Situation in Venezuela

Citigroup Global Markets
July 2003

We are optimistic that a political resolution to the conflict will ultimately be found. The path toward a political resolution is likely to be turbulent and at some point asset prices are likely to take a hit. However, we are confident that Venezuela's debt service capacity will remain sound throughout potential periods of political turbulence.
We have more confidence in our ability to forecast a political resolution than in our ability to estimate the timing and magnitude of the political and social turbulence. For these reasons, we remain overweight on Venezuelan debt.

Can Chavez Avoid a Referendum and Win? Recent polls indicate that 65% of Venezuelans believe that President Chavez will attempt to obstruct a recall referendum on his presidency.

This begs the question can Chavez avoid a referendum and still remain in power? To block the referendum and to remain in power for an extended period of time Chavez would need to accomplish three objectives, which most successful authoritarians in modern history have achieved:

1. Control a military apparatus that is willing to support a blatant violation of the constitution and use repression to intimidate and break opposition forces.
The Venezuelan armed forces have not given any
indication that they are willing to engage in such activities. Small, armed groups have attempted (unsuccessfully)
to intimidate opposition forces.

The Chavez government, sensitive to the illegitimacy of these paramilitary forces, claims that it has no control over these groups. These armed groups have not been able to effectively intimidate Venezuelan mass mobilizations.

2. A talented team capable of either delivering a level of economic performance to maintain a critical level of support and/or a sophisticated network capable of penetrating society to detect and control descent.
Chavez's team has been completely incapable of either.

3. The destruction of opposition forces. In Venezuela the opposition suffers from organizational problems but it is vibrant and active. The media remains a strong and relentless force of opposition. Business elites are fully involved in the opposition movement. Opposition political parties and civic organizations are active and working to bring about political change. Most importantly, large segments of society have demonstrated their willingness to take to the streets against Chavez. The mass opposition in society are frustrated and fatigued from failed protests late last year and early this year. However, if they are given reason to mobilize again, for
example if they are denied their constitutional right to vote, they will take to the streets again. The military was willing to stand by Chavez during the strike earlier this year. But by defending the president the
military was also acting in defense of the constitution. If Chavez blocks the referendum, the military would confront a very different set of circumstances. The domestic groundswell of opposition would likely receive support from the United States and the Group of Friends in defense of constitutionality-pressures the military would probably find difficult to ignore. The Opposition is not an Obstacle to a Solution We continue to believe that disorganization in the opposition will not be an impediment to an eventual opposition victory.

There are clearly splits in the opposition, but they are less related to ideological differences and more related to several individuals having presidential aspirations, and are therefore not difficult to overcome.
Should the opposition need to face Chavez in an election, at this point here are really only two serious candidates-Enrique Mendoza, governor of the state of Miranda and head of the umbrella opposition group known as the Coordinadora Democratica (CD), and Henrique Salas Romer, former governor of Carabobo and former presidential candidate in 1998. There is deep concern in Venezuela and abroad that the opposition will launch more than one candidate, enabling Chavez to win. Such an outcome is highly unlikely. Both men are very aware that Chavez would likely win an election with more than one opposition candidate. Mendoza and Salas Romer are intelligent and experienced and are likely to behave like politicians. It will not be in either man's interest to split the opposition vote and hand victory over to
Chavez. They will wait for the appropriate time to maximize their bargaining power, and then strike a deal and fall behind one candidate.

For now Salas Romer's strategy is to try to increase his popularity by attempting to appeal to the segment of society that is dissatisfied with both the CD and Chavez. He will leave the campaign for the referendum to
others and will distance himself from other opposition groups. He will seek to enhance his support by portraying the CD as incompetent and divided.

Enrique Mendoza's strategy is very different, Rather than explicitly positioning himself as a presidential candidate, he will work within the confines of the CD and pursue a two-pronged strategy:

I. First, he is working on a campaign to encourage the referendum. The campaign strategy involves a step-by-step process. The first step is to campaign for the creation of a national electoral council (CNE). The second
step is to deliver the signatures to the CNE on August 20 and campaign for the signatures to be validated (or invalidated) within the 30 day period established by the electoral law and a referendum to be held within 90 days
of receipt of the signatures (meaning that according to the
electoral law, a referendum should occur no later than November 20 assuming the signatures are valid). The third step is to campaign for the"Si"vote, the resignation of the President.

