Venezuelan economy runs dry as oil slumps

Wrapped in a humanitarian crisis of unprecedented proportions, what is left of Venezuela’s economy has descended into uncontrolled chaos

Venezuelan economy runs dry as oil slumps
The fall in the price of oil has hit the Venezuelan economy particularly hard 
Author: Callum Glennen
April 19, 2017

Amid the tumultuous political situations in many Latin American countries, for a long time, Venezuela stood out as an exception. Rich in oil, the country boasted a stable, democratic government and a healthy GDP. In fact, between 2005 and 2012 the country boasted an average annual GDP growth of around five percent. According to government figures, poverty in the country fell from approximately 50 percent to 30 percent between 1998 and 2012.

However, since 2014, things have been different. With the price of oil falling from $111 per barrel to less than $40 over the course of mere months, the rivers of black gold that used to carry waves of bolívars into the Venezuelan Government’s pockets completely dried up. Suddenly unable to fund the sweeping social programmes that had destroyed the country’s private sector, the full extent to which Venezuela’s economy had been eroded became clear.

Far worse has been the effect on the Venezuelan people; reductions in poverty have now been reversed (see Fig 1), inflation is accelerating faster than it can be calculated, and shops now lack even the most basic products. The IMF estimated inflation could hit 1,660 percent in 2017, potentially reaching 2,880 percent in 2018. Even more disturbing are the results of the recent Venezuela Living Conditions Survey, which revealed that, due to food shortages, 75 percent of Venezuelans have lost 19lb since the crisis started.

While it may be easy to blame the current situation on the sudden drop in oil prices, Venezuela is alone in suffering a crisis this severe. Other nations that rely on oil exports have certainly felt some economic pressure from the slump, but none are suffering the same horrifying consequences. The situation, rather, can be attributed to decades of economic mismanagement, a surge in populism and a government refusing to admit defeat. Unfortunately there are no simple answers or clear solutions, with little chance of the situation improving in the near future.

Oil drilling started in Venezuela in 1912 and almost immediately transformed the country. By 1929, Venezuela had become the world’s biggest oil exporter and second largest oil producer. This invigorated the country’s economy, and by 1935 oil accounted for 91 percent of the nation’s export income. But while this boosted the economy, it came at the cost of the country’s other industries.

Miguel Tinker Salas, a professor of Latin American History at Pomona College in Claremont, California, is the author of Venezuela: What Everyone Needs to Know and The Enduring Legacy: Oil, Culture, and Society in Venezuela. Speaking to World Finance, he said the country’s history has significantly contributed to the current crisis: “If you go back and think of Venezuela, for decades it promoted the idea of being the exceptional country in Latin America; of being the country that, because it had oil, had been able to construct a different reality, to view itself as a unique Latin American country. It didn’t have the experiences of scarcity and inflation, and economic crises.

“The current situation is a dramatic reflection of the fact that the oil has not, and will not, produce fundamental change for Venezuela on a long-term basis, and that it cannot sustain an economic development with the dependence on oil that it has had since the 1920s.”

Tinker Salas added that the warning signs that a situation like this could arise existed as far back as the 1930s: “Venezuela had, as I point out in my own book, been a net importer of food since the 1930s, so it never had food sovereignty. It never produced what it consumed.” Such a startlingly high reliance on imports should have set off alarm bells in more diversified economies, let alone one with such a high reliance on a single export.

More equal than others
Inseparable from Venezuela’s current situation is the rise of Hugo Chávez. A former lieutenant colonel in the Venezuelan army, Chávez attempted to mount a coup in 1992 in order to overthrow the government after years of what he perceived as a growing disconnect between the people and an elitist political class. While Venezuela’s economy grew substantially between the 1960s and 1970s, as in much of Latin America, the 1980s and 1990s saw a lot of stagnation. After being jailed for two years following the failed coup attempt, he turned his popularity and reputation as someone willing to stand up for the poor into a successful presidential run in 1998.

