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Venezuela's Fiscal Policy and Oil Rich Economy

Presented by: Herman Antonov Yelena Khan Shoya Ushurova Brett Nordeen. Venezuela's Fiscal Policy and Oil Rich Economy. Analyze the Venezuelan economy over 1990-2003 and determine if Venezuela runs an expansionary fiscal policy in good time, and a contractionary fiscal policy in bad time.

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Venezuela's Fiscal Policy and Oil Rich Economy

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  1. Presented by: Herman Antonov Yelena Khan ShoyaUshurova Brett Nordeen Venezuela's Fiscal Policy and Oil Rich Economy

  2. Analyze the Venezuelan economy over 1990-2003 and determine if Venezuela runs an expansionary fiscal policy in good time, and a contractionary fiscal policy in bad time. Objective

  3. Economy of Venezuela Fiscal policy in Venezuela Methodology of detrending the business cycle Analysis of fiscal policy Outline

  4. General Information • 26,814,843 people currently • 93% live in cities • GDP: $350.100 billion (2009 est.) • GDP per capita: $13,100 (2009 est.) • President - Hugo Chavez (since 1999).

  5. General Economic Acticity • Industries: Petroleum, food processing, textiles, iron ore and steel mining. • Exports: Petroleum, aluminum, steel, agricultural products • Imports: Raw materials, machinery and equipment, construction materials

  6. Oil Dominance • The Venezuelan Oil sector represents 80% of exports. • Top 10 in Oil reserves • ~ 50% of gov. income is from oil • Contributes 1/3 to GDP

  7. Petroleos de Venezuela, S.A. • PDVSA - nationalized • The world’s third largest oil producer. • Controls large portion of country’s wealth • Holds interest in refineries offshore (i.e. CITGO)

  8. Hugo Chavez – Since 1999 • Social programs emphasis • PDVSA spends 10%of its annual investment budget on social programs. • Reportedly spent $14.4 billion in this manner in 2007, doubling the 2005 figure of $6.9 billion. • Spent $60 million in 2004 on exploration as apposed to $174 million in 2001.

  9. PDVSA's Outlook • Venezuela claims current production level of 3.3 million barrels per day, placing it as a top ten producer in the world. • However, lack of investment in infrastructure leads experts to believe and annual investment of $3 billion to just maintain current production is needed. • And the oil prices themselves...

  10. The aggregate economy • Oil comprised 25% of real GDP from 1991-2002. • This means that fluctuating oil GDP imply a large portion of GDP is fluctuating. • The more variable the countries GDP, the more likely that the whole economy has poor growth.

  11. Same Old Story? • Economy dependent on an export commodity. • Exposes macroeconomic stability to external shocks. • Forced to borrow from other countries when exogenous forces turn against them. • Heavy government involvement in enterprise.

  12. Introducing Fiscal Policy • Definition • The pattern of Venezuelan fiscal policy (1991-2003) : • limited access to international MKTs • changes in discretionary component of public spending • high dependence on cyclically sensitive revenue sources

  13. Fiscal Policy facts • Venezuela runs and average external debt to GDP ratio of over 40% for the time period of 1990-2002

  14. The Role of Oil • Generated 50% of government revenue over 1991-2002 • Intuitively, we would expect that volatile revenue generation, caused by erratic oil GDP, would lead to unstable fiscal outcomes in Venezuela.

  15. Oil Price Dependence • High dependence on global business cycle (1% growth decline = 10% oil price decline) REASONS: • huge output declines in oil-intensive sectors • Short term low price responsiveness of oil demand and supply

  16. Implications for Venezuela • Venezuelan GDP generated by oil is highly correlated to oil price fluctuations with correlation ratio of 0.80 • Thus a volatile oil price implies volatile oil GDP for Venezuela.

  17. Fiscal Policy Volatility

  18. Other explanations for fiscal volatility • Undertaking poor discretionary policy that causes recession rather than sustaining growth. • Political incentives that cause governments to begin discretionary spending in times of revenue gains. • Increases in spending growing out of proportion to revenue growth.

  19. What to believe? • Do we conclude that fiscal policy is driven by temporary cycles, mainly contained in the oil price, or by one or more of these discretionary actions by the government? • In order to distinguish between the two, it is necessary to break down the variables into their trend and cycle components.

