Put Money Into Venezuela? No, Thanks

Chavez' political moves are scaring off investors

For many Venezuelans, the "peaceful revolution" President Hugo Chavez Frias promised earlier this year is proving to be anything but. Since February, when Chavez took office and launched an all-out campaign to end corruption and promote social justice, unemployment has doubled to more than 20% and demand for consumer products, from cars to baby formula, has fallen by more than half. Chavez has made some sensible moves, analysts say. But anxiety as to where he intends to take the country has brought investment--local and foreign--to a screeching halt. "The economy's big problem," says Boris Molina, research economist of Santander Investment in Caracas, "is the political uncertainty."

The turmoil was at its worst in late August, when the Constituent Assembly, elected by popular vote in July to rewrite the constitution, declared itself the nation's sovereign power. It seized judicial and legislative power, terming the courts and congress corrupt beyond salvation. The assembly, whose members are 95% pro-Chavez, is now auditing all public agencies to weed out graft and mismanagement. Some critics say Chavez--a former paratrooper who attempted a coup seven years ago--is using the assembly to assume something close to dictatorial powers.

The economic fallout of this political mess could be far worse. Chavez has been saved in part by a dramatic rebound in the price of oil, Venezuela's biggest revenue earner. Venezuelan heavy crude now goes for $18.65 a barrel, compared with a low of $7.76 in February. Chavez may be able to cut a projected fiscal deficit of $9 billion by as much as a third. But the oil price, which has bounced during the spring and summer, did nothing for overall growth. In the first six months of the year, the Venezuelan economy still shrank by almost 10% from the year-earlier period.

Nonetheless, Chavez enjoys a 78% approval rating, since most Venezuelans agree with him that the country has been mismanaged for decades. That gives him time to pursue his political agenda. And that's just what worries the Venezuelan elite, which views Chavez as a populist intent on increasing state control over the economy. "We're headed toward a more rigid model," says Molina. "We've lost the opportunity to change to a truly open, market-oriented system."

Chavez right now is focusing on measures to get people back to work and spending again. He has already launched a $900 million public-works program and a Peoples' Bank to hand out microcredits. Beginning in January, Mitsubishi, Ford, and GM will produce a job-generating "people's car." Chavez plans to pay for these projects with windfall oil profits and savings from wasteful programs. He has also made needed regulatory reforms and cut ministries from 16 to 13. In July, he pushed through a tax treaty with the U.S. and will soon approve a bilateral investment-protection treaty.

THIRD WORLD. These initiatives are not too alarming to business executives. But other moves are more worrying. The recent forced resignation of Roberto Mandini, president of Petroleos de Venezuela and a career oil exec, has raised eyebrows. He was replaced by Hector Ciavaldini, a lower-ranking executive and a Chavez loyalist. Economists now worry that the world's second-largest state oil company will be gutted to fund social programs. "We've got a first-world company in

an impoverished country," Ciavaldini says. "This is the ideology we have to correct."

The new constitution is another concern. Chavez is expected to increase the 38-year-old charter's emphasis on a labor-oriented, interventionist state. Foreign investors are particularly alarmed by a proposal to require that contractual disputes be resolved by Venezuelan arbitration, not by foreign courts. Alfredo Pena, who heads the assembly's economic commission, says investors need not worry: "There will be clear rules of the game, and guarantees to free enterprise." Maybe. But as Venezuela's caudillo hits his stride, investors fear the rules will change dramatically.

Before it's here, it's on the Bloomberg Terminal.