Venezuela is facing the most serious economic crisis of any country in Latin America. Inflation is expected to top 400% this year and electricity companies are already failing to keep the lights on in many parts of the country. The country's largest beer company has already shut down and Coca-Cola is struggling to buy sugar to keep producing soda. In a recent article for The Washington Post's wonk blog Matt O'Brien explained, "Venezuela has become a failed state. According to the International Monetary Fund's latest projections, it has the world's worst economic growth, worst inflation and ninth-worst unemployment rate right now. It also has the second-worst murder rate, and an infant mortality rate at public hospitals that's gotten 100 times worse itself the past four years." Venezuela's currency has lost 99% of its value over the last four and half years. Beyond the statistics, Venezuela has become a nightmare for many citizens. The New York Times recently published a story documenting the crisis Venezuela's hospitals face on a daily basis. At some public hospitals doctors are washing their hands with seltzer water before surgery. “It is like something from the 19th century,” according to one doctor. Since 2012 the number of new born babies who die in Venezuelan hospitals has increased one hundred fold. Ford,General Motors, Goodyear and a number of other U.S. companies have already been hurt when Venezuela has adjusted its woefully out of balance official exchange rate. There is also a growing push by protesters and opposition politicians to remove Nicolas Maduro, the successor to Hugo Chavez, from office. According to some opinion polls 60% of voters want him removed from office by the end of the year. Maduro, however, appears to be ready to bunker down and fight to stay in power. To get a sense of what's going on I reached out to Grant Sunderland, Latin America Analyst at risk analysis company Verisk Maplecroft.
Nathaniel Parish Flannery: Maduro recently declared a state of emergency, a troubling new development in an already problematic situation. Are things taking a turn for the worse in Venezuela?
Grant Sunderland: Venezuela’s political and economic crisis has intensified over the last month, but it has yet to reach its climax - and there seems to be no peaceful end in sight. Riots over food shortages; preventable deaths in hospitals due to a lack of medicine; water and electricity rationing, and alarming levels of violent crime are now a daily reality for ordinary Venezuelans. These factors have set the stage for a spike in anti-government protests that will further push the country towards severe instability over the coming weeks and months.
The opposition has tried every legal mechanism at its disposal to resolve the political crisis and hold new elections. It is currently trying to terminate President Maduro’s term in office through the use of a constitutional three-step process known as a "recall referendum," which would give the electorate the opportunity to pass a no-confidence vote on the president. Over 1.8 million Venezuelans have signed a petition to force this through, but Maduro’s control of the judiciary means the attempt has so far been blocked, which is adding fuel to the fire and risks triggering a spiral of political violence.
Time is now running out for the ruling PSUV-dominated National Electoral Council (CNE) to validate the signatures by the June 2nd deadline. Popular belief that the body will either miss this date or reject the signatures on bogus claims has grown and with it the size and recurrence of anti-government protests. More worryingly though, so has the use of force against protesters by the security forces. This was illustrated on May 11 when peaceful protestors were met with tear gas and rubber bullets. The opposition’s 2013 presidential candidate, Henrique Capriles, was pepper-sprayed and police snipers have surveilled crowds from atop the CNE Caracas headquarters. So far, the confrontations have not turned lethal, but as the 2014 demonstrations showed us (when 43 died and thousands were injured), the risk of an escalation is considerable.
Maduro’s declaration of a "state of exception" and the subsequent organization of the largest military exercise in history constitute a clear attempt by the President to show that he intends to remain in power and is willing to use force to do so. If the size and recurrence of anti-government demonstrations continue to grow, Maduro is likely to up the ante and raise the "state of exception" to a state of "internal commotion." This would allow him to suspend civil rights and implement a curfew. Maduro may then dissolve the National Assembly and block the recall referendum.
Capriles has called on the military to choose between remaining loyal to Maduro or to the Constitution. However, it is unclear of the military would switch sides and if the armed forces remain loyal to Maduro, a severe clampdown on protestors and the arrest of opposition leaders should be expected in the near future.
Parish Flannery: When you look at Venezuela what are the most important economic statistics you watch?
Sunderland: The official data in Venezuela are notoriously unreliable, which makes getting a true picture of the health of the economy a lot harder. Figures on gross domestic product or inflation, for example, haven’t been published since late 2015. That said, internationally traded markets and some baseline monetary indicators give more of an insight into what’s going on at a macro level. Specifically, when it comes to measuring the financial health of the country we tend to focus on three indicators – foreign reserves, hard currency bond yields and the black market exchange rate.
