Venezuela used to be the richest country in Latin America with one of the largest oil reserves in the world. But today Venezuela’s democratic institutions and its economy are in shambles. It has the highest inflation rate in the world, making food supplies and life-saving medicines inaccessible for most Venezuelans. How did the economy of this oil-rich nation collapse?
Hugo Chávez came to power, after unsuccessfully attempting a coup, by winning an election in 1998. He won by selling the idea of giving power to the people and ending the corruption of the traditional political parties that had governed Venezuela for the last quarter-century. His populist message resonated with the country’s poor who eventually helped bring him to power. He redistributed land and wealth. He nationalized oil, finance, agricultural and industrial companies. The key moment in his presidency came in 2004 when oil prices surged. Venezuela’s petroleum-dependent economy started booming. Chavez went on spending billions from the profits on social welfare programmes for the poor. He subsidized food, improved the education system and built an enviable healthcare system. These programmes certainly helped the poor but they served a purpose for Chavez as well. In order to get re-elected, he needed to keep Venezuelans happy. But he didn’t scale back Venezuela’s dependence on oil and his unrestrained spending led to a grown deficit which meant all of these programmes would be impossible to sustain if oil prices fell. After Chavez’s death when Maduro took office as his successor, the oil prices plummeted in 2014 and Maduro failed to adjust.
Declining oil prices caused government revenues to plummet and reduced foreign reserves. The government increased the number of bolivars available in the streets, as the money in circulation was not enough to finance domestic bills and pay for basic goods. Hyperinflation took hold, destroying the savings of individuals and making productive business investment nearly impossible. The government then made things worse by implementing price controls, setting maximum prices that private businesses could charge for a wide range of basic goods, from food to medicine. The government controls set prices well below what otherwise prevailed on the free market. As a result, private business owners have cut back production or shut down as their losses have mounted. The country’s currency is worthless and its cash crisis is only getting worse.
On top of that, Venezuela hasn’t been taking good care of its oil facilities and the state-run oil company, PDVSA has defaulted on its payments to subsidiaries. It hasn’t paid the companies that help extract its oil, such as Schlumberger (SLB). In the spring, Schlumberger and other companies dramatically reduced operations with PDVSA, citing unpaid bills. PDVSA is generating negative cash flows and piling up a mountain of debt.
The loss of dollar reserves resulting from low oil prices and defending a fixed exchange rate has put pressure on debt-service payments. The government borrowed heavily in dollars from international creditors to finance the social programmes when oil prices were high. After oil prices plummeted and dollar revenues from oil exports fell, the government began to struggle with debt payments. It has paid international creditors at the expense of public subsidies. At present, the country’s external debt is $140 billion which is around 34% of its GDP.
The government slashed imports resulting in food and medicine becoming scarce. The weakened local producers could not keep up with the demand and food prices skyrocketed. The cost of basic groceries is now about five times the minimum wage. An estimated 25,000 Venezuelans make the trek across the Simon Bolivar International Bridge into Colombia each day. Many of them looking for household supplies they cannot find back home or to eat in one of the facilities offering struggling Venezuelans a free plate of food. In Colombia, social services and hospitals in border cities are saturated with the influx, and the national government has taken steps to prepare for even more arrivals. Several Latin American countries fear that the crisis in Venezuela will unleash a wave of refugees.
On the political front too, things have not gone down smoothly. The current conditions have sparked protests against the president, Nicolas Maduro. Maduro has consolidated his power bringing the country closer to authoritarian rule. His political ambition became evident in December 2015 when a coalition of opposition parties called the Democratic Unity Roundtable (MUD) won a two-thirds majority in National Assembly putting Maduro’s rule at risk. In response, he quickly forced out several Supreme Court justices and filled the positions with his loyalists. In March 2016, the court ruled to strip the opposition-led National Assembly of its powers. Despite the public outcry and violence, Maduro held a vote in July 2017 to elect a new governing body called the National Constituent Assembly which would have the power to rewrite Venezuela’s constitution and essentially replace the National Assembly, thereby leaving no opposition to Maduro’s rule. The citizens didn’t have a say in whether the Assembly should exist. They only had the option to elect its members.
Maduro had announced the restructuring of bonds worth $60 billion. However, the most common financing mechanisms are effectively blocked by US sanctions which were levied this year. The sanctions are meant to block banks from dealing with the government of Venezuela and the state-run oil and natural gas company PDVSA. Venezuela and PDVSA cannot carry out ‘swap’ transactions in which they exchange maturing bonds for ones that come due further down the road because financial institutions with US headquarters (IMF, World Bank) would not be able to acquire the new debt.
The biggest concern right now is that Venezuela will default on sovereign debt. Unable to extract more oil, PDVSA has few options to increase its cash flow – making a sovereign debt crisis for the oil-dependent country more likely.
By Rubina Boparai