Running Out of Time: Dimming Prospects for Reform in Venezuela

By: Harold Trinkunas

The collapse of global oil prices is putting particularly severe pressure on Venezuela, with unpredictable but serious economic and political consequences. The price of Venezuela’s oil has fallen from $97 per barrel to less than $40 in the past year. For a country that imports over 70 percent of all consumer goods (including food) and depends on oil exports for over 95 percent of its foreign exchange, the effects on Venezuelans’ well-being are severe. Gross domestic product contracted by 3 percent in 2014 and inflation exceeded 60 percent. Reports from Venezuela indicate longer lines at markets, shortages across a wider spectrum of goods and occasional outbursts of looting at supermarkets. These problems are even worse in the regions most distant from the national capital, Caracas.

President Maduro’s recent global tour to China, Russia, Iran, Qatar, Saudi Arabia and Algeria, had the twin aim of convincing oil producers to take coordinated action to raise the price of oil and to find additional money to cover the gap in Venezuela’s finances. While Iran and Russia expressed interest in proposals to drive up global oil prices, the Saudis (the deciding vote due to their superior production capacity) have declined to cooperate. And although President Maduro announced fresh investments from China, Qatar and Russia, the perception at home and abroad is that he has been largely unsuccessful in securing new money. The $20 billion in support from China is less than meets the eye, since at best it constitutes an expression of interest from the Chinese in acquiring control of some of Venezuela’s heavy industries. The size of Qatari and Russian pledges remain vague, andQatar has so far been reluctant to confirm any specific amounts. By and large, even if this constitutes new money, it is in the form of investment in hard assets that is likely to be paid out over several years rather than immediate cash that Venezuela could use to bridge its present financing gap.

No Room to Maneuver on the Economic Front

In the absence of new loans from new sources, Venezuela’s government is rapidly running out of resources. The breakeven price of oil to balance Venezuela’s government budget is reported to be $117.50, and even President Maduro has placed it at $100. A Wall Street investment bank recently calculated that, even under extremely generous assumptions about revenues and one-time sales of government assets such as CITGO, Venezuela would still be short $7 to 8 billion in foreign exchange in 2015. Moody’s rating agency has recentlylowered Venezuela’s credit rating to levels typically seen in countries on the verge of bankruptcy, and the credit default swap market is pricing the probability of Venezuela’s default on its international bond obligations as near 100 percent in the coming year. This lack of creditworthiness will have the effect of cutting Venezuela off from international capital markets that it might have used to secure loans to weather the storm caused by lower oil prices. Venezuela is worst placed among the large oil producers to address the consequences of the current drop in oil prices. It has among the lowest foreign exchange reserves of large international oil exporters, having consumed rather than saved the income it derived from oil during the commodity boom of the past decade.

With almost no savings to fall back on during the present crisis and little access to new loans, Venezuela will have to look to cut spending and increase revenues. Cutting spending will be difficult and politically costly. It is difficult for the government to track, let alone control, the spending conducted by a sprawling array of nationalized industries and state-sponsored programs. On the revenue side, at least 42 percent of the oil it exports has been commercialized under non-market arrangements that further decrease Venezuela’s earnings. For example, much of this oil is sent to China to pay for over $40 billion in loans. Since its oil production is also contracting and non-oil exports have dwindled, it is difficult for the government to increase revenues quickly. While a number of countries and companies have pledged to invest in Venezuela’s oil sector in the past, they have found business conditions difficult, and there is no sign that production will turn around quickly. Self-help by the Venezuelan government is therefore unlikely to cover the financing gap, and the Maduro administration knows this.

Difficult Economic Choices Ahead

With Maduro coming away largely empty-handed from his global tour, what’s next for Venezuela? Many affiliated with the government may hope that the traditional Venezuela expression, “Diós es Venezolano” (God is Venezuelan), once again comes true, and that oil markets miraculously recover, freeing them from their present straits. A rise in oil prices, even if only to the $75 to $85 per barrel range, would place Venezuela in a much more manageable position to deal with the crisis through its own resources, but this seems highly unlikely under present market conditions. In his recent annual report to the legislature, President Maduro offered little in the way of new policy beyond a change in the foreign exchange allocation regime (possibly devaluating the currency), a discussion of possibly raising the highly subsidized price of gasoline, and an aggressive campaign against alleged hoarding in the private sector distribution system. While these measures might positively affect government revenues in local currency, they will not produce an increase in foreign exchange earnings nor address the underlying distortions in the economy, which is what it would take to overcome the present crisis. They are also likely to stoke inflation and further depress already declining levels of domestic consumption.

