maracaibo-106398_640.jpgEconomy 

Venezuela’s Future Hangs in the Balance

By Cristobal Vasquez

A drop in international oil prices and a series of failed domestic economic policies are driving Venezuela’s economy to the brink of collapse. Yet Nicolas Maduro’s government is doing little to stabilize the situation. This begs the question, then, what is Venezuela planning to do next?

For every dollar drop in the per barrel price of oil, Businessweek estimates that Venezuela loses approximately $1 billion in average annual government revenue. This number is particularly striking when considering that since June 2014, oil prices have dropped from $115 to $60 per barrel—a  $55 decline in less than six months.

If oil prices stabilize at $60 per barrel, Venezuela could lose an average of $55 billion in government revenue, representing a 12.5 percent decrease in total GDP ($438.3 billion in 2013). Given that 96 percent of Venezuela’s revenue depends on oil exports and that the government is struggling to address an existing fiscal deficit of 16.9 percent of GDP, this problem demands immediate attention.

But Venezuela’s issues extend beyond its devalued oil exports. To date, the Venezuelan government has tried to lead a socialist revolution, nationalizing businesses, expropriating land, assuming control of the national oil company’s finances, dictating the monetary policies of the national bank, over-printing money to meet its fiscal obligations, and offering significant subsidies to large parts of its electorate. Additionally, the government has maintained a fixed exchange rate, while tightly controlling the amount of foreign currencies its citizens are allowed to have. This is particularly problematic because the government desperately needs foreign currencies to balance its budget.

Currently, businesses must ask permission from the government in order to exchange the local currency (bolivares) into dollars. Since import transactions are usually done in foreign currencies—typically dollars—the country’s hard currency crisis, facilitated by a limit of foreign currencies entering the country, is leading to a mounting debt problem. Thus far, the Venezuelan government has limited the number of dollars it exchanges and defaulted on many exchange deals with businesses, rather than addressing the problem directly.

“These [defaults] include the government’s $3.5 billion unpaid bill for pharmaceutical imports, payment arrears of more than $2 billion for food, and nearly $4 billion owed to airline companies. Oil production has more than halved since 1997, in no small part because the state-owned oil company has repeatedly defaulted on suppliers and joint-venture partners,” said Carmen Reinhart, Professor of the International Financial System at Harvard University. She added that the real question was, “Should Venezuela’s government default on its foreign debt, given that the historical record shows that nearly all domestic defaults go hand in hand with external default?”

Given these policies, economic competitiveness has plummeted and many businesses have declared bankruptcy, subsequently reducing production and significantly decreasing imports. “Total imports will plunge this year to about $43 billion compared with $77 billion two years ago… That will exacerbate shortages in an economy already ravaged by inflation,” said Andres Schipani, Andean correspondent for The Financial Times, in reference to a prediction done by Ecoanalítica, a local Venezuelan consultancy firm. Notably, Venezuela’s inflation rate currently stands at 63.3 percent, the highest in Latin America.

Not surprisingly, Maduro’s approval rating has dropped to 25 percent, the lowest it has been since assumed the presidency. With food and medicine shortages—and no apparent end to either in sight—Venezuelans are frustrated. “I have lost 10 kilograms going from one place and queuing to find milk and other things,” said Elena Gonzalez, a Venezuelan citizen.

Maduro’s response to a massive fiscal deficit and oil price windfall has been anything but effective. In place of implementing long-term structural policies, his government has decided to complement ineffective exchange and price controls with measures, such as sealing the border to prevent smuggling, dispatching 27,000 government inspectors to check shop prices are fair, and fingerprinting shoppers to prevent “hoarding.”

 

Undoubtedly, the solutions to these dire economic straights are far from simple. Analysts agree that printing more money is not a viable option because it will generate hyperinflation—and at best offer a temporary solution. Almost everyone agrees in lifting the exchange and price controls, this pairing the bolivar to the international price of the dollar and eliminating the parallel exchange rate of 175 bolivares per dollar. Some argue that selling Citgo, the Venezuelan oil refinery in the U.S., is also an option the government should consider. Still others say that the government needs to reduce the amount of subsidies on electricity, housing, and gasoline. In fact, eliminating subsidies on the world’s cheapest gasoline is an option that has been frequently discussed because it would undoubtedly free up enough money for the government to continue to finance itself.

However, many of these solutions require quite a bit of time to implement. In the interim, to boost the economy, Venezuela needs a devaluation of prices and currency in order to regain competitiveness with respect to other currencies. Despite generating inflation, devaluing the currency increases the real value of that dollar in the market. In other words, Venezuelans could purchase more with the foreign currency that enters the country, incentivizing foreign investment and dollars.

“There has to be an important devaluation, otherwise there are going to be more shortages and inflation will soar. Without a devaluation, the government would have to print more bolivares, and that can bring us to a triple-digit hyperinflation,” said the economist José Luis Saboin.

Collectively, these options can provide a long-term structural solution. That said, Maduro is afraid of adopting any of these policies because of the significant political implications they have on people’s pocket books. And since next year is an election year, in which Maduro cannot afford to lose any more support, it may be awhile before structural measures are implemented.

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Cristobal Vasquez is an economic reporter at World Policy Journal. Follow him on twitter @tobalvasquez.

[Photo Courtesy of the Financial Times,  globalpetrolprices.com, and wikipedia]

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