by Michele Delera
On September 10, Venezuelan opposition leader Leopoldo Lopez was sentenced to thirteen years and nine months in prison. Arrested on grounds of inciting violence during the wave of protests that engulfed Caracas and other major cities less than a year ago, Mr Lopez is but another casualty of the executive’s often criticized interference in judicial matters. However, with President Maduro’s approval ratings lower than ever and street protests still ongoing, the sentence might be interpreted as a sign of the government’s weakness – a last-ditch attempt at intimidating the opposition ahead of December’s parliamentary elections.
One may say that the recent upsurge in social instability across the country comes as no surprise. Corruption is widespread and the economy is in a sorry state. Import controls, a rapidly collapsing bolívar and hyperinflation – a legacy of the late President Hugo Chávez’s policy of sustained macroeconomic expansion – are causing shortages of everyday items across the country. Venezuela’s GDP is expected to shrink 7 percent this year. The inflation rate is likely to reach around 95 percent by end-2015, the world’s highest (see Table 1).
Table 1 – Selected economic and fiscal indicators. Source: IMF.
The plunge in oil prices has made matters worse. The hydrocarbon sector accounts for more than 95 per cent of Venezuela’s export earnings and over 60 percent of government revenue. Assuming current oil prices remain unchanged – as seems likely – Venezuela’s exports will decline by around $40bn this year. With lower export receipts, the fiscal deficit may increase from over 10 percent to nearly 17 percent of GDP by end-2015, says the IMF. Perhaps more worryingly for a country that imports more than it exports, the oil price drop is also rapidly widening Venezuela’s foreign exchange gap.
As concerns about liquidity grow, international capital markets have started to signal that the country’s balance-of-payments crisis may evolve into a sovereign default. The government and PDVSA, Venezuela’s state-owned oil and gas company, ought to make $5.8bn in principal and interest payments on their debt this year and $10.8bn in 2016 – money they may not have. With the government running a growing budget deficit and Central Bank reserves reportedly at less than $18bn, the strain on the country’s ability to pay its dues is significant. Bonds are trading at historically low prices (see Figure 1), and the price of insurance against Venezuela defaulting on its debt via five-years credit default swaps is now signalling an above 50 per cent chance of default before the end of the year.
Figure 1 – Emerging market government bond prices. Source: Financial Times.
It needn’t have to come to this stage. In 1998, a year before Mr Chávez came to power, then-president Caldera established an oil stabilization fund – FIEM, or Fondo de Inversión para la Estabilización Macroeconómica. Part of the oil receipts would have been saved when prices were higher than a reference value – then set at $14.7 per barrel. Withdrawals could only be made if prices fell below that benchmark. Not unlike sovereign wealth funds in other oil-rich countries, FIEM could invest its resources in foreign assets and would be managed – with a large degree of independence from the executive – by the Central Bank.
Though never formally abolished – it still exists, with holdings of merely $3mn – FIEM was first marginalised and then forgotten under Mr Chávez’s administration. Instead, the executive started to channel oil revenues directly into the federal state’s coffers. There they funded massive social programmes (misiones) aimed at improving education, health and housing for lower-income groups in rural and urban areas – the ruling party’s core constituency. Table 2, below, shows how much PDVSA has paid out in income taxes, production royalties and social development expenses over the past five years.
Table 2 – Contribution by Venezuela’s state oil firm to public expenditure (in million US$), 2009-2014. Source: PDVSA Annual Reports.
So far high levels of public expenditure have been certainly beneficial to the regime’s survival. Just as many people took to the street last year to show their support to the government as those who did to protest against it. Consequences on the economy have been less rosy. According to an estimate, with FIEM left untouched Venezuela could now have accumulated between $146bn and $223bn in reserves – more than enough for debt repayments and to provide budget support. The pillaging of PDVSA may also have contributed to shortfalls in the company’s production capacity since the early 2000s, with crude production down from a 1997 peak of almost 3.3m b/d to around 2.8m b/d (2.4m, according to global energy agencies).
Whether Venezuela will default on its obligations between the end of this year and 2016, when another $11bn are due, is hard to predict. The country’s access to unconventional sources of debt financing may delay a default for some time. Earlier this month, China has agreed to a $5bn oil-secured loan as part of a 2007 scheme that enables Venezuela to borrow from China in exchange for oil. The People’s Republic has also reportedly agreed to reschedule payments on the country’s existing debt stock. Other options are available. The government could, for instance, decide to sell Citgo, a US-based refiner owned by PDVSA that is currently valued at up to $10bn. It could also securitize the receivables of other countries that take part to the PetroCaribe scheme, as it did through the sale of Dominican Republic’s debt ($1.9bn). This is likely to put pressure on the fiscal position of the weakest countries that are part of the scheme, most notably the Dominican Republic, Haiti and Nicaragua. It would also weaken Venezuela’s standing in the region. But just like Mr Lopez’ arrest, these are somewhat desperate moves. Addressing the country’s economic woes requires bold reforms. An end to price controls and cuts to public expenditure would constitute a good start. It is increasingly unclear whether Mr Maduro should be trusted to bring these about.