His policies aimed to redistribute the wealth generated from oil exports back to the people through generous and expansive social welfare programmes. Charismatic and tremendously popular, Chávez was overall quite effective at decreasing poverty.

While it may be easy to blame the current economic situation on the sudden drop in oil prices, Venezuela is alone in suffering a crisis this severe

Behind the scenes though, these policies proved to be tremendously inefficient and, in many cases, just plain unfair. Tinker Salas said subsidies managed to trickle into almost every aspect of the Venezuelan economy, including unsustainable contributions to education, food, transport and housing. Petrol subsidies reduced costs to lower than the commodity could be produced.

“The ludicrousness of the Venezuelan social and political situation is that not just this government, but previous governments would subsidise middle-class travel abroad”, said Tinker Salas, adding that these policies came from a time when Venezuela thought of itself as a Saudi country in Latin America – rich in oil and able to afford these expansive social programmes.

Dany Bahar is a Venezuelan economist and a fellow in Global Economy and Development at the Brookings Institute. He said Chávez’s efforts were not just limited to social spending, but transformed into a full-fledged war on the private sector. He told World Finance: “When the price of oil was very high, this was completely feasible because the government could control the economy, because it had an infinite inflow of cash from oil. At the same time that was happening there was an increase in regulations, and the government basically asphyxiated the private sector.”

Over the years, regulations tightened and the economy became increasingly locked down, eventually culminating in a coup attempt against Chávez in 2002. Following this, Chávez sought to take a firmer grip on the situation.


The level of inflation in Venezuela in 2017 as predicted by
the IMF


of Venezuelans have lost 19lb
in weight since the country’s crisis started

3m+ barrels

Venezuela’s daily oil production prior to the oil
price crash

2.55m barrels

Venezuela’s current daily oil production

“He put his own people in the military, then he put his own people in the Supreme Court”, Bahar explained. “He suddenly got all the different authorities under his power, basically, and while the price of oil was so large and so high for so long, he was indestructible.”

In 2003, Chávez introduced more policies that would contribute to the coming catastrophe. Venezuela implemented an exchange control system that set a fixed exchange rate. Bafflingly, the exchange rate system has since evolved to a state where it now operates on multiple tiers depending on what the currency is used for. With the complex, tangled diplomacy that is required to get access to foreign dollars, people began to find other ways.

“At the beginning it was working very well… but every time that you control a market, a black market emerges”, said Bahar. “So since the beginning there was a gap between the official exchange rate and the exchange rate in the black market, which was about two to three times. Today, this gap is about 1,000 times. And this gap was increasing year by year because, the worse the mismanagement became, the less they could do with the inflow of dollars that was coming in to provide to the private sector.”

Chávez died in 2013, passing on power to then-Vice President and Foreign Minister Nicolás Maduro. Maduro inherited a country with an almost unimaginable dependence on oil and a private sector that couldn’t stand on its own legs. A far less charismatic leader than Chávez, Maduro displayed the same unwillingness to transform Venezuela into an economy capable of sustaining itself, and when the collapse in oil prices began, Maduro’s grip on power began to weaken.

According to Bahar: “Maduro is highly unpopular. He was from the beginning, and even more so today.” However, it is difficult to imagine Chávez faring any better than Maduro currently is; both would have been stuck with the same chaotic system and humanitarian crisis. What could have been different is how the leaders dealt with the power.

State-owned oil
Petróleos de Venezuela (PDVSA), the country’s state-owned oil producer and exporter, is a similarly key figure in the Venezuelan economic crisis. In the 1980s and 1990s, PDVSA was one of the world’s premier oil businesses, capable of operating on the world stage.

However, according to Bahar, following the attempted coup against Chávez in 2002, PDVSA’s management was largely replaced by Chávez’s cronies. Since then, the company’s productivity has gradually fallen. When the price of oil was at its peak, this mattered little. However, in the depths of the global price crash, such a fall in income has scuppered any attempt of rebuilding or re-establishing PDVSA’s oil production capacity. As per the figures release by Venezuela’s oil ministry, production has dropped from a little over three million barrels per day to less than 2.55 million per day.