II. Second, he is working on a governability project that includes a detailed economic development an anti-poverty program. Many of Venezuela's major universities are working on the project.His idea,and the idea of
most of the CD, is that the next president and political parties who sign onto the pact will be bound by the governability project. The idea is to both put together a successful government and economic program as well as
limit the importance of which individual is the opposition candidate.

Chavez's Strategy will be shaped by the CNE political actors recognize the great importance of the electoral council(CNE), which is probably the reason why creating it has been such a long and difficult process. Chavez's
range of strategies to deal with the recall referendum is likely to be shaped by the kind of CNE that is appointed. An independent CNE would eliminate Chavez's ability to delay the Referendum by using subtle, "legalistic" tactics.

He would be forced into one of three strategies:

i) Accept the recall referendum on his residency,

ii) Negotiate a mega-referendum on the presidency, governors
and mayors or:

iii) Resort to extreme and blatant strategies such as declaring a state of emergency) to avoid the referendum.

If he chooses an extreme strategy, hundreds of thousands of people could take to the streets. In contrast to the protests that occurred during the November 2002 through February 2003 period, it would be clear to the world
which side would hold the moral authority. The US government and the Group of Friends would be presented with a clear opportunity to condemn the Chavez government for obstructing the most basic constitutional and democratic
guarantee, -the right to vote. While many Venezuelans and analysts base their views on the oil strike and believe that the military would chose to defend Chavez over the constitution, we believe that the overwhelming majority in the military would, in the face of domestic and international pressure, defend the constitution.

Since the events of April 11, 2002 Venezuelan society and the armed forces have been told in blunt terms that the United States would not accept anything other than a constitutional resolution to the conflict.
The incentives of the military would likely change if the United States backed the protestors' defense of democracy. If Chavez exerts control over the CNE his capacity to delay would be enhanced. It might be more difficult for the opposition and the international community to point out a clear violation of democracy. Nevertheless, the capacity to avoid a referendum would still be constrained by monitors, both domestic Sumate) and international (the Carter Center and representatives from the OAS), who will be present to judge the validity of the work of the CNE. A biased CNE would probably enable Chavez to delay a political
solution, but not avoid.

A transformation of society:

Hope for the future.
Over the past five years, there has been a transformation of Venezuelan society that will make it less tolerant of ineffective or authoritarian governments.
The transformation is a direct result of the crisis that has occurred during the Chavez presidency.
Ironically, most Venezuelans and therefore most investors are so focused on the current political crisis that they are unaware of positive changes that have occurred in society.

First, Venezuelan society has learned to organize itself rather than being organized from the top down. Civic organizations, which had traditionally been controlled by political parties,are now independent.

One in particular (Sumate) has developed sophisticated methods to gather signatures for the recall referendum and monitor the electoral process.

Society is far more prepared today than ever before in its 45-year history of democracy to resist abuses of power.

Second, for most of Venezuela's democratic experience, society did not take an interest in politics. Decisions were left to the government with little influence or oversight from society. Gross mismanagement was the result.

Today almost all Venezuelans are focused on politics. As a consequence, society is far less likely to tolerate mismanagement or abuses by government authorities.

Third, in 1998 almost all Venezuelans were in search of a savior, a messianic leader. Society was willing to sacrifice all checks and balances and endow their savior with great powers. Venezuelans have learned a lesson and will be much less willing to vote for self-proclaimed saviors. The next president will probably be required to take a more inclusive approach and seek to create a broad based coalition. Checks and balances on Presidential power will likely be quickly imposed.

Fourth, the private sector understands that high poverty rates led to political instability and the resulting economic collapse.
They believe that poverty is among the most pressing problems in the country. The private sector will pressure politicians that future economic programs must directly address this problem.