venezuela: country strategy with the idb (2001-2003)

DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANK

REGIONAL OPERATIONS DEPARTMENT 3 COUNTRY DIVISION 5

VENEZUELA COUNTRY PAPER

This document was prepared by a team consisting of Román Mayorga (COF/CVE), Carlos Elías, Humberto Gobitz, Asunción Galdón, and Jorge Lamas (RE3/OD5), with contributions from the following members of the Bank’s resident mission in Caracas: Eduardo Zamora, Genevieve Walravens, Martha Arbeláez, Tomás Muñoz, Sergio Urra, Eduardo Casati Pastor, Carlos Allia, Nohora Alvarado, Rudi Cressa, Xiomara Alemán, and Rafael Cortés. Moritz Kraemer (RE3/OD5), Inder Ruprah (RE3/OD5) and Carlos Oliva (RE3/OD5) contributed to earlier versions of the paper. The team is grateful to Javier León (RE3/OD5), Kim Staking (RE3/FI3), Alvaro Llosa (RE3/EN3), Máximo Jeria (RE3/SO3), and Jaime Fernández (RE3/FI3) for their comments on this paper.

CONTENTS

EXECUTIVE SUMMARY I.

ECONOMIC CONTEXT AND DEVELOPMENT CHALLENGES ................................................. 1 A. Political and macroeconomic context....................................................................... 1 B. Development challenges ........................................................................................... 6

II.

BANK OBJECTIVES, STRATEGY AND AGENDA FOR DIALOGUE .......................................... 7 A. Objectives.................................................................................................................. 7 B. Strategy...................................................................................................................... 7 1. Previous Bank support and portfolio review .................................................... 7 2. Major strategic areas ......................................................................................... 9 3. Coordination of private-sector instruments ...................................................... 1 4. World Bank and CAF participation in development projects in Venezuela.... 1 5. Financial projections and lending scenarios ..................................................... 1 6. Risks .................................................................................................................. 2 7. Monitoring......................................................................................................... 3 C. Agenda for a country dialogue.................................................................................. 3

ANNEX

EXECUTIVE SUMMARY Venezuela finds itself at a unique juncture that is characterized by sweeping structural changes in the political, economic and above all social spheres. Since President Chåvez was elected in December 1998, Venezuelan society has had to make decisions on such fundamental issues as the framing of a new constitution. As a result of this process, democratically ratified at every stage, the government is committed to carrying out a program that responds to the new expectations generated in the economic, political and social areas over the past 21 months. The administration’s promises are underpinned by oil revenues which make that program sustainable.

Oil provides Venezuela with revenues attainable by very few countries in the region.

Now that crude oil prices are improving, Venezuela can capitalize on this to reactivate its economy. As a result of the international financial crisis of 1998 and 1999, demand for crude declined, the terms of trade deteriorated, and fiscal revenues fell. In addition, torrential rains hit Venezuela in late 1999, causing devastating human and material losses. The combination led to a 5.9% economic contraction in 1998 and 1999. Since then, however, the international financial recovery and its effects on demand for petroleum have given Venezuela substantial resources. The country now has the opportunity not only to rebuild the infrastructure lost in the natural disaster of 1999 but also to make preparations for the future so as to lower its vulnerability due to dependence on oil.

Against such a backdrop of change, this country paper endeavors to define the Bank’s work program over the coming three years. Our analysis of the Venezuelan situation leads us to identify two major challenges. In the short term, the necessary confidence must be regained for private sector investment. In the medium and long term, Venezuela will need to diversify an economy that has historically been coupled to its oil industry.

Overcoming these challenges calls for maintaining macroeconomic balance, strengthening public institutions, and deepening regional trade integration, to ensure growth with equity and poverty reduction.

The short-term challenge is reflected in the fact that, with the price of Venezuelan petroleum at over US$30 a barrel in late 2000, the private sector still hesitates to invest.

The environment of political changes and the process of shaping structural changes do not, for the time being, offer the assurances that private enterprise needs in order to invest, particularly private enterprise in Venezuela, accustomed to a certain degree of state protection. The government has taken steps to promote private investment by introducing tax measures, by opening up the telecommunications sector to private investors, and by allocating public funds to economic recovery. A fiscal stabilization fund has been created in which to accumulate a portion of oil revenues when prices are high, to be used when oil prices fall. Thanks to the expansive fiscal policy pursued in 2000, GDP will grow in real terms both this year and next. The government hopes that these fiscal measures, in combination with a full agenda of the legislative and executive

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branches to draft laws that will fill the legal vacuum generated by a new constitution, will offer an institutional framework attractive to private investors.

Over the medium and long term, the Bank can support the government’s efforts to diminish its dependence on oil revenues. To this end, the Bank has identified four areas of intervention: the social sectors, economic issues, institutions, and science and technology.

In the social sphere, the Bank could support the government in projects that reduce poverty and develop human capital through better access to basic social services. The Bank is now preparing operations to finance support for children and young people, a social investment fund, low-income housing, basic and preschool education, and training for young people.

In the economic area, the Bank will collaborate through projects to increase the productivity of nonoil resources, to diversify the economy. Programs and projects that the Bank would finance, as agreed with the government, are the rebuilding of infrastructure destroyed in the 1999 natural disaster, consolidation of rural communities, food security, technology and policy management, legalization and registration of rural land titles, control of Lake Valencia water levels, reorganization of the water and sanitation sector, solid-waste management, the national highway and urban transit programs, rehabilitation of mid-sized irrigation and land drainage systems, and a transportation study.

In terms of institutions, the Bank will support the government’s efforts to strengthen the public sector and thus improve the delivery of public services. Operations planned in this area include justice system reform, preinvestment and institutional support for the Planning and Development Ministry, citizen security and coexistence, and institutional strengthening for the Finance Ministry.

In the area of science and technology, the Bank will support the generation and use of knowledge to support human capital development and increase economic productivity.

Loans identified include an information technology program and support for technology institutes.

The Bank’s agenda is clearly quite ambitious and could lead to commitments averaging US$565 million per annum for the 2001-2003 period. Given the context of change in Venezuela, the Bank understands that the proposed lending program could undergo adjustments. There are two foreseeable risks in implementing this operating strategy. One is an institutional risk in connection with structural changes in the Venezuelan public administration. The other has to do with the administration’s execution capacity, if it will be focusing on the definition of major legal issues. Nevertheless, the proposed work agenda in Venezuela is feasible and could make a significant contribution to the country’s development.

