Explaining the perverse economic dynamics that brought Venezuela to its knees

One question sums up the situation in Venezuela today: Is it possible that the gross domestic product of the country that holds the largest oil reserves in the world will suffer also the worst decrease, below Sudan and Equatorial Guinea? Yes, Venezuela's wealth will contract this year by 8% according to the International Monetary Fund. For those who prefer other sources, the UN Economic Commission for Latin America (CEPAL) has a 6.9% estimate, while Latinfocus' is 7.2%.

One question sums up the situation in Venezuela today: Is it possible that the gross domestic product of the country that holds the largest oil reserves in the world will suffer also the worst decrease, below Sudan and Equatorial Guinea? Yes, Venezuela’s wealth will contract this year by 8% according to the International Monetary Fund. For those who prefer other sources, the UN Economic Commission for Latin America (CEPAL) has a 6.9% estimate, while Latinfocus’ is 7.2%.

Inflation is about to turn hyperinflation (that is when it is more than 1% per day). According to the IMF in 2016 it will exceed 700%, another world record.
“Venezuela is facing three challenges: political, economic and socio-economic, the latter being a result of the former two,” said economist Leonardo Vera speaking at the round table on Venezuela’s economic scenarios organized by Prodavinci, a media think tank in Caracas, whose director is Angel Alayón.
Supporters of the chavista government could argue that Lieutenant Colonel Hugo Chávez’s policies for the most disadvantaged sectors of the population lifted out of poverty 16-17% of Venezuelans in a country of extreme inequality, like all Latin American countries, which were throughout their history feuds of economic elite that overlapped with the ruling classes.
All of those social advances, disregarding whether they were welfarism or not, have now been wiped out. The rule is war-like shortages of consumer staples due to almost dried up foreign currency reserves. The average diet is at survival level and deficient in protein, according to the Encovi, the survey on living conditions. A 12% of the population eats only two meals a day compared to 11% the previous year.
“Poverty estimates sped up in the past two and a half years. In 2013 30% of Venezuelans lived below the line of poverty, now it’s over 60%,” said Vera.
Even more dramatic are the numbers reckoned by sociologists at the Venezuelan Observatory of Violence: as much as 76% of the Venezuelan population lives with a poverty income. Hospitals long run out of food or antibiotics for the hospitalized. Many families live without water or electricity.
Aside from the fall of oil price in the last couple years, this an outcome of the economic policies of the Chávez governments between 1999 and 2013. In several of those years, the price of Venezuelan crude oil leaped and stayed at 110 and 120 dollars a barrel. There was no need for much accounting to fund social programs, the misiones, and to subsidize gasoline and consumer goods. The state expenditures followed the oil prices upwards.
Subsidized gasoline, which Chavez “would have rather give away”, meant an outflow of 26 billion dollars a year already in 2008, according to economist Asdrúbal Oliveros, associate director of Ecoanalítica.
Economists, among who Emeterio Gómez, were already saying in 2008 that the government’s economic policies were unsustainable, and that “the fiscal situation could become so critical as to force the government to devalue and raise taxes or the price of gasoline.”
Allowing the economy’s dependence on oil to climb to 96%, Chávez stayed that course, as did Maduro after him, all of it however at the expense of the productive sector and of the oil infrastructure, by now on its knees.
The phrase “Sowing Oil” expressed already in 1936 the risks of a mono-producing economy: with 20% of the world’s oil reserves under its soil, Venezuela shares just 3% of the world’s oil output. Chávez had forcasted before passing away that by 2015 the country’s output would be of 5 million barrels a day. It is producing less than 2.7.
The causes lie in the vicious circle of lacking investments. Obsolete equipment and plants produced less and export less. That means fewer dollars to buy abroad spare parts and services to keep the plants running, many of which now almost shuttered.
“Electricity generation is a case in point”, said economist Igor Hernández, coordinator of the International Centre for Energy and the Environment. “When hydropower is not available [as currently because of severe droughts], electricity must be obtained from diesel or gas. There are no infrastructures for gas, so diesel is used, but this lessens oil exports to China. The lack of that liquidity zeroes the operating margin needed to pay suppliers. Among the latter are those from which Venezuela imports crude oil [the light crude needed to dilute the local heavier crude oil] because local production could not be kept running”.
Rumors have it that the government was forced to sell a Petroleos de Venezuela (PDVSA) production stake to Russia’s oil behemoth Rosneft, thus further reducing the assets from which PDVSA generates foreign currency.
The problem is that PDVSA is the state’s ATM. It pays out external debt interests too.
