Chavez Ambitions in Venezuela May Fade With Oil Price (Update2)

By Matthew Walter and Steven Bodzin

Oct. 27 (Bloomberg) -- The same tumbling oil prices that led OPEC to slash output last week threaten to send Venezuela's economy into a tailspin, and put an end to President Hugo Chavez's ambitions to expand his socialist revolution at home and abroad.

To cope with plummeting oil revenue, the source of half the government's spending, Chavez may have to cut domestic handouts and foreign aid. The first items likely to go will be arms purchases from Russia, oil subsidies for Cuba, and job-creating local projects such as bridges and subways, economists say.

``You have a country with an oil boom, that doesn't know how to save, doesn't know how to set up productive industries that generate jobs, and goes into debt,'' said Elsa Cardozo, a professor of political science and international relations at the Universidad Central de Venezuela. ``Then oil prices fall and the party ends.''

Venezuela may be poised to repeat the economic collapse it suffered in the 1980s at the end of its last oil boom. Former President Carlos Andres Perez, employing policies similar to Chavez's, lavished petrodollars on public works projects, foreign aid and nationalizations in the late 1970s, setting the stage for a 1983 currency devaluation and spending cuts that sent millions of Venezuelans into poverty.

'Most Vulnerable'

``Venezuela is now more dependent than ever on oil,'' said Jose Toro Hardy, a former board member of state oil company Petroleos de Venezuela SA. ``Venezuela is the most vulnerable country in all of Latin America to a falling oil price.''

Chavez is already spending beyond his means, posting a $7 billion budget deficit in the first half of 2008, a period of unprecedented oil prices, on a $63.9 billion budget for the year.

Economists' estimates of the minimum oil price Chavez needs to sustain his economic policies range from $120 a barrel to $65. Oil fell 93 cents, or 1.4 percent, to a 17-month low of $63.22 a barrel today on the New York Mercantile Exchange.

Below $80 a barrel, it's likely that Chavez will devalue the bolivar for the first time since 2005, sparking a surge of inflation and a drop in real wages because of Venezuela's reliance on imports, said Gustavo Garcia, an economics and public finance professor at the Instituto de Estudios Superiores de Administracion, a Caracas business school.

Oil Shock

``Depending on the intensity of the shock, it could be a situation without precedent in Venezuelan history,'' said Tamara Herrera, managing director at Caracas-based economic consulting company Sintesis Financiera.

Venezuela's benchmark 9.25 bond due in 2027 fell 20.5 cents to 50.79 cents on the dollar from 79 cents a month earlier, pushing the yield to 18.83 percent, according to JPMorgan Chase & Co.

The government, which has historically calculated its spending plans based on a conservative forecast for oil prices, is projecting a $60-a-barrel average for the 2009 budget, and output well above today's level. Oil options contracts to sell crude at $50 by December almost tripled Oct. 24.

Venezuela, which pledged last week to trim 129,000 barrels a day from its production as part of the Organization of Petroleum Exporting Countries' 1.5 million barrel-a-day cut, is the fourth-largest supplier of oil to the U.S. and the biggest petroleum exporter in the Americas.

Aid, Arms

Slashing foreign aid and arms purchases, while diminishing Chavez's influence in the region, will have the smallest political cost domestically, said Alejandro Grisanti, director of Latin American analysis at Barclays Capital Inc.

Venezuela spent $4.4 billion on 12 contracts for Russian weapons, the Kremlin said. The agreements include deals to buy 100,000 Kalashnikov rifles, 50 military helicopters and 24 Su-30 fighter jets, according to a U.S. Defense Intelligence Agency report. Russia last month offered Venezuela a $1 billion line of credit to buy more weapons.

The president has also used his oil-fed largesse to offer subsidized financing for poor countries in the Caribbean and Central America to buy Venezuelan oil products. As of July, the 18 countries in his Petrocaribe alliance were receiving up to 200,000 barrels of oil a day.

Domestically, Chavez may have to end his drive to nationalize businesses in the so-called strategic sectors, Grisanti said. The government so far has swept up the country's biggest telephone, electricity and steel companies, among others, at an estimated cost of $11 billion, according to Ecoanalitica, a Caracas-based economic consultant.

Tripled Spending

Chavez probably won't cut spending on the social ``missions'' that have brought services such as health care and adult education into some of the country's most impoverished areas and which have been key to securing electoral victories. Chavez has more than tripled total government spending in the past five years.

Chavez says he has enough resources between the central bank's $39 billion of international reserves and other off- budget assets to weather the global economic slowdown sapping demand for oil and dragging down prices.

``Some people are uniting behind falling oil prices thinking that now Chavez will fall,'' he said on state television on Oct. 24. ``I want to remind them that we arrived with $7 oil, and if it drops to $7 again this revolution won't fall, it will only get stronger.''

Reserves

Even so, the government will probably have to burn through some of the assets it accumulated during the past three years as oil climbed toward a record $147.27 on July 11.

Chavez's National Development Fund, an off-budget discretionary account that's soaked up $38 billion in PDVSA earnings and central bank reserves since 2005, will for now lose the benefit of a windfall tax that kicks in when Venezuelan crude rises above $70 a barrel.

The government will probably tap the fund for operations instead of infrastructure projects, Sintesis Financiera's Herrera said. Finance Minister Ali Rodriguez has called for an ``austerity'' budget in 2009.

Economists say the biggest concern is a currency devaluation, which would reduce Venezuelans' buying power, pushing many people who have joined the growing middle class into poverty.

The government is expected to devalue the official exchange rate 26 percent to 2.7 bolivars per dollar sometime next year, according to the median forecast of nine economists in a Bloomberg survey.

More Poverty

``Poverty will inevitably grow,'' said Pedro Benitez, a professor of economic history at Central University of Venezuela in Caracas. ``In the past, governments have preferred to devalue than to cut spending.''

That may hit Chavez's approval rating a time when high crime and inflation are already causing Venezuelans to question his policies, said Jose Antonio Gil Yepes, a director at Caracas-based pollster Datanalisis.

The president's approval rating was 58 percent in September, down from 75.4 percent in May 2006, according to the monthly survey of 1,300 residents nationwide, he said. The poll has a margin of error of 2.7 percentage points.

``If oil prices implode, the model he's trying to build implodes,'' Gil Yepes said. ``Everything he's built is based on subsidies, which are financed by oil.''