I.

ECONOMIC CONTEXT AND DEVELOPMENT CHALLENGES

1.1

Venezuela is undergoing a period of structural changes in the political, economic and social spheres that began in late 1998 with the election of the Chávez administration. Since December 1998, Venezuelans have voted five times: in a referendum to approve the drafting of a new constitution, election of the National Constituent Assembly, a referendum to approve the new constitution, and election of the National Assembly and of President Chávez for a six-year term under the new constitution. In addition, major changes have been made in the public administration, including a reduction in the number of ministries. Within that dynamic context, this paper presents the Bank’s work program for Venezuela for the next three years, in the awareness that major changes in the institutional or macroeconomic framework could necessitate adjustments to the proposed lending program.

A.

Political and macroeconomic context

1.2

Venezuela is undergoing structural change in the political, economic and social spheres. In the sociopolitical sphere, the Chávez administration took office in December 1998 with an agenda that called for fundamental change. At the beginning of 1999 the government asked the Congress for special legislative powers, granted under the 1999 Special Powers Act, to restructure the public administration and reduce the number of ministries. The government also presented a proposal to draft a new constitution, approved by referendum by the Venezuelan electorate, and appointed the National Constituent Assembly to implement the initiative.

1.3

The Constitution of the Bolivarian Republic of Venezuela was approved by referendum in December 1999. In July 2000 the governing party won the elections for the single-house National Assembly and President Chávez was reelected for a six-year term. The approval of the new constitution left a vacuum that called for the drafting of legislation in line with the new legal framework to govern political and economic activity. The government again obtained authority from the National Assembly to legislate matters of national interest for one year, under the 2000 Special Powers Act, including the Land and Rural Development Law and the Hydrocarbons Law. The coming 12 months are expected to be very busy ones in terms of defining matters of national interest that encompass economic and financial areas and public administration.

1.4

Within this context of structural change, the government is committed to furnishing the necessary means to reactivate the economy after the 5.9% fall in GDP in 1998 and 1999. That drop came about because of the international financial crisis that hurt most emerging economies through deteriorating terms of trade, a result of lower international demand and smaller lines of credit provided by international counterparts for local financial systems. In late 1999 Venezuela also suffered the devastating effects of torrential rains that caused enormous human and material

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losses. With recovery of the Asian economies in the last quarter of 1999, combined with the thrust of the U.S. economy, terms of trade improved, especially for oil. The increase in global demand for petroleum and coordinated action by OPEC to shrink the supply of crude may in the short term lead to a period of reduced price volatility.

Figure 1 Price of Venezuelan oil 35

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1.5

1

The government is aware of the importance to Venezuela’s development of reducing volatility in oil prices, and has taken the lead within OPEC to promote an oil production strategy to keep prices within a band of US$22 to US$28 per barrel.1 This strategy was confirmed in late September at the second meeting of Heads of State hosted by Venezuela since the founding of OPEC. The policy has so far been successful: at the end of last October the price of Venezuelan oil was about US$30 a barrel, 50% higher than a year before; at the end of 2000 the price closed above US$20 a barrel. For the moment there are no signs of any drastic reduction in global demand for

OPEC, which produces 40% of the world’s total oil supply, will increase production whenever the price of crude stays above the band for 20 consecutive days. Friday, 27 October 2000 marked the twenty-first day on which the price per barrel closed above US$28, and the President of OPEC, Mr. Alí Rodríguez of Venezuela, sent notes to the cartel’s members to boost production by 500,000 barrels a day.

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oil, and OPEC’s intention to adhere to the band continues in place. This policy to reduce volatility in petroleum prices is complemented internally by the creation of the Macroeconomic Stabilization Investment Fund (FIEM).2 Petroleum revenues are deposited to the FIEM whenever the price rises above US$9 per barrel, the aim being to hold reserves that can be used when prices fall, as a fiscal cushion against volatility in the price of crude.

Petroleum revenues generated this year have enabled the government to add to FIEM deposits as well as increase public spending, thus reactivating an economy that is still suffering the effects of the 1999 recession.

Figure 2 Nominal exchange rate and future price of the bolívar 850 12-month NDF 800

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1.6

2

The internal reactivation strategy includes using petroleum revenues to finance initiatives that promote growth in accordance with the government’s avenues of action. For this reason, current public spending and investment, which had fallen to

The central government’s oil royalty revenues are part of current revenue and unrelated to the FIEM. These resources explain the increase in public spending in 2000. The FIEM is subject to a ceiling and any surpluses are transferred to the central government, state governments, and Petróleos de Venezuela, S.A. (PDVSA). Funds transferred to the central government would be deposited in the Single Social Fund, the Venezuelan Investment Fund, and the Debt Buyback Fund. There were no drawings on FIEM funds in 2000.

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9.1% in real terms in 1999 as compared to 1998, grew 44.9% in the first half of 2000 compared to the same period in 1999.3

Table 1 Key macroeconomic aggregates 1998 1999 GDP at 1984 prices (% change) 0.2 -6.1 Oil 2.0 -7.4 Nonoil -0.9 -5.4 Central government deficit (% of GDP) 4.1 2.6 Saving and investment (% of GDP) 1 15.6 21.2 Total investment 14.3 19.1 Gross fixed capital formation 6.3 8.8 Public sector 8.0 10.3 Private sector 1.3 2.1 Change in inventories 15.6 21.2 Total saving 21.9 18.3 Domestic saving -6.3 2.9 External saving 3,689 -2,562 Current account external balance (US$million) 16,023 15,458 Gross international reserves (US$million) 15,164 14,849 Central Bank 215 0 FIEM 644 609 FIV Exchange rate (bolívares/U.S. dollar) (year565.0 649.3 end) Consumer price index (% change Dec.-Dec.) 31.0 20.1 Source: Year-end address by the Chairman of the Central Bank, 26 December 2000.

1. Gross fixed capital formation data for 2000 estimated by the Bank.

1.7

3

2000 3.2 3.4 2.7 1.8 18.5 17.0 9.0 8.0 1.5 18.5 30.4 -11.9 13,365 21,647 16,070 4,551 1,026 697.0 13.2

An expansive fiscal policy has had the anticipated result in Venezuela, leading to economic growth of 3.2% in 2000. The bolívar has remained within a band set by the Central Bank in December 1998, underpinned by substantial petroleum receipts.

