By John Manning – International Banker
On July 30, Venezuelan President Nicolás Maduro followed through on previously made promises with an election for a new “constituent assembly” that would rewrite the country’s Constitution. The move has since been met with considerable dismay from both the opposition within the oil-rich Latin American country, as well as around the world, with the United States, the European Union and a group of 12 countries from across the Americas swiftly condemning what is widely being perceived as a power grab. As such, there are very few countries that have acknowledged the legitimacy of recent events. Although there is a precedent for rewriting Venezuela’s Constitution—President Hugo Chávez did so in 1999, but held a referendum beforehand to allow the people to decide—Maduro has given Venezuelans little say in determining this outcome.
One of the biggest sources of consternation for Venezuelans is the significant lack of clarity from Maduro regarding his underlying intentions for wanting to amend the Constitution. As such, a significant amount of uncertainty pervades the country at a time when the economy is on the brink of collapse. Maduro believes the changes he has rung will save the nation from economic and political disaster, but many fear they could result in the opposition-controlled Congress being dissolved, which would ostensibly mark the first steps towards ending democracy in Venezuela. While most Latin American states have made the transition from dictatorships to fully fledged democracies over the last 20 years, it now appears that Venezuela is moving in the opposite direction.
With street protests against Maduro continuing in full flow nationwide, despite having claimed over 120 lives to date, clashes have been exacerbated by a comprehensive decline in economic well-being and living standards. By almost every conceivable measure, Venezuela’s economy can now only be categorised as an unmitigated disaster. On the one hand, the macroeconomic picture is very bleak—hyperinflation, an effectively worthless currency and a deep, inescapable recession are just a few of the problems with which the country now must contend. As of August 4, Venezuela’s annual inflation rate was recorded at 1728 percent, meaning that the majority of the population simply can’t afford the basic necessities. Then there’s the collapsing bolivar, which has devalued almost 95 percent against the US dollar since the beginning of the year, or equivalent to a 2000-percent rise in the dollar versus the Venezuelan currency. To put this into context, it was recently observed that the value of the bolivar is now worth less than the fake gold in the popular video game World of Warcraft. The International Monetary Fund (IMF) expects that a quarter of Venezuelans will be unemployed this year, with that being forecast to continue rising to 36 percent by 2022.
Overall, this has led to Venezuela’s economy shrinking by a quarter in just the last five years. Perhaps just as alarming as this contraction is the sharp drop in living standards that the majority of Venezuelans are now having to endure. Take nutrition as an example; given that household groceries are currently about 20 times the minimum wage, it is now estimated that around 95 percent of Venezuelan citizens consider their income to be insufficient to afford their required food intake, while almost 75 percent of Venezuelans have reported significant weight loss during the last year, at an average of 9 kilograms per person. With government price controls limiting domestic supply, and low oil prices causing imports to plunge, food shortages are now rife across the country. Medicines have also become extremely scarce, with estimates from the beginning of the year suggesting that Venezuelans are 85 percent short of what they need. Painkillers are nowhere to be found, and with treatment for malaria also in short supply, the number of reported cases of the mosquito-transmitted disease has risen dramatically.
Furthermore, with widespread violence having broken out—both in response to the government’s recent actions and due to a basic need to survive—Venezuela is now the largest source of asylum applications to the US, having surpassed China and Mexico this year.
The fact that the Venezuelan economy was still performing satisfactorily at the start of the decade is perhaps the most perplexing issue—it has been only within the last five years or so that things have hit rock bottom. Collapsing oil prices have undoubtedly played their part; indeed, the irony of such a disastrous economic performance is that Venezuela has among the largest quantities of oil reserves of any country in the world—if not the largest. Revenue from petroleum exports accounts for more than 50 percent of Venezuela’s gross domestic product (GDP), as well as a whopping 95 percent of its total exports. The country is also the sixth largest oil-producing member of OPEC (Organization of the Petroleum Exporting Countries). Despite being blessed with such a wealth of natural resources, however, Venezuela’s over-dependency on this single resource has brought about much of the misery being witnessed today. The price of oil was over $100 per barrel back in 2014; since then, it has plunged, reaching a low of around $26 in early 2016. Although it has recovered to around $50 since then, that still means Venezuela is only taking in around half of what it was just a few years ago.
To ascribe Venezuela’s economic woes wholly to falling prices is too simplistic, however. Indeed, back in 1998, the country had devised an effective strategy to ensure its over-dependency on just one natural resource—and a volatile one at that—did not result in the mess we are seeing today. Prior to Hugo Chávez’s election, the savings fund FIEM (Investment Fund for Macroeconomic Stabilization) was created, which collected revenues from excessive oil prices to be used in times of emergency—for example, if the most recent price of a barrel of oil was higher than the average price for the previous five years, then the surplus amount was to be put into FIEM; conversely, if the latest price was lower than the average, money from the savings account could then be used to make up the deficit. In the words of the Constitution, “a macroeconomic stabilization fund will be established by law to ensure the stability of state expenditure at the municipal, regional and national levels, in view of fluctuations in income. The basic rules of operation of the fund shall be efficiency, equity and non-discrimination among public entities that contribute resources to it”.