In February, economic observers “almost had a heart attack” after President Maduro announced that “Venezuela had sold in January 77 million dollars of oil”. The math said that 77 million times 12 months would cover just a drop in the state budget. “It was legitimate to think that the president had confused the daily sales with monthly ones”, said Oliveros. “Two months later, when Venezuela mid-April paid over $200 million of debt service, there there was the evidence that PDVSA was holding back a substantial part of the dollars it cashes in to pay down debt”.
The aggressive decision of paying on schedule debt installments implies a low risk of default,” the economist said. “The government will never default on its bonos! That means however that it will have to cut imports by another 40% adding to the 20% cut last year. This will create a minefield. An explosive situation. The brutal acceleration of inflation, now borderline with a hyperinflationary cycle, has not been accompanied by indexed wages, which explains why poverty has doubled“.
All of this screams a need for change, experts agree. And for the first time, even members of the ruling party are calling for the current leadership to step down, and for political and economic reforms, like simplifying the currency exchange rate to just one, and supporting family income instead of having a regulated prices system.
Poverty levels rising in the past two and half years from 30% to more than 60% – “a socio-economic and social catastrophe” said Vera – are also at odds with data for the rest of Latin America and the Caribbean, where in 2014- 2015 poverty averaged 28%, according to the UN.
The chavista economic policies have been challenged in December by Venezuelans in the polls won by the opposition, but the government continues “to fill a hole emptying another one”, and doing too little too late, like the increase of the price of gasoline in February by 6086%. Experts believe that the longer this transition plays out, the more the country will deteriorate, because stagflation [recession with high inflation] is now chronic.
“Among other reforms, we have to put an end to the atomization within the public administration, because that causes dollars to leak like through a sieve, and into who knows whose pockets,” said Herrera. Venezuela is the most corrupt country in Latin America.
Getting the announced two-exchange-change system going is urgent, as is lowering the dollar rate in the black market, which causes agents to raise prices. “The government knows very well that it could defeat the black market,” said Oliveros. “It is a question of how they choose to allocate the foreign currency available”.
The process of obtaining currency to import goods is extremely complex. “In the end, it all boils down to what the Central Bank, the government and the various centers of power do to maintain control over their own small territories. This is why all currency exercises failed in recent years”.
On the political front, on May 2 one of the opposition coalitions delivered the signatures need to call a referendum to force to Maduro to step down, but the process is lengthy and complex. Many believe that the government wants to get to January 2017, so avoiding elections, and staying at the lead of the transition process.
There are some signs that the government begun to realize that it will not be able to go much further with no funds in the Treasury vaults. The dilemma is whether Venezuela will be forced to draw on international funding sources.
On April 12 Maduro and Barack Obama held an informal meeting which the former described as “even friendly”. He said to Obama that Venezuelans “are not enemies of the United States.” The attitude is total prime and in contrast with the traditional rhetoric that for the crisis and woes in Venezuela only the United State are responsible.
Many bet that the funding source would be China, but did not materialize. Indeed, Venezuela is exporting to China not even the amount of barrels needed to service the debt with the Asian country.
In addition, economists estimate, it is unlikely that China could assume alone the financing of Venezuela’s debt, which is gigantic: Herrera’s research group estimates it to be as much as 30 billion dollars.
“My perception is that the government is considering several possibilities, including restructuring PDVSA’s debt, and reprofilig the enormous total figure. Be as it may, we now need already some 10-15 billion dollars to take off some pressure from the depressed domestic economy,” said Herrera. The price of oil is not likely to increase in the short to medium term to previous levels.
“The point is that the margin of illiquidity is extremely narrow, and cash flows from oil are very weak. Hence any small mistake in the financial schemes could lead to an unwanted moratorium, a delay or just rumor.”
The question is whether the country will be able to withstand the adjustments after another brutal cut of imports.
There the government was active. It renewed a consulting agreement with Cuba to prepare the population to bear “à la Cuban” a period of great scarcity and shortages.
According to Herrera, it is unlikely that this government will resort to the IMF, in itself a feasible path, because only a government which truly believes in the need for changing the current economic model will put in place a solid and credible plan.
In the meantime, the lack of liquidity is so severe that the Treasury has no means to print money.

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