The external current account balance, which reflects oil revenues, stood at US$13.365 billion in 2000, more than double the 1999 figure, and international reserves totaled about US$21.647 billion, including US$4.551 billion for the FIEM. As a result of a moderate increase in the exchange rate, inflation continues to fall (13.2% annualized in December 2000) while wages and salaries rose about 5% in real terms. Real lending rates are approximately 14% while deposit rates are a negative 2%. As the spread between the two narrows, pressure is being exerted on the financial system, the banking sector in particular. The country’s more than 40

Public spending fell 22% in real terms in the first half of 1999 compared to the same period in 1998 as a result of fiscal adjustment. Growth in public spending in the first half of 2000 is just 13.2% in real terms as compared to the first half of 1998.

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banks are undergoing a healthy process of consolidation led by foreign-owned banks.

The economic recovery encompasses the petroleum industry and domestic industry selling goods and services to the state and, to a lesser degree, the rest of the private sector. The Caracas stock exchange, however, reflects the appreciation of national assets as oil prices rise, and has shown a spectacular recovery with 54% growth between December 1998 and December 2000, though in a context of low liquidity.

The private sector has been quite passive during this transition period, in part because of the political changes and the ongoing process of shaping structural changes. This is reflected in the modest 2.7% growth in nonoil GDP in 2000.

Preliminary data indicate that gross private investment will hover around 8% of GDP, the same as in 1999 and less than the 1998 figure of 10.3%. Private capital continues to flee the country. Steps taken by the government to restore private sector confidence include lowering the value-added tax from 16.5% to 14.5%, eliminating the tax on bank debits, maintaining the direct tax burden, and issuing regulations to open up basic telephone service to open competition, transparency and freedom of choice for users. The executive also created the Economic Policy Commission to foster participation among economic sectors. These steps have yet to be reflected in higher output, and unemployment, despite a small decrease this year, continues to be high at about 13%, generating social friction.

Figure 3 The perception of country risk remains steady at about 800 basis points

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1.9

The perception of Venezuela’s country risk is high despite a marked drop in public external debt to 19.3% of GDP in 2000 compared to 24.7% in 1998. The domestic public debt stock has grown significantly in the past two years but remains low at 6.2% of GDP. Prices for Venezuelan government bonds on international markets remain stable, with a spread of about 800 basis points compared to similar U.S. bonds.4 Rating agencies that gauge country risk place Venezuela well below investment grade,5 reflecting historical volatility in the price of oil and the current political transition. The government is preparing a swap of Brady bonds for sevenyear bonds in the amount of US$1 billion, which could take place next year. This transaction would improve the international portfolio of Venezuelan securities.

1.10

Venezuela is actively engaged in the process of globalization and has taken the lead in Central America and the Caribbean by expanding the San José Pact agreements through the Caracas Energy Agreement, doubling the region’s petroleum exports to 160,000 barrels a day. The Caracas energy agreement, signed in October 2000, calls for Venezuela to supply petroleum to the signatory countries at market prices but with payment in foreign exchange for between 75% and 95% of the total transaction, in inverse relation to oil prices; the difference may be capitalized at interest of 2% with a 15-year repayment period, or the country may opt for payment in goods and services.

1.11

Prospects for the next three years are good assuming no substantive change in the international demand for oil. Reserves are more than adequate to ensure that the exchange rate will remain within the band proposed by the government. FIEM reserves are sufficient to prevent adverse fiscal effects if oil prices fall suddenly. In this context, GDP will rise next year, likely topping 3%, thanks to recovery in the nonoil sector.

B.

Development challenges

1.12

Venezuela faces two fundamental challenges in the short, medium and long term in the current context of political, economic and social structural change. a. In the short term, the government’s challenge is to win back the confidence of the country’s private sector so it will invest in Venezuela, taking advantage of the oil bonanza and thus reactivating the economy and reducing high unemployment to maintain macroeconomic balance and social stability needed in this period of structural change and institutional strengthening.

4

The last time Venezuela sold bonds on international markets was in March 2000, when 500 million euros in 5-year bonds were sold. Total Brady bonds on the market are US$10.4 billion.

5

Moody’s rates Venezuelan long-term external debt at B2; Standard and Poors at B.

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b. In the medium and long term, Venezuela will need to diversify its productive base in order to diminish its dependence on oil in a context of macroeconomic balance, institutional strengthening, regional integration through trade agreements, and development of science and technology, in such a way as to achieve growth with equity and reduce poverty.

II. BANK OBJECTIVES, STRATEGY AND AGENDA FOR DIALOGUE A.

Objectives

2.1

The Bank’s lending program is designed to assist in Venezuela’s development plan and support the government in its medium and long-range efforts. The program focuses on four areas of intervention: social, economic, institutions, and science and technology. a. Social: The Bank will support the government in projects whose benefits include poverty reduction and human capital development, through better access to basic social services. b. Economic: The Bank will carry out projects to boost the productivity of nonoil resources in an effort to diversify the economy. c. Institutions: The Bank will support the government’s efforts to strengthen the public sector and thus improve the delivery of public services. d. Science and technology: The Bank will support the generation and use of knowledge to develop human capital and boost economic productivity.

B.

Strategy 1. Previous Bank support and portfolio review

2.2

As of 31 December 2000, the Bank’s portfolio contained 23 loans totaling US$1,972.6 million: 16 investment loans, 6 technical cooperation loans and one fast-disbursing sector loan. In addition, 44 MIF and nonreimbursable technicalcooperation operations have been approved. At this writing, 43% (US$852 million) of amounts approved has been disbursed, close to the Bank average of 42%, even though funds flows for loans to Venezuela have been negative since 1993, with the exception of 1998 when sector loans were disbursed. The Bank is Venezuela’s primary source of multilateral finance. There are no loans to the private sector or Project Preparation Facility operations.

2.3

The Bank and the government decided early this year, as a result of the emergency caused by floods and mudslides in Vargas State, to approve an emergency operation for US$20 million and reallocate loan balances of US$154 million to

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attend to the natural disaster. The details of these operations and specific problems are set forth in the portfolio review of August 2000 (document CP-1053-5). Table 2 summarizes the main problems affecting project execution, which are the subject of continuing dialogue with the authorities.

