Analysis - Chavez seeks to contain voter angst over economy

CARACAS (Reuters) - Venezuela's economy is plagued by shortages, high inflation and crippling currency controls, but a massive spending spree by President Hugo Chavez will likely keep an incipient recovery alive, at least until a 2012 vote.

Polls show support for the charismatic leftist leader has edged up since he announced in June he had cancer. But unless he can generate as much sympathy for his economic stewardship, his re-election bid could be at risk.

In the short term, Chavez can paper over underlying problems with subsidies, price controls and ramped-up spending on his flagship health and housing programs for the poor.

But eventually, falling oil production by the OPEC nation combined with mounting debt will make it harder to finance his socialist "revolution," analysts say, leading to sub-par growth and possibly another painful currency devaluation.

"We expect Venezuelan growth to lag behind the rest of Latin America over the coming years," said David Rees, emerging markets economist at Capital Economics in London.

"Of course Chavez, current health concerns aside, will try to pump the economy ahead of next year's presidential election with strong government spending."

Venezuela has the world's largest oil reserves, according to OPEC. Yet it was the last in Latin America to pull out of recession, returning to growth in the fourth quarter of 2010.

The recovery advanced at a healthy clip in the first half of this year and is on track for 4.5 percent annual growth, the U.N.'s regional economic body ECLAC predicts.

High oil prices and public spending are powering the expansion. Since taking office in 1999, Chavez has nationalized large swaths of the economy, scaring off foreign investors and slowing domestic manufacturing, farm and even oil production as companies are reluctant to bet on new projects.

The 57-year-old former soldier's illness has slowed him, but he has made an effort to show he remains in charge, displaying his characteristic flair during regular phone calls to state television programs. He has undergone two chemotherapy sessions in Cuba as Fidel Castro's guest and says he is recovering well.

Oil prices may continue to work in Chavez's favour, rallying since a sharp sell-off last week over the U.S. and European debt crises and fears of another global downturn.

"Even if we see a Lehmann-style sell-off like we saw in 2008 ... as long as oil stays above $70 (42.69 pounds) a barrel, they're in pretty good shape," said Russ Dallen, head of Caracas Capital Markets.

"IT'S BUYING TIME"

Perhaps the biggest wrench in the economy is the mind-boggling set of rules limiting the amount of foreign currency businesses can obtain. The result is a dollar drought that hangs like a curse over a country that imports 90 percent of its needs and where basic items like milk and cooking oil are in short supply.

Annual inflation hit 25.1 percent in July, the highest in the region, but may not constrain growth as long as Chavez' redistribution of oil wealth provides stimulus.

"The main thing that the government needs to do is to maintain adequate levels of aggregate demand, to maintain growth and increase employment. said Mark Weisbrot, co-director of the Washington-based Centre for Economic Policy Research.

"This it can do through spending on public works projects, including housing," he said.

But the system puts huge strains on the bolivar currency, seen as substantially overvalued at the official rate of 4.3 to the dollar and 5.3 for the central bank's SITME rate.

Still, few believe the government will devalue the currency again anytime soon but rather will seek stop-gap measures to increase the dollar supply. It devalued the bolivar twice last year in an attempt to make local businesses more competitive.

"It's buying time, the postponement of tough policy adjustments until the post-electoral period," said Angel Garcia, analyst at local think-tank Econometrica.

It is all a far cry from the oil boom days of the 1970s when the bolivar was one of Latin America's strongest currencies, letting middle-class Venezuelans enjoy foreign travel and cheap shopping at plush Miami malls.

To soften the blow of price hikes and shortages, the government introduced more price controls last month and said it was boosting local production of goods like cement and food.

Dollar-denominated bonds are one way authorities try to supply dollars to businesses, which buy the notes in bolivars before selling them abroad for hard currency. The $4.2 billion sovereign bond issued in July, however, shut out much of the private sector.

The opposition says these are temporary measures that further distort an already dysfunctional economy and look to the 2012 ballot as their best chance of stopping Chavez and luring back investment.

"If there's a regime change in Venezuela, this country is wide open for investment and the turnaround will be incredible. It will be like a Wild West stampede," said Dallen.

(Editing by Daniel Wallis and Padraic Cassidy)

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