Venezuela facing a deep economic crisis

• How the economic disaster plagued Venezuela?
• Reasons for the catastrophe
• Maduro wins another 6-year term. What lies ahead?

Venezuela has the largest proven oil reserves in the world, which are even more than Saudi Arabia, but still, the nation faces a biggest socio-political crisis in the contemporary world. In spite of being oil-rich, it lacks cash reserves. Venezuela is marred with numerous issues ranging from hyperinflation, plummeting oil production, scarcity of food and medicines, default on debt payment and geopolitical unrest with tens of thousands fleeing the country every day. Moreover, there are appalling conditions of its citizens, it is believed that three-quarters of its population have lost on an average 11 kg weight in the past 12 months due to food scarcity, while, presently, 90% of its inhabitants live in acute poverty.

What caused the adversity of such magnitude? Without a war (civil or foreign) or natural disaster. The collapse of present-day Venezuela can be solely attributed to the extreme mismanagement by its leaders; Hugo Chavez (1999-2013) followed by his handpicked successor; Nicolas Maduro (2013-present).

Oil is a keystone of the Venezuelan economy and made it one of the wealthiest nations in Latin America at one point in time. Oil accounts for c. 95% of country’s export revenue and has a 50% share in its GDP. This is clearly indicative by the over-dependence of the economy on oil and lack of diversification for expansion and reliance on import-based goods. In essence, everything in the nation is imported from toilet paper, food, antibiotics to clothes. However, this did not create a significant problem back in the 2000s, when the oil prices were soaring and conveniently filled the government coffers. This, in fact, allowed Chavez to fund all the generous social programs of the government (worth c. $718 bn between 1999-2014) and imports of consumer goods.

The real problem came to light in the latter half of 2014 when oil prices spiralled down to c. $40-50 per barrel from c. $100 per barrel. Needless to say, Venezuela was badly hit, oil revenues dipped from around $121 billion to roughly $48 billion between 2014-16. However, it is essential to note that the oil was made a scapegoat by the government. A steep downfall in oil prices revealed years of economic mismanagement; expropriation (in the name of nationalisation), dirigisme, currency controls, price controls and uncontrolled monetary creation. What worsened the situation was Venezuela’s utter lack of preparedness for volatility risks associated with crude oil prices. Further, unlike most other oil-exporting nations, Venezuela failed to use the inflows during the peak to build forex reserves, these could have been used to pay import bills and foreign currency obligations in an event of a crisis. The nation was also ineffectual to channelise the profits earned from the oil industry towards sovereign-wealth funds. Instead of saving for a rainy day, Chavez took advantage of the oil boom and borrowed heavily to fund the dream of a social revolution. The country issued PDVSA (Petróleos de Venezuela, S.A. [state oil giant]) sovereign bonds worth c. $62 bn, besides borrowing from China and Russia. Although external debt increased fivefold to approx. $150 bn, the government spending soared to a point that the budget deficit rose to 15.6% (2012) despite oil being steady around $100 per barrel.

In 2013, Chavez passed away after struggling with cancer, the reigns of the economy fell into the hands of Maduro, who carried the legacy of his predecessor. Furthermore, with oil plummeting in 2014, fewer dollars were available at Maduro’s disposal. If he would have allowed the bolivar to depreciate, this would have spiked the prices of imports, which was against the spirit of the socialist government and may have turned the new president unpopular. Thus, Maduro allowed bolivar to retain its artificial (overvalued) exchange rate. He rationed imports and further tightened the government control on dollars, which was a flawed policy initiated by Chavez. Wherein, a fixed rate was set for the dollar and a currency control board decided on who could exchange dollars for the home currency. The result was devastating as the flow of imports weakened, prices rose. Maduro attempted to control the prices, which miserably failed as supply either made its way to the black market or evaporated. Hence, with plummeting oil revenues and soaring government deficit, the president turned to the printing of bills instead of cutting down the expenditure or widening the tax base. All this led to a high inflation, which further complicated the functioning of the economy.