Table 2 Portfolio problems Problem Financing and timely availability of local counterpart funds

Institutional weakness of some executing agencies

Inadequate design of some operations

Manifestation There are two sides to this problem. First, on certain occasions the national authorities have resorted to financing the local counterpart contribution with treasury bond sales. Since the executing agencies in charge of processing the bonds have no access to securities markets, availability of local funds is delayed, causing problems with project execution. Furthermore, projects being executed with regional governments sometimes lack clear arrangements for transferring funds to executing agencies. Second, although counterpart funds are budgeted, they are not transferred to projects on a timely basis and in some cases are not available until fiscal year-end. This leads to delays in contracting and project execution.

The effectiveness of executing units has been affected by high staff turnover.

The units lack knowledge for effective tendering and contracting, with delays in implementation of recommendations to solve problems identified during administration missions. As to procedures, executing units tend to begin execution (contract signing, fulfillment of conditions precedent and tendering processes) sequentially, rather than in parallel to avoid unnecessary delays.

Some operations have been approved before preliminary designs are available and conditions precedent to approval are fulfilled. Nor has sufficient weight been given to the complex Venezuelan institutional environment. In some cases, then, conditions precedent to first disbursement include actions that ought to have been taken prior to project approval.

2.4

The government has taken an important step with approval of the Financial Administration and Public-Sector Control Act. This will enable the first of the above problems to be overcome by having a multiyear budget framework with global public borrowing authorizations and better coordination between programming and centralized cash management. However, since the Act will be fully implemented during the 2001 budget year, short-term measures need to be defined together with the government in order to: (i) expedite contract approval, authorization and signing; (ii) allocate global indebtedness by institution to make ministerial spending more flexible, while expenditure authorizations are synchronized with the pace of project execution; and (iii) implement a mechanism that takes into account the needs of executing units and an effective method of transferring funds in resorting to domestic debt.

2.5

The Bank also suggests that executing units be strengthened through training in tendering and contracting, financial administration procedures, and other project management-related areas, as well as through seminars as execution begins. Finally,

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the Bank will endeavor to keep conditions precedent to first disbursement to a minimum, completing an operation’s design and negotiation prior to its approval and taking advantage of this step to provide technical assistance and transfer best practices. The Bank will also assess the advisability of executing some operations in stages, linking disbursements to specific targets.

2.6

In view of the foregoing, the portfolio is considered to be in a process of adjustment and review. The Bank will focus on operations in the last stage of execution, to see them concluded, and on addressing the new country-program priorities. Another set of operations exhibits low execution levels and should be cancelled because their objectives are no longer priorities. The final objective is to adjust the portfolio, to the extent possible, to the government’s development objectives, as well as lowering costs and optimizing the use of funds through planning in accordance with execution capacity.

2. Major strategic areas

2.7

The Bank’s four strategic action areas for operations are listed below (see also the summary in Table 3). a. Social: poverty reduction and human capital development

2.8

Issues: Lack of equity in income and wealth distribution—combined with inefficiencies in the public and private sectors and inadequate and excessively geographically concentrated public resources—places large numbers of people in a difficult situation with deficient access to the social safety net (education, health care, housing, etc.). Although there is a positive correlation between economic growth and poverty reduction by virtue of increased employment, a capitalintensive oil sector and less than effective public policies have not been able to prevent an alarming poverty rate – proof that the majority have not gained from the oil bonanza.

2.9

In the area of education, performance indicators are low and insufficient attention is given to comprehensive child development. The national employment training system is weak and has not brought enough young people into the labor market.

Low performance indicators are observable also in the health care sector, where problems are exacerbated because the ministry continues to undergo restructuring to strengthen its role as policy and rule maker and grant more powers to the regions.

Low-income housing is insufficient, a situation complicated by an underdeveloped mortgage market and the lack of adequate titling and public utility delivery systems.

2.10

Objectives: The Bank’s participation in support of government programs will be designed to: a. Improve targeting of social programs to vulnerable and low-income groups, thus helping to mitigate poverty.

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b. Strengthen basic education, including by developing preschool programs, to develop human capital and raise projected income. c. Collaborate on the design of a new health care model and strengthen new sector institutions. d. Continue supporting the housing sector by helping to implement new legislation governing the financing of low-income housing.

2.11

Current actions: The Local Social Investment Program (loan 658/OC) reinforcing state and municipal social investment programs has concluded, and the Civil Society Support Program (1045/OC) now being financed strengthens civil society’s role in providing social services at the local level. In education, a program is being carried out to strengthen basic education (1220/OC) by renovating schools and training teachers. In health care, the Health Sector Strengthening and Modernization Program (867/OC) now in execution supports the ministry’s restructuring and institutional strengthening and decentralization of services to the states. Also approved was a sector loan (1098/OC) accompanied by technical cooperation (1097/OC) to reform the social security system by clearly separating health care, pension, and unemployment programs. The second and third tranches of the sector loan have been cancelled, since the government is examining a new system reform. A pilot program of housing solutions for low-income households (928/OC) is under way.

2.12

Proposed actions: a. Support for creation of a social safety net based on the Single Social Fund with an adequate transition of actions under the Bolívar 2000 program. Financing for a Social Investment Fund (US$100 million) is being planned to finance smallscale works in response to emergency needs identified by the community, as well as to provide direct and indirect employment to help reduce poverty. A US$30 million program of support for children and youth was approved in late December 2000. b. In the education sector, the system’s management needs to be strengthened through a management and administration approach that focuses on the needs and problems of each locality and works with schools, families and local communities. The Basic Education, Phase II, and Preschool Program (US$125 million) will continue to strengthen basic education under the loan in execution, and will support increasing preschool coverage to achieve the aim of giving each child at least one year of preschool education. Consideration will be given to supporting the use of new information technology in the school system and evaluating the possibility of setting up nontraditional preschool systems.

