The Curse of Chávez’s Ghost

The precipitous 50 percent collapse in global oil prices since June of last year has laid bare Venezuela’s flimsy economic foundations. The failure of the Bolivarian Republic — the world’s most oil-rich country, measured by reserves — to develop alternative sources of revenue over the past 15 years has bound its fate to black gold, which accounts for 95 percent of its hard currency reserves. President Nicolás Maduro, late President Hugo Chávez’s handpicked successor, has few options left to avoid default. And this most likely scenario may be the final blow to the country’s current government.

By almost any objective measure, Venezuela’s economy is falling apart, as its dependence on imports to contend with severe shortages of food and medicine grows. Meanwhile, its treasury is facing a critical dollar drought, suggesting that its economy cannot survive being starved of its precious petrodollars.

When Chávez took office in 1999, crude prices were $12 per barrel. But by 2008, they had soared to a record $145 per barrel. Rolling in oil money, Chávez embarked on a series of controversial and ambitious social-spending reforms that greatly boosted the lives of Venezuela’s most marginalized. But compelling evidence has surfaced that a great deal of the money Chávez invested has been lost to corruption and utter incompetence.

When Maduro took over in April 2013, he inherited an economy in tatters due to years of massive social spending that had widened the fiscal deficit to 11 percent of GDP. Inflation had skyrocketed to 29 percent, and growth had slowed from 5.6 percent in 2012 to 1.3 percent in 2013. On the black market, the bolívar traded at nearly four times its official exchange rate, even after Venezuela devalued its currency by 32 percent to 6.3 bolivars per dollar under the orders of a bedridden Chávez in February 2013.

Rather than dealing with the economy’s underlying structural problems, Maduro pledged to finish Chávez’s socialist revolution. In May 2013, Maduro approved a last-minute $79 million line of credit to import toilet paper, toothpaste, and soap to relieve shortages. His economic policy has been one of firefighting measures, including regular currency devaluations, expropriation of private companies, and rampant inflation resulting from unsustainable public spending. He has laid the blame on the United States and his other political opponents for damaging the economy with months of street protests last year focusing on food shortages, inflation, and crime, that claimed the lives of 40 people.

This could be why Venezuela spiraled into recession last year, contracting by 2.8 percent. According to figures released by the Venezuelan Central Bank this month, inflation has climbed to 68.5 percent. The Inter-American Development Bank also estimates that the country could face an unsustainable fiscal budget deficit of 24 percent of GDP if Maduro fails to take action, like reducing imports — which would worsen shortages — or get creative financing options, such as cashing in Venezuela’s gold reserves. In addition, Chávez’s two-tier currency system, in which the bolívar is worth a different amount of dollars based on the method of exchange, has added a third tier. Each has its own rate: 6.3 bolívars for food and medicine, and two complementary rates of around 12 bolívars and 52 bolívars for other goods. Meanwhile, in the parallel market, the exchange rate depreciated 750 percent in two years and now trades at almost 200 bolívars per dollar:

The country has already lost $35 billion on an annualized basis, thanks to dwindling returns on oil exports in 2014. According to official figures (whose accuracy is highly dubious), international reserves have shrunk to $22 million, while the country’s coffers contain liquid reserves of only $3.5 million, according to Barclays.

Taking into account Venezuela’s U.S. dollar assets and liabilities, the external financing gap could be as big as $14 billion this year, and grow to $28 billion in 2016, according to estimates by the investment bank Jefferies. They and others have suggested that Venezuela needs oil prices to climb to at least $60 per barrel to generate enough cash flow for 2015, and $85 per barrel once the country exhausts its non-recurring revenues. But for the time being, it’s impossible to determine oil’s break-even price.

As the new year dawned, bringing with it $50 oil, Venezuela’s economy sunk deeper into crisis. And so the president made a last-ditch attempt to help his cash-strapped government improve its finances. After a tour of China, Russia, and the Middle East in January failed to raise funds to alleviate the crisis, Maduro announced the new foreign exchange system and a hike in subsidized gasoline prices. His Marginal Currency System, or Simadi, which devalued the currency by 69 percent to 170 bolivars per greenback at the opening, close to the black-market rate. This move may help boost the supply of dollars, but risks fueling already soaring inflation amid recession, product shortages, and bulging supermarket lines.

Venezuela needs a complete economic overhaul, and concrete measures to tighten its fiscal and monetary policy to sustain any competitiveness gained by the recent devaluation. But considering Maduro’s recent promises to increase minimum wages and boost social spending, there doesn’t seem to be any intention to decrease spending. There is still no commitment from the government to hike the cost of gasoline, which is heavily subsidized — to the tune of some $12 billion a year — and spurs cross-border fuel-smuggling, especially with Colombia. Venezuelans can fill their gas tanks for only 6 cents a gallon at the official exchange rate, but those who can trade on the black market can get it almost for free. According to Siobhan Morden, managing director at Jefferies, there will need to be an adjustment at least of 200 times current prices to reduce domestic consumption and smuggling in order to divert towards oil export gains.

Maduro is embarking on a very slow process to revamp the economic model of Chavismo. But shortages of basic goods and high prices remain the chief concern of the people, and seem likely to continue hammering at his popularity ratings, which have already fallen to an alarming low of 22 percent. His gradual approach is a step in the right direction, but it’s insufficient against the daunting funding gap Venezuela faces.

When Maduro submitted his annual address in front of the National Assembly in January, he recognized that “Oil will never cost $100 again, but God will provide.” Venezuela will certainly need more than that in order to avoid a default. Adjustment will be slow, gradual, messy, and incomplete. For Maduro, it’s a race against the clock with mounting economic and social pressure possibly giving rise to a reform.

Photo credit: AFP