By Srishti Malhotra
Edited by Namrata Caleb, Associate Editor, The Indian Economist
Under the leadership of Nicolas Maduro, Venezuela is crumbling. The country needs to pay $4.5 billion as foreign debt in October, and the investors are fearful that the country might default. Maduro has assuaged investor concerns stating that state-owned US oil refinery Citgo will not be sold which might mean that the country has enough reserves to pay back bondholders for now. Venezuela has the largest oil reserves in the world and is the 10th largest oil exporter in the world with oil accounting for 94% of export earnings and 30 % of GDP.
The troubles for Venezuela began much before Maduro’s reign. When Hugo Chavez came to power in 1999, Petrolos de Venezuela, S.A. (PdVSA) the state-owned oil and natural gas company, was producing 3.5 million barrels of crude per day. But since 2001, overall oil production has fallen by roughly 25%, much of it coinciding with his term till 2012. In 2002, PdVSA employees went on strike for 63 days as part of a national protest demanding the ouster of President Hugo Chavez, triggered by the signing of 49 revolutionary laws by him. PdVSA suffered losses of US$ 12.8b as a result of the strike. Therefore, the PdVSA, being the cash-box of the government ,was able to contribute much less to government coffers than earlier, as a result of which the Chavez administration reduced the funds allocated for the 2002-03 social investment plan to almost nil leading to shortages of basic goods ,as gasoline used to produce the goods became scarce. PdVSA promptly fired 18,000 employees, replacing them with workers who were inadequately trained, yet pro-Chavez. This policy, in the long term has added to the decrease in oil production.
Chavez was able to earn supporters through his policies of providing fuel and food subsidies in the form of subsidized rice and bean and charging only a few pennies for domestic gasoline consumption. In his bid to create a socialist state he provided the people with healthcare, education, social security ,higher minimum wages and land for the poorest of the society. In 2012, Chavez’s government suffered a blow when an explosion at the country’s largest refinery in Amuay caused 42 deaths. To be sure, Chavez expanded his social security programs through increasing oil revenues and these socialist policies were the ones that led to his re-election in 2006 and 2012 before he passed away in 2013.
Now, however, Venezuela is running out of cash to pay for these support-buying schemes. Maduro, a supporter of Chavez has not been able to do much to revive the stagnating economy. Venezuela’s economy will contract as much as 3.5% this year after expanding 1%in 2013, according to Standard & Poor’s. Annual inflation in Venezuela, the highest in the world, accelerated to 63.4 percent in August 2014 leading to a decline in real wages.
According to The Organization of Petroleum Exporting Countries (OPEC), Venezuela produces 2.3 million barrels of crude daily but more than half of this production does not generate any foreign currency since most of it is supplied domestically to meet the needs of the people, which have grown substantially over the past decade as a result of the low price at which fuel is offered to them. Due to defaults of the suppliers of goods and services, Venezuela suffers from acute shortage of vital goods including food, medicine and spare parts for cars and machinery. Public services including electricity, water, education and health are getting worse. The Central Bank has increased the money supply by more than 50% during the past two years which has led to a fall in the value of the currency. Due to inadequate foreign reserves, the government is forced to sell a limited quantity of dollars at higher than the market rate, with the rates being much higher for the general public than for the priority businesses. The basic institutions of democracy have been stifled under the combined regimes of Chavez and Maduro. Independent television channels were eliminated and government influence was used to transfer ownership of newspapers to government supporters.
Ricardo Hausmann and Miguel Angel Santos, two noted economists recently in an article wrote that the government should default on its debt and stop paying bondholders, a policy that is leading to hardships for the people of the country. If Venezuela were to default on its payments, part of the burden of adjustment would be shared by bondholders and creditors, which according to them could allow for the provision of basic services to the people. The news that Citgo was to be put up for sale in July, which could have meant that investors are deprived of a basic asset in case of default, along with the economists ‘observations ,led to panic among the investors about a potential default in October by the country. Calm returned only after the President’s comments that Citgo would not be sold. Venezuelan bonds are still the most expensive in the world to insure using credit default swaps, an indication of the risk faced by the investors and of the market sentiment.
The Venezuelan public has been demanding Maduro’s resignation through protests which have turned violent. This year from February to June, dozens of people died, hundreds were wounded and several thousand more were detained during conflict between protesters and government security forces. The people demand an end to goods shortages, better security and protection of their freedom of speech.
While the probability of default is low, what certainly needs to be done, as was also stated by is that the government needs to reduce the fuel and electricity subsidies provided to the public, and charge a fair price for the dollar. The priority sector is able to get these dollars at a lower rate, which in effect is paid for by the inflation tax levied on the general public in the form of higher prices. The reduction in inflation brought about by these measures will cover up for the reduced subsidies. Although the protests have been silenced for now but anti-government sentiment will not subside unless an effective solution is found to the problems of the people. Strengthening democratic institutions is a part of the solution. An external agency might be required to intervene as the friction between the government and the anti-government protestors does not seem to be of the kind that can be internally brought to an end.
Srishti Malhotra is pursuing M.A. Economics at Centre for Economic Studies and Planning, JNU. She graduated in economics from University of Delhi. Subjects that interest her the most are macroeconomics, international economics and finance. Dance is the passion of her life and she is a trained dancer in western styles .Her future plans include travelling the world and learning to play the drums.