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c. In the health care sector, the operation in execution will be reviewed to define options for reformulating the program to address new requirements. In connection with social security, technical cooperation will continue and, once the government defines a model, another loan will be considered for its implementation. d. In housing, the first stage of the pilot program of low-income housing is being evaluated, and a second stage (PROVIS II, US$120 million) will take in more states and include a slum improvement subprogram. b. Economic: Boosting productivity and diversifying output 2.13

Issues: Venezuela’s economic growth is built on the petroleum industry, even though the country has a rich and varied natural-resource endowment. However, a number of factors are hindering sustainable development:

2.14

The country’s physical infrastructure problems have to do mainly with: (i) regulatory, institutional, and legal frameworks that are weak, if they exist at all (transportation sector); (ii) an incentives structure that does not spur efficient service delivery; the result has been poor quality and coverage (water and sanitation); (iii) not enough financing for maintenance or new capital outlays (transportation, water and sanitation, electricity); and (iv) scant private-sector involvement in service delivery.

2.15

The agriculture sector has enormous potential as a source of foreign-exchange earnings and saving, and as a way of increasing employment, improving production possibilities in rural areas, and contributing to the nation’s food supply. But a history of fluctuations in real exchange rates, frequent policy changes, and meager private investment have held this sector back. Priority areas of concern here are: (i) land tenure regularization; (ii) lags in agricultural health areas and agricultural research, and the absence of a secure, autonomous financing base for these subsystems’ fundamental operations; and (iii) deteriorating irrigation and land drainage systems, which are not being well operated or maintained because farmers are not duly organized for that purpose.

2.16

The financial sector has rallied from the mid-1990s crisis thanks largely to the entry of foreign-owned banks and insurance companies. Nevertheless, an evaluation would need to be done of current conditions in the sector. There are weak points in securities and insurance market regulation and supervision, and continuing efforts are needed to bolster bank oversight, complete the liquidation of assets accumulated during the financial crisis, and review the deposit insurance scheme.

2.17

Even with constructive institutions and legislation, progress in the environmental sector has been hampered by: (i) the need for the Ministry to operate more

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efficiently and focus its work; (ii) discharges of raw industrial and household sewage; (iii) inefficient solid-waste collection and disposal systems; (iv) pollution in urban areas; (v) the country’s acute vulnerability to natural disasters, and (vi) inadequate land use (deforestation, degradation).

2.18

Objectives: a. Support the development of three key infrastructure sectors: transportation, electricity, and water and sanitation. In the transport sector, the Bank will support central government and regional institution-strengthening, along with investment projects to rehabilitate roads and improve urban transit. The Bank could assist in the design of regulatory schemes and implementation of new laws on concessions and delivery of water and sanitation services. Concurrent support would be provided for reviews of cost and tariff systems, in order to put more efficient subsidy arrangements in place. Consideration also would be given to the demarcation of responsibilities among the different levels of government and to infrastructure-rehabilitation project financing, if there were assurances of long-range sustainability and of user involvement in the services, wherever possible by intermediary of institutionally and financially autonomous operating companies. b. Support agricultural development through low-cost standalone projects, in light of experience to date in this sector where ambitious large-scale, multi-objective projects have proved difficult to implement. Focuses of interest here are: (i) institutional strengthening of the Ministry of Production and Trade; (ii) design and implementation of policies to promote efficient agriculture and improve the agrifood trade balance, drawing on competitive advantages; (iii) support for regional and local rural development that creates jobs; (iv) regularizing land tenure; (v) sustainable support for agricultural research, animal health and plant protection; and (vi) transfer of ownership of small irrigation systems to users, and transfer of management of mid-sized systems to their users, including rehabilitation of the systems in a framework of support for production chains. c. Continue the process of financial-market strengthening and modernization by supporting efforts to improve the regulation and oversight of financial, insurance, and securities market operations. There also would be a need to explore the creation and use of financial instruments that can broaden access to financing and help achieve sustainable economic growth. d. Foster environmental management by way of economic and market instruments, and equip the Environment Ministry to administer and enforce its environmental regulations more efficiently. Another aim is to boost investment in natural-resources management, pollution control, and environmental protection programs. Specific issues of interest are: (i) financing for productive forestry and native-forest management projects; (ii) support for watershed management

- 13 -

projects, focusing particularly on strategic watersheds like the Caroní River basin; (iii) development of toxic and hazardous waste management and disposal systems; and (iv) technical assistance to the Ministry so it can concentrate and optimize its environmental quality control work.

2.19

Current actions: The Bank has supported a variety of infrastructure improvement operations. At present it is funding expansion of electric power generation and the industry’s regulatory framework through the Caruachi hydroelectric plant program (788/OC). It is assisting in the institutional strengthening of the Transportation Ministry and rehabilitation of the national road network and bridges (732/OC) and urban transit improvements (818/OC). In the water and sanitation sector, the Bank’s support for modernization and rehabilitation is taking the form of a project to help establish a regulatory framework and rehabilitate production and distribution systems in the state of Lara (994/OC). In the agriculture sector, it has been helping to fund production infrastructure through two operations (692/OC and 696/OC) that were reformulated recently to speed up their execution. The Bank is supporting the finance sector by way of a technical-cooperation loan (893/OC) to restructure agencies in charge of financial oversight, deposit insurance, and the system’s stability.

2.20

Proposed actions: In the infrastructure area, funding would be provided to support the reorganization of the water and sanitation sector, with the aim of segregating policy and regulatory functions—which would fall to the national government— from delivery of these services, which would become a municipal responsibility. In the transport sector, the Bank would finance new stages in the National Roads Program and the National Urban Transportation Program once the ongoing programs have been completed and evaluated. The Andean Development Corporation (CAF) plans to finance Line 4 of the Caracas subway system. The Bank has no specific electricity-sector operations planned; the above-mentioned objectives could be pursued using unexpended resources from prior approvals for the sector. The World Bank is expected to approve technical cooperation in 2002 to support reforms in the electric power industry, and the CAF plans to finance transmission lines of Electrificación del Caroní (EDELCA).

2.21

The following agriculture-sector operations are envisaged: (i) rehabilitation of midsized irrigation and land drainage systems (US$100 million), to rehabilitate irrigated acreage, help transfer the systems’ operation and maintenance to their users, and do a preliminary study of expansion options to pursue national targets in this area; (ii) food security, policy and technology management (US$40 million), to support the financial sustainability of the agencies in charge of those areas, leave them fully equipped, boost agricultural productivity, facilitate exports, and improve food quality; (iii) consolidation of rural communities (US$10 million), to attract investment in production chains associated with rehabilitation of small Andean irrigation systems, and improve environmental sustainability (operation approved in

- 14 -

December 2000); and (iv) regularization of land tenure and registration (US$80 million), to regularize rural land tenure.

