quarter of 2005, down from 12.1% in the previous quarter. Most industries performed very well in the first quarter of the year, with the notable exception of the oil sector. Indeed, oil GDP expanded just 1% y/y in this period, thus confirming the fact that the oil industry has failed to recover completely from its 2002/2003 oil strike. This comes as somewhat of a surprise given the current level of oil prices. Yet, it also speaks of the difficulties the government is having in putting PDVSA back on track after having fired half its employees in the aftermath of the 2003 strike. Curiously, PDVSA has recently questioned the central bank's GDP figures, saying it has actually increased output to pre-strike levels. This conflict only brings more uncertainty regarding the actual level of oil output in the country - not even PDVSA seems to know how much it is producing.

In the meantime the non-oil sector grew 9.4% year-on-year in the first quarter, amid a very expansive fiscal policy and improved macro-economic stability. The sectors that showed above-average growth in this period were banking and insurance (24%), construction (15.4%), commerce (17.8%), transport (14.7%), communications (16.2%), and government services (10.8%). All these sectors benefited from a solid expansion in aggregated domestic demand in the first quarter. The all-important manufacturing sector grew 6.4% over this period, which represents a significant slowdown from the previous quarter's growth of 16%. Other sectors such as utilities, agriculture, and other services had below-average performances in this period. Meanwhile, the mining sector registered the only contraction in the first quarter (-2.6%).

Sharp Growth in Imports Brings Concerns

Central bank figures show that real imports grew 49.6% y/y in the first quarter. That rate comes on top of a 60% expansion in 2004, which makes it even more impressive. Imports have grown at such a pace due to booming domestic demand and an overvalued currency. In terms of GDP, imports growth somehow reduces the rate of expansion of the overall economy as it implies some constraints in domestic output capacity. The appearance of cheap imports hurts domestic manufacturers, which find themselves unable to compete in the local market and, in many cases, are forced to go out of business. This situation becomes worse when the country imports mostly consumer (finished) goods rather than capital or intermediate goods - which are used in the manufacturing process. Unfortunately, Venezuela has become a big importer of consumer goods in the last two years.

Meanwhile, real exports growth has remained very sluggish in recent quarters, which reflects not only the struggles in the oil sector but also lack of expansion in the non-oil exporting sector. The non-oil exporting sector has had little incentive to increase exports in the last two years due not only to a strong domestic demand but also to the imposition of troublesome foreign capital controls and an overvalued currency.

Outlook and Implications

First-quarter GDP figures do not show any big surprise. Overall they repeated the same growth pattern of 2004; that is, strong domestic demand and sluggish oil and export sector. We do not expect this pattern to change during the remainder of 2005 as current conditions prevail. The government will continue to struggle with increasing oil output capacity, which could even decline in the second quarter amid new problems at PDVSA. Furthermore, the government's recent statement that private oil companies must pay back-taxes could jeopardise the permanence of some of these firms in the country. Unfortunately, it has been the expansion of oil output by private companies that has kept the overall oil sector afloat in recent quarters.

On the other hand, stubbornly high oil prices will allow the government to sustain current public spending levels for the rest of 2005. Such an impressive fiscal stimulus will continue carrying the economy in the next three quarters. Yet, the government will find it increasingly difficult to keep the economy growing at current rates. Furthermore, the increasing intervention of the government in the economy will do little to attract much-needed private investment. Thus, we expect economic growth to decelerate progressively over the last three quarters of the year. The long-term sustainability of the current expansion will depend heavily on the government's ability to boost oil output capacity and on oil prices.