The story of present Venezuela is of extreme economic disaster and humanitarian crisis, people are starving, supermarkets are empty, hospitals are devoid of basic supplies and businesses are simply shutting down for lack of funds, inputs and customers. Inflation is expected to exceed 13,000% this year (2018) and has completely destroyed savings of the common man. Steve Hanke (professor at Johns Hopkins University), however, estimates that the aggregate inflation increased by an alarming 16,000% in the past 12 months. The GDP has fallen by close to 50% since 2013 and is projected to further shrink by 15%. Thousands of people are trying to flee to neighbouring countries such as Colombia and Brazil. Those who are not that fortunate, visit these nations to buy essentials that are unavailable on the home soil. Caracas, the Venezuelan capital is said to be the most violent and dangerous city in the present-day world.

PDVSA, which was once Venezuela’s joy and pride is now broke. While, the country’s highest ever oil production took place in 1998, it has been on a decline ever since. Currently, PDVSA has a whopping debt of $90 bn. The situation is so grave that the company cannot even extract oil in spite of 20% of world’s reserves. There are two interrelated reasons that have put PDVSA in such a colossal mess. The first, a major mistake was committed when PDVSA’s 19,000 employees were fired in 2003 by Chavez due to a general strike. The replacement of these qualified and well-equipped workers with Chavez’s loyalists was a disaster as these lacked the required skills. The second blunder was made in 2007, which drew out international expertise from the nation. In order to serve its greed (with soaring oil prices), the government demanded more revenue when the investments made by international oil companies paid off. Venezuela sought changes in the agreement with international firms and wanted a majority control in these companies for PDVSA. While, billions of dollars from oil exports were diverted for funding of the socialist programs, the money required for investments to maintain the capital-intensive sector was vehemently ignored.

Hence, the country’s oil output declined drastically as it was barely able to keep its infrastructure operational. Oil output is expected to fall to 1.1 MBPD by the end of 2018, albeit there is also a very high risk of this falling below 1 MBPD. Creditors are closing on PDSVA, confiscating its assets and further threatening to cripple its operations. For instance, Cuba took over PDVSA’s 49% stake in the Cuban-Venezuelan refinery, ‘Cienfuegos’ as payment against debt incurred from rentals and professional services. In addition, quite recently S&P Global Platts reported that PDVSA has informed 8 international clients that it would be unable to fully meet the crude supply commitments for the month of June 2018. Further, vis-à-vis the contracted volume of 1.27 MBPD, PDVSA merely has 578,000 BPD of the grade available. In fact, while PDVSA’s total crude commitments for June stand at 1.50 MPBD, it only has 694,000 BPD available. Sinopec, a Chinese oil firm has sued PDVSA for unpaid debts.

In December 2017, in an attempt to resuscitate the economy and circumvent the US sanctions against the nation, Maduro launched a new digital currency backed by the nation’s oil reserves. The administration hoped that the sales of the ‘petro currency’ would allow the treasury to pay off its debts, while at the same time increase imports of essential consumer goods. In the words of Francisco J. Monaldi (professor at Rice University’s Baker Institute), ‘the petro is a cryptocurrency that isn't crypto, that is backed by reserves that aren't reserves. That can only be monetised with a production that is collapsing and issued by a government that is in default and has no dollars’. Interestingly, President Trump banned the use of petro in March 2018.

Additionally, Maduro is said to have destroyed the last semblance of democracy by managing to ‘win’ another 6-year term as millions of citizens boycotted the widely criticised elections. The ruling party ignored calls to suspend the elections despite a threat of sanctions on the oil industry and further isolation from the US and other regional players. Maduro retained the power by curtailing press freedom and jailing his opponents. In order to avoid a military coup, the army was given a hold on the large and profitable sectors of the economy. Venezuela has already defaulted on certain portions of its debt (which stands ~162% of the GDP). Thus, with the economy in shambles, Maduro has continued to subsidise the oil shipments to Cuba as it assisted in the continuance of his leadership. The nation is far-off from injection of a fresh finance with $70 bn bond default and hyperinflation. The fall in oil production to a 30-year low has further strained government’s revenue, thereby, making it extremely difficult for Maduro administration to import basic necessities as well as keep the loyalty of other factions (military and political class). The biggest concern as of now is the default on sovereign debt. S&P has downgraded 7 sovereign Venezuelan bonds to default levels. Therefore, with a tribulation of this extent, the future seems bleak  for Venezuelans as they suffer each and every day at the hands of the dictator.