2.22

In the financial sector, the Bank would afford support for small and mid-sized enterprises through a line of credit as part of a multisector global credit program, with a single second-tier institution as intermediary. Support for microenterprises would be included in the technical-cooperation loan currently being executed to strengthen the financial sector, as a component to assist in the coordination of government-owned banks. As for the credit component, consideration could be given to a global microenterprise credit program operated through a second-story bank. The government also would explore possible IIC and MIF support in this area.

2.23

In the environmental protection sector, the Bank would finance an operation to regulate Lake Valencia water levels, in light of the water being imported from other watersheds via the central region water supply system. The CAF might cofinance the project funded by the Bank’s loan. The viability of other activities would be examined, based on the above-described objectives, when the government had confirmed that they were priorities. c. Institutional: Public sector institution-strengthening

2.24

Issues: Historically, the country’s enormous oil revenues have gone to waste owing to ineffective public-sector management. The treasury is fragile, in part because its receipts are so dependent on oil prices and thus can zigzag (oil revenues make up about half of aggregate central government revenues). The result of weak fiscalmanagement institutions and the rigid budgeting system in place has been inefficient resource management and, generally, a public sector in need of better fiscal management along with improvements in the areas of justice and public safety.

2.25

Moreover, in transfers of political and administrative functions and resources from the national government to states and municipalities, the guiding criterion has been population size. As a result, the divide between some parts of the country and others has become more pronounced. The concentration of investment outlays, a weak government presence, and serious infrastructure gaps have kept the country from tapping the huge potential of vast expanses of land, and in the process have kept private investors at a distance. This same concentration has pointed up the considerable differences in institutional development between states and municipalities, and in the level of public services each is delivering.

2.26

Objectives: To work with the government on programs to promote more efficient use of public funds, pursuing institutional and structural improvements in three mutually complementary action areas. The first is to improve financial management in the central government and build the groundwork for a flexible budgeting

- 15 -

system. The second is to support the revamping of the public sector apparatus by streamlining institutions, giving specialized agencies more financial autonomy, and strengthening management capacity in government, notably in the social sectors.

The third aim is to support government efforts to improve the justice system and public safety. Supplementing these efforts would be actions at the regional and local levels to give the citizenry a stronger say in decision-making and make for more efficient use of the funds managed by local and regional governments.

2.27

Current actions: A number of operations being funded by the Bank have launched the process of reforming the State. The Bank is supporting institutional strengthening of the national tax authority (942/OC-VE) to boost nonoil treasury revenues. Financing also was provided to set up a Programming and Macroeconomic Analysis Office in the Ministry of Finance and an Economic and Financial Advisory Office in the National Assembly (945/OC-VE). Another approved operation (1145/OC-VE) will improve fiscal statistics. The aim of all these programs is to strengthen macroeconomic and fiscal analysis. A sector loan approved in late 1998 helped create the Macroeconomic Stabilization Fund to cushion the effects of volatile oil prices on the public finances, and supported plans for tax reform and trimming of the State apparatus. An in-house Bank study evaluated the efficiency of public spending in recent years. The World Bank is helping to set up an integrated public-sector management system that will complement the fiscal-management enhancement activities.

2.28

There are provisions in some projects in the portfolio to involve states and municipalities directly in the projects’ execution. One feature of the health, basic education, and water and sanitation programs currently under way is the prominent role of states and municipalities. The Bank also approved a loan for a pilot program for decentralization and modernization of government operations (1101/OC-VE), which promotes private-sector participation in the states.

2.29

Proposed actions: One operation in pursuit of the strategy is the second stage of a preinvestment loan (US$15 million), one component of which would enhance the public investment system. The Bank also would support the restructuring of the Ministry of Finance (US$20 million), a key piece in improving programming and resource use, underpinned by the new Financial Management Act. With respect to government services, there are plans for a US$100 million justice system reform operation to aid in the transition to the model enshrined in the new code of criminal procedure, which might be approved in 2000, and a loan to improve citizen security and civic coexistence (US$30 million). A salient consideration here is that a series of operations currently under way, as well as future loans, are being restructured or designed with major institution-strengthening components for ministries, states, municipalities, and executing units.

- 16 -

d. Science and technology: Knowledge creation and use 2.30

Issues: It is by now a commonplace that support for science and technology is one of the most powerful engines of human development and economic progress.

Though Venezuela has one of the region’s largest human-resources pools in this field, Latin America is falling far behind as science and technology advances, leaving it ill-equipped to compete successfully in the global marketplace with highvalue-added goods and services. This is a cross-cutting issue that is hindering efficiency and productivity everywhere in the economy.

2.31

Objectives: To strengthen institutions that create and transfer knowledge and know-how, gear their operations to effectively tackle development problems, and spur technological innovation by giving the entrepreneurial community access to the services and financing it needs. A specific target for strengthening would be the nonuniversity technical higher education system, to make that system’s institutions more universally accessible, improve the quality of their offerings, and make their program content more relevant.

2.32

Current actions: The Science and Technology Program has come to a successful end. A loan has been signed for the program’s second phase, which is slated to begin before the end of 2000. This program aims to strengthen the national innovation system by funding research and development (R&D) and information projects and others to strengthen thematic networks, training researchers, supporting R&D and technology service centers, fostering innovation in the productive sectors, and disseminating and popularizing science and technology.

2.33

Proposed actions: In response to a Venezuelan initiative, the Bank would fund an information technology program (US$10 million) under its new “innovation loan” modality. The operation would be coordinated with the other four Andean countries so similar loans can be funded to put together an Andean regional program. In the field of higher education specifically, financing would be provided to restructure nonuniversity technical education by way of a technology institutes program (US$60 million). The World Bank is expected to approve an operation in this same area in 2002, so the Bank would coordinate with that agency.

Government action • • • • •

– 17 –

The Bank’s strategy Design of a new social safety net Basic education: community participation and management Higher education: support for nonuniversity technical education Review of health portfolio Low-income housing: evaluation of the first stage and expansion, perhaps including slum improvement

Bank actions • Social Investment Fund • Support for children and youth • Basic education II and preschool education • PROVIS II • Studies • Youth training

Table 3 Summary of the Bank’s operational strategy focuses Other multilateral agencies

Social: Poverty reduction and human capital development World Bank: • Higher education • Health (Caracas)

• Consolidation of the social safety net and creation of a Single Social Fund • Bolívar 2000 Program • Support for children and youth

• • • • • • • •

• Support for development of infrastructure sector frameworks. Evaluation of transport sector operations.

