Up Front

The road ahead in Venezuela: Navigating through a rough sea of economic crisis

Dany Bahar and Miguel Ángel Santos

By the time the 112 representatives of the Venezuelan opposition walk into the National Assembly on January 5, the party will be over. On December 6, the coalition of political parties and civil movements grouped under the umbrella of Mesa de la Unidad Democrática won exactly two-thirds of the representatives in the Venezuelan unicameral congress. Such a super majority gives the bloc plenty of room to maneuver (at least in theory), including removing Central Bank directors, reforming the constitution (and submitting those changes to referendum in 30 days), and appointing members to the Electoral Council and Supreme Court. It has taken the opposition 17 years, a crash in oil prices, and a heavy debt overhang to hit such an electoral grand slam.

The Venezuelan economy is currently undergoing the worst crisis in the country´s 200 years of history. In 2015, oil prices, the only source of foreign currency, crashed by 50 percent and are running down into the low thirties per barrel. GDP loss is estimated on the proximity of 10 percent, inflation seems to have surpassed the 200 percent mark, and scarcity of basic staples is rampant. The government is running a fiscal deficit of 20 percent of GDP, financed mainly through printing money and financial repression taxes on domestic bondholders.

As it turns out, the country has become the poster child for illustrating the effects of the pro-cyclical bias of international lending as portrayed by the textbooks. In the years of the bonanza (2006-2012), Venezuela multiplied its foreign debt by a factor of six, engineering an import-based consumption boom that fueled Hugo Chavez’s popularity and created the illusion that socialism was, after all, possible. Now that the oil winds are blowing against Venezuela, when financing is badly needed to smooth consumption and provide for a soft landing, the international markets have effectively shut down. Venezuela´s sovereign risk, roughly 150 basis points back in 2006, is nowadays beyond 2500 basis points.

The dependence of Venezuela’s economy on oil exports is not news. Yet, during the Chavez era, this dependence has only deepened. Between 1998 and 2013 oil products passed from being 70 percent to 98 percent of Venezuela’s export basket. This shift was not only a result of the commodity price boom that characterized that same period, but also the fact that long-standing controls on foreign currency transactions, which hindered the imports of intermediate goods, eradicated the already small non-natural-resource sectors of the economy.

With oil prices in free fall, lack of sources of foreign currency is Venezuela´s most troubling feature. In 2015 the country managed to avoid defaulting on its massive foreign debt by cutting imports down more than 40 percent, selling foreign assets at a large discount (including all of its liquid reserves, a refinery, and oil trade credits), swapping 25 percent of the value of its gold reserves, and even withdrawing 80 percent of its Special Drawing Rights at the International Monetary Fund. Despite having drained all of these sources, the future does not look any better.

In the next few years, with oil sales at prices that are forecasted to stay below $50 a barrel, together with an external debt of roughly 100 percent of GDP (with 8 billion to 12 billion dollars in annual bond payments per year for the next 5 years), Venezuela will be effectively isolated from international financial markets. The combination of socialism during good times and inaction during bad times has bled the Venezuelan economy to its near death.

Venezuela: Beyond socialism and oil

As of today, Venezuela is producing roughly one million oil barrels per day less than 50 years ago, and yet its population has grown by three. Thus, the number of oil barrels per capita produced today is 74.5 percent less than 50 years ago. Even in the unlikely scenario that oil prices rise again to beyond $100 a barrel and remain like that for decades, this economic activity would likely not generate enough resources to put the country back in a path of economic prosperity: Venezuela’s oil production capacity has become too small for its population to rely on. In the medium and long term Venezuela must depart from its oil dependency and find alternative ways to improve access to foreign currency.

In the context of an executive power that has done little to avoid the current crisis (in fact, has done everything possible to exacerbate it), what can the new National Assembly do to turn the ship around?  Venezuela is in need of a strategy that will provide additional sources of foreign currency and at the same time diversify its export basket towards tradable industries that would be globally competitive. These are ambitious goals to achieve, but it all starts with a first step: legislating the creation of a new, autonomous Foreign Investment Promotion Agency.

In the past decade, many multinational corporations housed in Venezuela left the country for reasons that include high levels of crime, the inability to repatriate dividends (e.g., many international airlines either reduced or stopped operations in Venezuela), and violations to fundamental private property rights. Last but not least, there was an exchange arrangement in place that effectively punished exports and stimulated companies to move abroad and sell their products in Venezuela via subsidized imports.

However, attracting foreign direct investment (FDI) is, perhaps, the best solution both to access external resources and develop new sectors in the economy. Such an agency, backed by the National Assembly, could create special conditions to multinational corporations willing to relocate to Venezuela (such as warranties on blocking expropriation efforts by the executive, or give them preferential access to foreign currency). Without foreign investment it will be very difficult for Venezuela to go back to path of economic prosperity.

Even if the opportunities for foreign investment in Venezuela are endless, the current challenges seem to outweigh them. These challenges might be a reason for the opposition to focus only on the short-term solution to the current crisis, and perhaps they should do so. Yet, if the opposition wants to remain relevant and indeed put the country back on track, they must have an economic strategy that goes beyond the short run. The need for Venezuela to reinsert itself in the financial markets, the key to recovery, goes through the openness to foreign investment. After all, this is the only way of diminishing the mammoth size of the Venezuelan state without inducing further recession and poverty.