The Venezuelan inflation rate puzzle


Last week, Central Bank of Venezuela, released the inflation rate results for the first quarter. According to the national consumer price index variations, accumulated inflation for the first three months of the current year achieved only 5.8% and on a year over year basis, the number was 26.2%.

Even though Venezuelan inflation rate is quite high for international standards, first quarter results are much lower than consensus expectations. In fact, based on the historically pass-through effect and after January devaluation of 60%, many analysts expected a much faster path of growth for consumer prices.

Apparently price controls could avoid higher pass-trough effects. But I do not find this a satisfactory answer for at least two reasons. Firstly, core inflation has not accelerated since January. If price controls are the main reason behind the lag in inflation, core inflation which explicitly excludes price control and seasonal effects, had grown significantly. However, core inflation is pretty much the same in March (30.2%) on an annual basis in comparison with January (29.8%)

Secondly, if price controls were an effective barrier against the inflationary consequences of devaluations then a “new inflation” associated with the new exchange rate can be only identified at the wholesale level.

Nonetheless, wholesale import index does not indicate a significant change on the first quarter of the year. Even the total wholesale index (adding domestic and imported goods) neither indicates meaningful inflation acceleration since January.

Originally question resurges, if price controls are not the driver of a lower than expected inflation, what is the main factor behind the inflation numbers?

A possible explanation is that pass-through effect is currently lower in comparison to other devaluation years because of the extensive period of exchange rate control (seven years) and due to the extensive use of the parallel exchange rate as a price set up. This argument states that prices were already fixed taking into account parallel market exchange rate which reduced the direct effect of the official devaluation on domestic prices.

However, as inflation rate in 2009 was also lower than expected (25.1%) a year in which parallel market rate gained influence on domestic price setting, my guess is that the main driver of the current inflation numbers is that our economy continues in a recession which means that aggregate demand keeps decreasing. As I posted last week, several leading indicators suggest that on the first three months, Venezuelan economy could have registered the worst growth numbers since 2002-2003.

A combination of power shortage and regional compulsory cuts and a significant drop in private investment are the main drivers of the current recession and therefore also the main explanatory factors behind the first quarter inflation numbers.

First Quarter of 2010. Preliminary comments



1. Current Context

After four years of strong numbers of economic growth associated with high oil prices, during the third quarter of 2009, Venezuelan economy officially entered into a recession. According to the Central Bank of Venezuela (BCV), our GDP registered a cut of 3.3% for the year as a whole and on a quarterly basis; for the last three months of 2009, BCV estimated a drop around 5.8%

In addition to the 2009 economic growth results, this year began with 60% of currency devaluation, a non-expected and severe power crisis and the aftermath of the private but Government-related banks crisis developed in the end 2009. Therefore, consensus among main economists, moved from a likely but modest recovery scenario for 2010 to a very probably second in a row year into a recession.

A couple of important facts increased the recession odds for 2010. On the Government side, the resign of the former Vice-President Ramón Carrizales, mean a return to inside administrative problems and added new temporal barriers in order to transform official announcements of more fiscal expenditure into real and effective transfers of resources to regions, paying domestic debt to Government suppliers and monitoring new state enterprises performance.

Due to the fact that Carrizales was a sort of a former “General or Chief Administrative Manager” who was in charge to deal with foreign and expropriated firms and occasionally was in charge to lead the Ministry Council (The maximum coordination mechanism inside the Executive Branch), the arrival of a new Vice-President will require a couple of months in order to complete the learning process and deal with all the administrative issues under his control and return to a normal working of the public administration.

On the other hand, during the first quarter of 2010, several microeconomics and regulatory problems surged in most of the productive sectors, especially in those sectors subject to price controls. In particular, labor conflicts, scarcity of imported inputs, long delays in adjustments of price control goods and the spread out of expropriations, have had a negatively impact on investment sentiment.

2. First Quarter Outlook

Nonetheless, statistical numbers about first quarter are not available yet, some leading indicators could help to address the current macroeconomic situation. In particular we are going to use the monetary supply numbers, the imports coming from Brazil and the United States, the unemployment data and the inflation results, in order to do a reasonable estimation about first quarter results.

2.1 Monetary supply.

As we can see from figure 1, estimated cut for real monetary supply during the first quarter of the year is around 6%. Real monetary reduction is responding to a lower demand for loans in a context of negative investment expectations, vehicle industry crisis and a cut in the household income. As real monetary supply is usually the best leading indicator for the Venezuelan economy, first three months performance of monetary liquidity would indicate that recession will extend for at least the first two quarters of this year.

2.2 Imports coming from Brazil and the United States

Venezuelan imports historically highly respond to national income. Therefore, an indirect way so see what is going on with the state of the economy can be found, just studying the imports performance coming from the main trade partners. Looking at the numbers of imports, we find a significant cut of Venezuelan external purchases. For instance, with the United States, January imports decreased more than 29 % in year over year basis and in regards to Brazil, annual growth for the first two months was -21% and -11% respectively.

2.3 Unemployment data.

For the first time in the last three years, total unemployment number is higher during January and February in comparison with the same months a year earlier. Actually, total non-employees grew by around 138,000 and 190,000 respectively in the first two months of the year. Unemployment results, suggest that economy keeps falling down during the first quarter of the year.

2.4 Inflation results.

On the inflation side, although inflation rate remains high, it is actually quite lower than the economists forecast immediately after the January currency devaluation. Historically, pass-through effect in Venezuela (Inflation caused directly by devaluation) is around 66%. As we observed 60% devaluation in January, originally inflation expectations were around 40%.

However, on a year/year basis, inflation still remains around 25% but is highly influenced by food price controls. Actually if we take into account only the goods that are not subject to price controls, this is core inflation, the number would be 33%. The gap between initial inflation expectation and current results -including core inflation- suggest that the recession period could be longer and greater.


3. Final Remarks
Leading and contemporaneous indicators, suggest that the recession period will extend for at least two or even more quarters. Without available information for the oil production, but based on the performance of imports from selective trade partners, the real monetary supply behavior, the unemployment data and the inflations results, we state that economy fell down by around 6% during the first quarter of 2010