Reform of water sector • Development of agriculture with standalone projects: strengthening the Ministry; land tenure regularization; competitive agriculture and production chains; animal health, plant protection and agricultural technology; transfer of irrigation systems

Economic: Boosting productivity and enhancing competitiveness of nonoil resources World Bank: • TC for electricity sector reform • Study: Urban transit • CAF: EDELCA transmission lines • Los Teques and Mérida subway • Lake Valencia water level regulation • Preinvestment in western region

New electric industry law New concessions law New gas industry law New mining law New procurement/tendering law New law to promote domestic and foreign investment Initiatives to promote nontraditional exports Reciprocal-guarantee law for small and mid-sized enterprises (SMEs)

• Reorganization of water and sanitation sector • Urban transport II • Roads IV • Rehabilitation of mid-sized irrigation and land drainage systems • Food security, policy, and technology management • Consolidation of rural communities • Land tenure regularization and registration • Agrifood management • Multisector credit

Performance indicator

• Public spending in each social subsector as a percentage of GDP • Methods developed and applied for measuring efficiency of social spending • Improvements in quality and coverage of social service delivery • Studies produced

•

•

•

•

•

Approval of laws/regulations for sector reforms, creating an enabling environment for privatesector participation Increase in private management of public utilities Percentage of land reclaimed for agriculture Number of regularized properties Number of credits approved for microenterprises and SMEs

Government action

– 18 –

Performance indicator

• Measurement of Lake Valencia water regulation • Studies produced

Bank actions • Lake Valencia water level regulation • Studies

• Increase in central government nonoil revenues • Approval of legislation reforming public borrowing and budgeting • Introduction of a new budget approval system • Reduction in size of the public sector • Decline in violent crimes; more frequent penalization

The Bank’s strategy

Table 3 Summary of the Bank’s operational strategy focuses Other multilateral agencies • Financial market modernization and enhanced credit access for underserved sectors • Promotion of economic instruments for environmental protection. Strengthening the Ministry

• Preinvestment II • Restructuring of Ministry of Finance • Judicial system reform • Public safety, civic coexistence • Studies

• Changes in public and private spending on science and technology

• New central-government organization law • New financial management law • New FIEM law • Tax reform • Formation of technical team to support the reform

Institutional: Improving performance in government operations World Bank: • Study on “Fiscal adjustment and sustainable development” • Fiscal Information System (SIGECOF, phase II)

• Improved government financial management: bring in a sound budget system and tax code • Public sector reform: a new, more functional structure, with efficient expenditure allocation criteria • Support initiatives to improve justice administration and public safety • Regional and local support

• Information technology • Technology institutes

• Support for the recently signed program and new initiatives

Science and technology: Knowledge creation and use World Bank: • Millennium Science initiative

• Define as a strategic area for development

2.34

2.35

2.36

3. Coordination of private-sector instruments

Annex Page 1 of 31

The Bank looks to its private-sector window (PRI) along with resources of the Multilateral Investment Fund (MIF) and Inter-American Investment Corporation (IIC) to promote private investment in Venezuela. The PRI window is currently exploring the possibility of funding operations to improve piped water service, and is awaiting that sector’s reorganization, associated with a possible Bank operation. The MIF is actively involved by way of its three windows. It approved three operations in 1999 and one in 2000; a further eight are expected to be approved by the end of 2001 (see annex). As for the IIC, apart from its traditional financing facilities it is specifically seeking out projects with small and medium-sized enterprises in Zulia, with local financial institutions as intermediaries.

4. World Bank and CAF participation in development projects in Venezuela

The CAF is very active in Venezuela. Most of its funding is for infrastructure projects, among them Line 4 of the subway system, the EDELCA transmission line and, in the transportation area, a technical-cooperation program for the Orinoco-Apure corridor. The World Bank is operating or developing a health program for Caracas, a Millennium Science initiative project, and an energy rehabilitation program.

5. Financial projections and lending scenarios

Projections run from present operations and the tentative lending program (see annex) show negative net funds flows in the 2000-2003 period.

The low-lending-scenario simulation in Table 4 posits implementing-capacity weaknesses on the government’s part. The base-case scenario assumes a lending program averaging US$565 million in approvals each year; in the low scenario the average is US$325 million a year.

Annex Page 2 of 31

Approvals Repayments of which loans from 2000 onward Disbursements of which loans from 2000 onward nterest and sundry charges of which loans from 2000 onward Net flow Cash flow

Table 4 Financial projections (millions of U.S. dollars)

1999

2000

2001 670.0 114.8 0.0 162.0 67.0 195.5 7.3 47.2 -148.3

2002 595.0 183.5 0.0 197.6 167.6 212.7 21.3 14.0 -198.7

2003

Base-case scenario

100.0 105.1

425.0 111.8 0.0 188.0 7.0 169.0 0.7 76.2 -92.8

139.0

187.7

50.0 120.7 0.0 200.0 0.0 149.3 0.0 79.3 -70.0

82.6 -56.4

1999

2000

2001

350.0 114.8 0.0 138.9 43.9 193.1 4.9 24.1 -169.0

2002

360.0 183.5 0.0 128.0 98.0 204.3 12.8 -55.5 -259.8

2003

Low scenario

100.0 105.1

260.0 111.8 0.0 188.0 7.0 169.0 0.7 76.2 -92.8 139.0

187.7

50.0 120.7 0.0 200.0 0.0 149.3 0.0 79.3 -70.0 82.6 -56.4

b. The possibility that it might take longer than expected for new staff of executing agencies to adapt.

a. An institutional risk associated with the restructuring of the Venezuelan government apparatus.

Two risks that could impede implementation of the Bank’s operational strategy are:

6. Risks

An important consideration here is that, in any lending scenario, Venezuela’s exposure ratio remains below the parameters established by the Bank.

Source: Inter-American Development Bank

2.37

2.38

2.39

The key to countering the first risk will be a policy dialogue with the government underscoring the importance of coordinating every facet of the Bank’s operation. To mitigate the second risk a series of seminars on project execution and Bank procedures will be organized, with active participation of the Bank’s Venezuela Country Office, for new executing-agency staff.