If oil prices remain at low levels during 2015, there are really only two options for Venezuela: seek a traditional bailout with the assistance of international financial institutions or undertake some form of default. In the former case, this would most likely require Venezuela to re-establish relations with the International Monetary Fund (IMF), which Hugo Chávez severed in 2007. The International Monetary Fund does have the mission, the funding and the deep experience required to help Venezuela navigate its way back to solid economic ground. However, the IMF has not undertaken annual reviews or visits since relations were cut off, which might slow the development of a financial package designed to support restructuring measures. In addition, Chavistas in Venezuela would find both the content of IMF policy recommendations and the conditions attached to assistance abhorrent. As such, President Maduro has so far ruled out going to the IMF for support. The opposition has also framed the prospect of economic adjustment negatively. For tactical reasons, they would prefer to tar the Maduro administration with responsibility for the painful consequences of an IMF-led bailout.

The alternative is that the Maduro administration will eventually be forced to default on Venezuela’s international debt obligations. A default would cut off Venezuela from international credit markets, but that is nearly the case under present circumstances anyway due to Venezuela’s low creditworthiness. If it defaults, Venezuela might continue to make good on its oil shipments to pay for its loans from China, if only to keep at least one potential source for emergency financing available. To minimize the amount of international assets that might be seized by creditors in the event of a default, Venezuela would be likely to shift its exports onto leased tankers. It would also be likely to require buyers to take delivery of product while it is still in its home ports. CITGO, which is wholly owned by the Venezuelan government, would be at risk in this scenario, but the Venezuelan government is already considering selling or mortgaging it for a short-term financial boost. Even a partial default, though, would mean further economic hardship for Venezuelans, greater scarcity and deeper economic contraction.

Economic reform measures work best when they are backed by a substantial degree of political and social consensus. However, this is something that is not currently available in highly polarized Venezuela. The possibility of a deal between the government and the opposition—never strong in 2014—has now faded even further. Last year’s Union of South American Nations (UNASUR) and Vatican-supported dialogue created some hope that a bargain could emerge around three points: the government would release political prisoners, the opposition would cooperate with the government’s plan to address Venezuela’s dramatic levels of criminal violence, and both sides would cooperate on renewing constitutional authorities key to ensuring a level political playing field. At the time, many members of the Supreme Court, National Electoral Council, as well as the Solicitor General and Ombudsman, were serving expired terms, and the requirement for a two-thirds vote in the national legislature created hope that the government and opposition would have to work together to reach the required supermajority. Alas, the Venezuelan Supreme Court recently decreed that one-half is equal to two-thirds, allowing the government to appoint loyalists to these positions with a simple majority in the legislature, clearly violating the procedures spelled out in Venezuela’s own constitution. This means that there is not much left for the opposition and government to bargain about. The opposition, which has been deeply split since last year over how to proceed during the present crisis, has suddenly papered over its differences and is calling for increased popular protest against the government. Diosdado Cabello, the head of the national legislature and a leading Chavista, has already threatened arrests of anyone in the opposition associated with such a program. This all points to a winter of discontent for Venezuela.

What Role for the International Community?

In recent weeks, outsiders have called for greater attention to the crisis in Venezuela.Former presidents of Colombia, Chile and Mexico visited Venezuela at the invitation of the opposition. Separately, Chile has reminded the Venezuelan government that last year’s UNASUR mediation process were still available. However Chile’s offer was swiftly and decisively rebuffed by the Maduro administration.

The international community has very limited options in the present situation. Declining Venezuelan oil sales to the United States have weakened the economic relationship between the two countries. Moreover, longstanding hostility by the Venezuelan government means that any U.S. recommendations to change course and adopt more sensible policies will be rejected out of hand. Recent sanctions legislated against Venezuelan officials by the U.S. Congress have reinforced this pattern of hostility. The emerging powers which seemed to have some influence over Venezuela in 2014—Brazil and China—have made scant progress in convincing the Maduro administration to actually change course. Neighboring Colombia has maintained a low profile to avoid any diplomatic incidents with the Maduro administration. Long-time Venezuelan ally, Cuba, with no warning to Maduro, chose rapprochement with its long-time adversary, the United States. If Cuba has made efforts to try to influence Venezuela’s government onto a more sustainable path, they do not appear to have succeeded.

Yet it is not in the interests of these countries to have a worsening situation in Venezuela fester. The Obama administration is already dealing with highly complex crises in Europe and the Middle East. Colombia is in the midst of complex peace talks with its Revolutionary Armed Forces of Colombia—People's Army (FARC) insurgents, and worsening conditions in Venezuela would be a distraction. Brazil has billions in trade and investment at stake, and China’s interests in repayment of over $40 billion in loans would surely be better served if the Venezuelan government were to adopt sensible (albeit difficult) economic reforms. Cuba has tens of thousands of its citizens on the ground in what is becoming a progressively more difficult and dangerous environment.

The convergence of interests among states and institutions with a stake in restoring peace and prosperity to Venezuela suggests that there is a more conducive international environment in place to support needed measures. But even if these international actors did a better job of working in concert to encourage economic reform, contentious domestic politics in Venezuela remains an obstacle. Any successful reform will require that Venezuelans achieve a degree of political and social consensus that they do not presently possess. This means dim prospects for pulling back from the abyss, and an increased likelihood of further political and social turmoil in this troubled nation.