  20. Trends and Business Cycles

  21. Trends and Business Cycles • High or low volatility • Procyclical or countercyclical

  22. Use of Filtering Methods • to recognize high or low deviations of variable • to best reduce the short run deviations • for robustness against the uncertainty (4 different filters)

  23. The Four Methods • Standard HP filter • ARIMA Model • Frequency Domain Approach • Modified HP filter

  24. The Four Methods All methods show 3 trends: • Real GDP of Venezuela • Non-oil GDP of the country • Oil GDP

  25. Business Cycles with Standard HP Filter • Procyclical • High volatility • Non-oil sector is more volatile than oil sector

  26. Business Cycles with Modified HP Filter • Procyclical • Still very volatile • Non-oil GDP trend is more volatile than Oil GDP trend

  27. Volatility • Measured in the quarterly average standard deviation. • High volatility in trend component of oil GDP suggests many shocks to the structure of oil production policy. See that these are the primary driver of Oil GDP volatility. • See that for the fiscal variables Oil revenue has the highest variability.

  28. Other business cycle aspects • Persistence: Total expenditures are more persistent then total revenue • Procyclicality: Non-oil primary expenditures, which account for 80% of total expenditures are observed to have a correlation of up to 0.50 with total GDP.

  29. Understanding Policy Stance • Now that we have calculated the values and observed the changes in the variables of interest, we can engineer the fiscal policy based on the cycle and trend elements. • Then by comparing the changes in fiscal policy to the aggregate economy, procyclicallity can finally be concluded.

  30. Non-oil Primary Balance • Defined to be the net lending/borrowing in assets and liabilities and interest expense that are deemed to be for public policy purposes without the proceeds generated from the oil sector. • This variable will be used as the main fiscal indicator.

  31. Why? • It has become clear from the break down of the GDP variables that oil revenue is based on volatile cyclical changes. • Don't want these types of shocks to contribute to fiscal stance. • A more reliable indicator in the long run.

  32. Environment for analysis • Compute the output gap using • Bstr = B – Л x Ygap • Bstr is the structural fiscal balance • B is the actual non-oil primary balance • Ygap is the output gap • Л is the cycle correlation between non-oil primary balance and GDP (0.39)

  33. The difference between the potential GDP and the actual GDP • The output gap will tell us whether the aggregate economy is in a period of growth or a period of decline.

  34. Fiscal Impulses • Discretionary changes in the non-oil primary balance. • Looking for either revenue reductions or expenditure increases, these are the actions of a procyclical policy maker.

  35. Fiscal stance is indeed procyclical • Response • Accumulate substantial non-oil assets in times of growth • Formulate accurate oil price assumptions.

  36. Investment • As mentioned, more oil revenue going to expanding social programs: Health care, education, basic needs subsidized. • Increased military spending • International aid programs • - Houston based subsidiary of PDVSA run a half price/free oil heating program for 200,000 houses in U.S.

  37. Conservative budgeting • Difficulty in forming accurate predictions for oil price. • Simply write the budget assuming guaranteed revenue at half the current price of oil. • The government should be trying to smooth consumption, maximize over the long run.

  38. Conclusion • Observe that Venezuela business cycle is mostly influence by short term cyclical components. • Oil revenue is indeed very volatile, due to price volatility. • Ran a procyclical fiscal policy. • Ultimatley, left in a fragile economic position.

  39. Baldini, Alfredo. “Fiscal Policy and Business Cycles in an Oil-Producing Economy:The case of Venezuela.” IMF Working Paper. Dec 2005 Main Reference

  40. Alvarez, Cesar, Hanson, Stephanie. “Venezuela's Oil-Based Economy” Feb 9 2009 <http://www.cfr.org/publication/12089/venezuelas_oilbased_economy.html>. Lipsky, John. “Economic Shifts and Oil Price Volatility” Mar 18 2009 <http://imf.org/external/np/speeches/2009/031809>. Padgett, Tim. “Why Dan't Big Oil Match Hugo Chavez?” Time. Jan 7 2009 <http://www.time.com/time/business/article/0,8599,1870219,00.html?iid=tsmodule>. “The Analytic framework” International Monetary Fund <http://www.imf.org/external/pubs/ft/gfs/manual/pdf/ch4.pdf>. “Venezuela” CIA World fact Book. Apr 22, 2010 <http://www.cia.gov/library/publications/the-world-factbook/geos/ve.html>. Weisbrot, Mark, Sandoval, Luis. “The Venezuelan Economy in the Chavez Years”. Center for Economic and Policy Research. July 2007. <http://www.cepr.net/documents/publications/Venezuela_2007_07.pdf>. Additional References

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