2.40

Agenda for a country dialogue

The Bank’s core strategy objectives look to the medium and long term. Progress toward objectives will be assessed through annual programming and portfolio review missions, backed by specific administration missions for each project and supported by the Bank’s Country Office in Venezuela. Progress will be measured by reference to general benchmarks set out in the strategy matrix, and project-specific benchmarks outlined in the respective loan documents.

Annex Page 3 of 31

C.

7. Monitoring

2.41

The country dialogue should center on two interrelated issues. The first is the need to continue working toward a solution to problems that are common to loans in execution, and those that are project-specific. The second is the need to tailor the dialogue on future operations to the strategy outlined herein and to address, in that dialogue, problems and solutions that come out of the portfolio review, since the Bank has approved loans in virtually every one of the action areas. Table 5 summarizes key items for a dialogue with the authorities over the next few years.

Strategy area

Annex Page 4 of 31

Portfolio

Social: Poverty reduction and human capital development, including science and technology

Economic: Boosting productivity and enhancing competitiveness of nonoil resources

Institutional: Improving performance in government operations

•

• • • • • • • • • • • • • • • • • •

Table 5 Country dialogue agenda Discussion points Continue portfolio reviews and seek solutions at two levels: (i) project-specific, including preparation of a loan (US$125 million) to remedy damage caused by torrential rains and landslides in the wake of the late-1999 Vargas disaster, and (ii) cross-cutting, affecting approval and execution of all loans.

Participation and coordination with country authorities to have the new Financial Administration and Public-sector Control Act yield the maximum possible benefit.

Preparation of seminars, with active Country Office involvement, for executingagency staff.

Dovetail government initiatives (Single Social Fund, Bolívar Program 2000) with design of a Social Investment Fund.

Underscore the need to execute loan 779/OC efficiently, to continue supporting decentralization of basic education, before approving a new operation.

Chart the future of the social security system and Bank support through the TC approved in 1998.

Review the health-sector loan (867/OC) to make better use of approved funds.

Evaluate the first stage of the national low-income housing program and discuss ways of making government priorities compatible in a possible second stage.

Evaluate the experience gained in the youth training program, to prepare a second phase.

Review of transport, electricity, and water sector frameworks.

Monitoring of policies the government is currently pursuing to spur private-sector involvement.

Joint review of roads and urban transit loans in execution; discuss ways to make government priorities compatible in possible second stages.

Support action in the agriculture sector to improve and expand production-chain processes.

Support strengthening of bank oversight and consolidation and rationalization of second-tier banking.

Support moves to make more financing available to microenterprises and SMEs. Dialogue on implementing environmental monitoring and protection mechanisms, and institutional support.

Emphasize importance and need to continue implementing reforms to leave the treasury less vulnerable, particularly to oil price volatility.

Support improvements in central government financial management through budget reform. The Bank can draw on experience with operations in other countries.

The new Financial Administration Act will need to be duly implemented in order to

Strategy area

Science and technology

• • • • • •

Discussion points expedite the process of approving and disbursing operations.

Need for more efficient public spending, streamlining of the government apparatus and training.

Assess the Ministry of Planning and Development’s need for support to strengthen its multilateral loans office and an investment system.

Assist in efforts to improve the justice system and public safety. The Bank can draw on experience with operations in other countries.

Coordinate monitoring of the recently approved operation.

Coordinate with the Andean countries to prepare information technology operations.

Support startup of the science and technology loan approved in 1999 and draw on that experience to design new activities.

Annex Page 5 of 31

Title

US$ mill No.

D.

US$ mill VE-0057

No.

Preinvestment loan

Justice system reform

30

15

100

US$ mill

VE-n/n

No.

Title

US$ mill

60

60

10

10

Technology institutes project

Information technology program

Science and technology: Knowledge creation and use

20

VE-0129

Public safety and civic coexistence

Title

10

VE-0115

Subtotal

40

145

VE-0046

Subtotal

20

Subtotal

70

Restructuring of Ministry of Finance

20

VE-0117 100 125 25 50 200 100 100 200 20 1,000

Subtotal

80

Institutional: Performance improvements in government operations

Lending program 2000-2003

Lake Valencia water level regulation Remedying of landslide damage Reorganization of water and sanitation sector Solid waste management National roads program National urban transportation program Rehabilitation of midsized irrigation and land drainage systems Multisector global credit program Transport sector study

Land tenure regularization and registration

Emergency caused by torrential rains, mudslides and flooding (approved) Consolidation of rural communities Food security, policy, and technology management

Title

Economic: Boosting productivity and enhancing competitiveness of nonoil resources

No. VE-0122 VE-0126

Subtotal

100

250

VE-0136 Subtotal

VE-0135

VE-0124

VE-0134

VE-0132 VE-0133

VE-0131

VE-0123

VE-0079

VE-0127

185

60

125

VE-0125

30

Basic education II and preschool education program Youth training program

120

Program of support for children and youth

VE-n/n VE-0114 Subtotal VE-0138

VE-0137

Social investment fund PROVIS II. Lowincome housing program

VE-0120

Social: Poverty reduction and human capital development

Annex Page 6 of 31

Year

20002001

2002-

2003

Subtotal

Total US$ million

475

1,265

–7–

Multilateral Investment Fund program 2000-2001 Estimated approval Project title / Window date Integrated services for Zulia entrepreneurs (TC-99-12-00-3) I Industrial restructuring in Guayana (TC-96-09-44-9) II and III Development of industrial incubators in Mérida (TC-98-06-33-4) IIIa Development of industrial incubators in Aragua (TC-98-09-23-9) IIIa Venture capital fund for SME support Operational development of reciprocal-guarantee companies Development of new exporter consortia Virtual business city

Amount (US$)

December 2000

600,000

2001

800,000

2001

1.1 million

2001

1.5 million

2001

3.0 million

2001

--

2001 2001

-1.3 million

Inter-American Investment Corporation program 2000-2002 Project title Operation in the state of Zulia

Amount (US$) 10 million

Private-sector window program 2000-2002 Project title Aguas de Matícora

List of studies and seminars 2000-2002 Study: Transportation sector analysis Study: Modernization of irrigation systems Study: Update of the state of the financial sector Study: Rural finance schemes Study: The state of technology institutes Study: Tourism industry potential Seminar on Bank procedures Seminar for state employees

Amount (US$) 137 million