In short, Venezuela is in the grip of an acute balance of payments crisis, which is now entering its endgame. Irrespective of whether this culminates in a sovereign default or a politically destabilizing social uprising, the current economic model and its steward President Nicolas Maduro appear to be living on borrowed time.
The state needs to find more than U.S. $20 billion to pay its maturing debt and interest over the next 18 months. Yet, foreign exchange reserves have fallen to less than U.S. $13 billion, with more than three-quarters of this total in the form of gold -- which is far less liquid than cash or money market instruments. In spite of recent speculation, a successful voluntary debt restructuring seems unlikely at this stage of the game.
Other macro indicators are equally worrying. Whereas most Latin American sovereign bonds trade at yields of around 5-7%, in Venezuela the equivalent figure is a distressing 30%. The dollar drought is also taking a heavy toll at a local level. While the official exchange rate of 10.3/US$ is largely symbolic, the cost of purchasing a dollar on the black market has soared to well over 1,000 bolivars fueling triple-digit inflation.
As the regime desperately attempts to stay current on its debt, households have been starved of imports of the most basic items, triggering an inevitable popular backlash. One way or another, Venezuela is sliding towards a large macroeconomic adjustment, which will have very painful consequences for ordinary citizens.
Parish Flannery: What's your view on political stability? How likely do you think it will be for Maduro to finish his term in office?
Sunderland: Venezuela’s political situation is extremely volatile and Maduro is unlikely to serve out his term. The vast majority of Venezuelans want Maduro to step down, and the staggeringly high number of people who signed the petition in favor of a recall referendum is indicative of this - though the likelihood of a new election as a result of a referendum is slim.
I believe the CNE will continue to drag its feet in authorizing a referendum so that the ballot doesn’t take place prior to January 10, 2017. If a referendum were to pass before this date, a snap election would be required to choose a new president for the remainder of the current term. A successful referendum after 10 January would remove Maduro, but not the PSUV, with Vice President Aristóbulo Istúriz serving out the remainder of the term.
The worst-case scenario is if Maduro bans the referendum altogether, which could trigger a total breakdown of political order as a result of an escalation of protests and violence and the unravelling of the internal PSUV power struggle that has, so far, remained behind closed doors. The PSUV is made up of three competing factions: the trade unions, led by Maduro; the "ideologues"; and the military. A palace coup – i.e. the ideologues forcing Maduro to resign – provides the best possible chance for a peaceful transition. The alternative, a military coup, risks increasing violence or a further crackdown on civil liberties.
A rise in civil unrest would increase the risk of a military overthrow. This is because even though the high command is loyal to the President, discontent within the rank and file – who also suffer from shortages - could tilt the balance in favor of a military overthrow.
Parish Flannery: Are there any easy policy solutions that could pull Venezuela out of this mess?
Sunderland: There are no magic policy solutions for Venezuela’s dire economic situation and any restructure will require the assistance of a multilateral institution or foreign partner. Even if the current government were to put aside ideology and adopt pro-market policies, it would still face an uphill battle. After years of populist economic policies and hostility to business, Venezuela’s industrial and agricultural fabric is crumbling. Major capital investments is needed to restore the country’s industrial production capabilities, but the government’s economic policies have shattered market confidence and make such investment extremely unlikely. Furthermore, emigration has sent the country’s best and brightest to seek opportunities abroad, and a new administration would have to prove its commitment to sustainable reform in order to attract some of this human capital back to the country.
Venezuela’s hydrocarbon reserves will continue to play a key role in the country’s economic future, but major reform is required to attract investors. Regulatory volatility has kept partners at bay for some time, and the current rise in political risk will deter potential investors from entering Venezuela in the immediate future. The country’s oil and gas infrastructure is in a creaky state after years of oil revenue being solely funneled into social programs, at the expense of investment in exploration and downstream maintenance.
Foreign companies will continue to wait on the side-lines, but are unlikely to make a move before a political shift provides some hope that pro-business reforms will be made and maintained by a new administration.
The currency will have to be floated at some stage to achieve external balance, but this will need to go hand-in-hand with a credible commitment to policy tightening in order to anchor expectations. Short-term capital controls and some kind of emerging backstop would also be needed. Given the current economic situation of the country, the process will be painful for the population, even if properly managed and executed. In this context, the recovery road ahead of Venezuela will be a long and winding one at best.