But despite the current situation, Venezuela’s government has continued to make payments on its debts, particularly those of PDVSA. After issuing bonds and taking loans to fund the company, PDVSA – and consequently the Venezuelan Government – has a debt far beyond what it can afford.

According to a report by CNN Money, Venezuela owes roughly $7.2bn in debt payments. The government had previously been paying this from its cash reserves, but according to the Central Bank of Venezuela, it currently holds only $10.5bn in cash.

“The government has up until now, in fact, contrary to most opposition arguments, actually paid the debt, something that social activism from those on the left critique the government for”, Tinker Salas said. “So the government has been very keen, and that’s something the Chávez administration was also very keen on doing – actually [paying] the debt and [trying] to find other mechanisms to either pay or leverage the debt.” Such payments allow continued relationships with several trading partners, including China, India and Russia.

Bahar said that, should Venezuela default, Maduro’s government would almost surely lose power: “They have been paying religiously to the people in Wall Street, even at the expense of having their citizens dying of hunger. It’s just absurd.”

Venezuelan students protest against the government of President Nicolas Maduro

Management crisis
The Venezuelan Government’s efforts to address the crisis have ranged from ineffective to ridiculous. Orders for a two-day workweek and rolling blackouts have cut back costs, but they are not much more than short-term solutions. To address hyperinflation, the government has been printing extra money; a move any economist would say is the worst thing you can do in such a situation. The desperate efforts by the current government to keep itself in power are only making the situation worse.

Many hypotheticals have been proposed as to how the current crisis could have been avoided. A theory often touted by Venezuela’s opposition party is that more money should have been saved for a ‘rainy day fund’, or that an increase in oil production could have improved the bank balance.

Tinker Salas said neither of these address the fundamental root of the problems facing the country. “First of all, the population has increased dramatically. When Venezuela discovered oil, we’re talking about [a population of] three to four million people – today, we’re talking about 35 million people. Even when Chávez came to power, we’re talking about something like 21 to 22 million.” This growing population naturally means a greater level of consumption, putting an increasingly heavy strain on oil dependence.

Inevitably, we must ask what is going to happen next. The strategy from Maduro’s government appears to be clinging onto power by any means necessary, hoping a rebound in the price of oil will be enough for them to resume the country’s subsidy programmes.

However, Tinker Salas said, even if the price of oil did skyrocket, it would only prolong the situation and fail to address the structural and cultural problems that caused the current crisis in the first place.

Bad policies stemmed from a time when Venezuela thought of itself as a Saudi country in Latin America – rich in oil, and able to afford expansive social programmes

He explained: “It requires… a cultural, social and political reimagining of Venezuela other than simply, as a US state department revealed in the 1950s, ‘a filling station for the US’. It has to be a reimagination of the country… One in which Venezuela has to be able to produce a significant portion of what it consumes. It has to have a completely different orientation where oil is part of an economic arrangement, but it is not the
only dominant sector.”

Bahar said that, in order to continue paying its Wall Street debts, Venezuela could potentially continue to mortgage off portions of its many state-owned businesses. While this may buy some time, it is unlikely to be effective beyond 2018. If Venezuela does default on its debt, what the political and financial situation would look like is very unclear.

In terms of what the global community could do, the options are few and far between. Bahar said: “It’s a question I ask myself every day, because sometimes I’m asked, not only by journalists, but sometimes people from government: ‘What can the outside world do?’ I think that the short answer to you is I don’t know, and I’m not very optimistic.”

A new government in the country is an absolute necessity, although the current opposition is disorganised and weak. Bahar said targeted sanctions on known criminals in government would most likely not be enough to incite change: broad sanctions would be the usual aggressive diplomatic move, but with people already dying of hunger, a ban on imports would only cost even more lives.

While economic collapses and surges of inflation are ultimately temporary problems, Venezuela’s current situation runs far deeper. With no easy answers, the world has little power over the catastrophe, which will surely only worsen before it improves.