Just a few months into Chávez’s tenure, however, oil prices rose above this rolling five-year average, and for the most part remained so during the next 15 years. While this should have resulted in FIEM accumulating substantial funds—around $150 billion, according to estimates—which would have easily paid off the country’s entire public-sector foreign debt, the fund was depleted by the Chávez administration and then largely ignored. Former ministers estimate that corrupt officials stole or misappropriated around one-third of the $1 trillion windfall from the oil-price boom in total, and as such, the mismanagement of FIEM has played a crucial role in turning Venezuela’s precipitous decline. Perhaps such mismanagement should come as no surprise given the history of corruption among the Venezuelan leadership, which seems to have grown only worse in recent times. According to Transparency International, the Venezuelan government is now the most corrupt in the Western Hemisphere.
Aside from oil-based corruption is the gross mishandling of economic policy by both Chávez and Maduro. An abject rejection of the free market has resulted in Venezuela being prevented from being able to utilise market mechanisms to organise itself and efficiently serve both producers and consumers. With restrictions on imports and drastic controls being put on exchange-rate operations, the allocation of resources has been severely distorted. Property rights have also suffered from a lack of security, with more than 1,400 companies and nearly four million hectares of arable land having been expropriated.
Of a myriad of reasons that explain Venezuela’s demise, it is arguably such inexplicably inept macroeconomic decisions taken by the powers that be over the last few years that have caused the greatest damage. When oil was averaging more than $100 per barrel back in 2012, the government decided to ramp up the public external debt by running a massive deficit of 17.5 percent of GDP. The resultant accumulation of debt, therefore, lost Venezuela its access to voluntary debt markets a year later. Oil prices then collapsed in 2014 to thoroughly worsen the situation. In response, Maduro halted imports, which resulted in a collapse in aggregate output, and in turn, the shortage of necessities that is now currently being observed.
With a rapidly deteriorating debt situation, therefore, Venezuela is now on the verge of default. S&P Global Ratings recently downgraded the country’s long-term foreign and local currency ratings from CCC to CCC-, which is now three notches below investment grade. The ratings agency has also maintained a negative outlook on the country, which suggests further downgrades could be in the offing. Indeed, the likelihood of a default is seemingly increasing month by month. According to monthly Bloomberg figures for June, the probability of the country missing a payment within the next year was 56 percent; by the end of July it rose to 62 percent; while the odds of a credit event occurring over the next five years rose from 91 to 95 percent between the same two months. And the figures seem wholly justified—Venezuela is rapidly running out of money; foreign reserves have been utterly depleted, with estimates putting current amounts at a 15-year low of around $10 billion. Given that that the country is scheduled to repay about $13 billion in debt before the end of next year, the situation looks desperately bleak.
Can anything be done to improve the situation? Possibly, but as far as inducing an economic recovery is concerned, it seems that any solution would be predicated on political reformation—and this does not seem to be in the offing. Since the election, the US has imposed a handful of sanctions, particularly on Maduro himself, who has been added to a growing list of Venezuelan officials whose assets are now frozen under US jurisdiction, and with whom US citizens are prevented from conducting business. According to US Vice President Mike Pence, moreover, the US hasn’t ruled out the possibility of pushing for new elections, with Latin American leaders also expressing support for such an outcome. President Donald Trump also refused to rule out the possibility of military intervention, although this has since been played down.
The possibility of US sanctions on Venezuelan oil exports still looms, but this may only worsen the country’s economic situation, especially given that the US is Venezuela’s largest market. While Maduro could begin exporting more oil to Asian buyers instead, such a move is likely to be accompanied by higher costs, and as such, the probability of a default would be further heightened. South America’s largest trade body, Mercosur, has also suspended Venezuela’s membership, but again this only exacerbates the economic gloom.
Either way, a return to the democratic process would seem vital for getting the economy back on its feet, and ensuring stability in the long-term. Policy could then focus on instilling free-market mechanisms that enable resources to be reallocated in line with the needs of the producer and the consumer. This would almost certainly require prioritising the availability of foreign exchange, which would require a renegotiation of Venezuela’s debt repayments to creditors, including Russia and China. This may well be possible, especially given that both nations are looking to expand their footprints in the region. External financial assistance should also be sought by Venezuela to restructure its debt. The IMF could play a crucial role in facilitating this and helping the country to preserve its cash, as it has done recently with the likes of Greece and Ukraine.
Before this can be achieved, however, Venezuelan’s political fate must first be decided, which makes the coming weeks and months a critical period for the country. It seems increasingly likely that Maduro wants to cement his position and consolidate power. However, should opposing forces manage to make their way to the negotiating table, with or without the help of outside forces, then Venezuela’s economic revival would turn out to be a more likely proposition.