By James Painter

BBC Latin America analyst

President Chavez is busy campaigning for key local elections next month

The dizzying collapse in oil prices has started a heated debate in Venezuela about the possible effect on its oil-dependent economy - and the political future of left-wing President Hugo Chavez. Venezuela is particularly vulnerable to oil prices. It is the Western hemisphere's largest oil exporter. More than 90% of its export revenue and more than half of the government's annual expenditure comes from oil. President Chavez's right-wing opponents are hoping a sustained drop in the oil price could curb his heavy spending on social programmes and undercut his support. "Some Venezuelans - the wannabe Yankees - are praying for a continued drop in oil prices," Mr Chavez said recently. "But a price range of US$70 to US$90 a barrel will give us more than enough room." Foreign reserves The Venezuelan economy is set to grow for the fourth year running this year on the back of strong oil prices. Last July the price reached more than US$147, but has slumped at one point recently to below US$60. Oil analysts Goldman Sachs say it could drop to US$50 in the event of a world recession. OIL PRICE DECLINE

Why have oil prices fallen? The former head of the Venezuelan central bank, Domingo Maza Zavala, thinks that anything less than US$70 a barrel would mean current levels of economic activity could not be sustained. "We are on the edge of a precipice and we should prepare for contingencies," says Mr Maza Zavala. "The government is presenting a different panorama to Venezuelans, which is dangerous because the best way of confronting dangers and risks is the truth." Analysts point out that the key factor is the average price of Venezuelan oil over several months and not the price on any particular day. "There is no chance of an economic collapse this year," Jose Manuel Puente, from the Public Policy Centre in Caracas, told the BBC. "Even if the price stays low for the rest of the year, the average price for 2008 will still be around US$95 a barrel". Government officials are also quick to point out that Venezuela has large foreign exchange reserves of nearly US$40bn. That figure rises to well over US$50bn when a special discretionary development fund (Fonden) is included which President Chavez has used to spend mostly on foreign policy initiatives. 'Illusion of harmony' However, even if the short-term outlook may be solid, next year may be another matter if the oil price is consistently below US$60 a barrel, analysts say. Mr Puente says his main concern is the sustainability of current economic policies. He points to three key weaknesses in the Venezuelan economy, which would be exacerbated by a low oil price - a burgeoning fiscal deficit, high inflation, and balance of payments problems. Sooner or later the bomb will explode

Jose Manuel Puente

Public Policy Centre, Caracas The Chavez government has been running an expansionary fiscal policy in order to pay for many of the social programmes for the poor known as "missions". This is one of the reasons why Mr Chavez remains popular, but the fiscal deficit has mushroomed in the first half of 2008. Inflation is running at 36% in the last 12 months, the highest in Latin America. And the balance of payments is heavily in deficit despite an estimated US$85bn in oil revenues this year. This is because a record amount of imports, nearly half from the US, has been sucked in to fuel a mini-consumption boom. "Everything is linked to the oil boom," says Mr Puente. "If oil prices continue to fall, the country simply will be unable to continue importing to meet rising demand, maintain the exchange rate and the expansionary fiscal policy, and keep this illusion of harmony." Ticking time bomb Critics say President Chavez's aggressive nationalisation policy has put off foreign investors, with the result that most investment now comes from the state, and not private companies. According to figures from the UN Conference on Trade and Development, total foreign investment in Latin America last year was worth about US$126bn. Of this, only US$600m was invested in Venezuela, compared to more than US$8bn in neighbouring Colombia, and US$15bn in Chile. Another structural problem is that despite the high oil prices, Venezuela's oil output has actually been falling, from more than 3m barrels per day in 1997 to about 2.4m bpd now. The problem, according to analysts Oxford Analytica, has been the absence of capital investment and of skilled management personnel in the state oil company, PDVSA. Not all analysts paint a bleak picture. They point out that there are plenty of non-essential activities which the Chavez government could cut both at home and abroad. President Chavez himself has spoken of the need to make revisions and to be more efficient in spending. Few doubt that Mr Chavez will face tighter funding next year - but how much is hard to quantify as the oil price is so volatile. Mr Puente is convinced that the "warning lights on the dashboard" are serious. "In the medium term", he says, "sooner or later the bomb will explode."



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