Abstract :
· The Venezuelan economy has been experiencing negative growth since 2014. In 2016, GDP plunged by 18%, while inflation and unemployment reached 255% and 21.2% respectively.
· The country, 95% of whose exports are generated by oil, has been hit hard by the fall in oil prices;
· Venezuela’s economic model is highly centralized and characterized by the dominance of the public sector, exchange and price controls, and excessive dependence on oil.
· Economic recovery faces many challenges, including the fight against corruption, diversification of production, sound management of oil revenues, and a return to political stability.
Since 2014, Venezuela has been facing a serious economic and political crisis. The fall in oil prices has highlighted the structural weaknesses of the oil-producing state. With its back against the wall, the country needs to radically rethink its economic model in order to halt the collapse of its economy.
1. The country has been hit hard by a severe recession.
Even when oil prices were at their peak, Venezuela’s growth was among the lowest in Latin America. Between 2010 and 2014, the average annual growth rate was around 1.3%, compared with 6% for Peru and 4.3% for Colombia. Since 2014, the Venezuelan economy has been experiencing negative growth. In 2016, GDP plunged by 18%, and this trend is expected to continue over the next few years (Figure 1). This recession has caused unemployment to skyrocket, reaching 21.2% in 2016. In addition, Venezuela is suffering from hyperinflation. Last year, the country had the highest inflation rate in the world (255%). Price increases are expected to accelerate, reaching four-digit growth by 2018. This is eroding the purchasing power of households, whose consumption fell by 7.8% in 2015.
According to the « Living Conditions » survey conducted by three of the country’s universities, poverty has reached historic levels and now affects 81.8% of households. The population faces daily shortages of basic necessities. The economic crisis is therefore compounded by a health crisis. Hospitals lack medicines and a large part of the population can no longer afford to eat properly. On average, Venezuelans lost 8.5 kilograms in 2016. It is in this context that Venezuela is seeing a surge in insecurity. According to the NGO Venezuelan Violence Observatory, the homicide rate rose from 67 to 91.8 per 100,000 inhabitants between 2011 and 2016, making Venezuela the second most murderous country in the world.
2. The failure of a centralized economic modelbased on oil revenues
· A single-product economy dependent on oil
The oil sector accounts for around 50% of tax revenues and 12% of GDP. Its share of national exports rose from 69% in 1998 to 96% in 2016. This model, described as « oil socialism » by Hugo Chavez, was made possible by the surge in oil prices between 1998 and 2013 (+848%).Revenues from oil exports helped finance social programs known as misiones, on which a large part of the population depends, particularly for food. However, between 2013 and 2016, Venezuelan oil prices collapsed from $99 to $35.15 per barrel. Prices have since risen but remain relatively low (USD 43.2/barrel). The fall in prices and lack of investment in oil infrastructure have led to a decline in exports in terms of both volume and value (down 9.1% and 21.2% respectively last year). The reversal of the oil cycle is therefore calling into question the sustainability of public spending and eroding foreign exchange reserves (USD 10 billion in July 2017 compared to USD 43.1 billion in December 2008).
· Preponderance of the public sector
From 2008 to 2015, the number of civil servants doubled to 2.7 million and public spending as a share of GDP rose from 21% to 36%. In addition, state-run economic activities accounted for 34% of Venezuela’s GDP in 2015. This can be explained by the wave of nationalizations that began in 2007 in key sectors of the economy such as oil, telecommunications, and food. The government of H. Chavez expropriated more than 1,200 companies between 2002 and 2012.
· Deindustrialization
In 2015, non-oil exports amounted to USD 2.2 billion, compared with USD 5.5 billion in 1998. Over the same period, their share of total exports fell from 31.2% to 5.8%. In addition, since 2013, manufacturing GDP has been declining (-20% in 2016). Currently, companies are using only 32% of their productive capacity. Venezuela’s deindustrialization can be explained by a business climate that is hostile to the private sector (price controls, currency shortages, labor market rigidity, legal uncertainty, political instability).
· Price controls
The « fair prices and costs » law, used as a tool to combat inflation, sets pricing standards and limits companies’ margins, which cannot exceed their costs by more than 30%. Artificially low prices have stimulated demand and discouraged producers and investors. Excess demand has encouraged the emergence of black markets with higher prices.
· Expansionary monetary policy and exchange controls
Faced with difficulties in financing the public deficit and spending, the state is pursuing an expansionary monetary policy. The government is therefore making massive use of money creation (printing money), which ultimatelyfuels inflation. In addition, the country has been exercising strict exchange controls since 2003. There are currently two official exchange rates:
– the protected exchange rate, known as DIPRO (1 USD = 10 bolivars VEF), which is used for public sector imports and imports of food and medicine. It covers nearly 90% of official transactions;
– the complementary floating market exchange rate (DICOM), which varies freely between 1,800 and 2,200 bolivars to the dollar. At this rate, individuals can obtain up to USD 500 per quarter. For businesses, the monthly ceiling is set at 30% of their gross monthly income, up to a limit of $400,000.
At the same time, unmet demand is turning to the black market, where the exchange rate (DolarToday) is equivalent to $1 = 18,982.93 VEF (August 6, 2017). According to the opposition, the multiple exchange rates encourage corruption. Some companies are said to be reselling dollars obtained at the DIPRO rate on the black market instead of importing essential goods (medicines and food).
· Financial dependence on China and Russia
The Russian state-owned company Rosneft is an important source of foreign currency for the country. Until August 2017, under cooperation agreements between the two nations, Rosneft paid in advance for oil imported from Venezuela. Rosneft’s claim is currently estimated at USD 6 billion. In addition, between 2007 and 2016, China granted USD 62.2 billion in loans to the country. Some of these are credits for oil, meaning that Venezuela undertakes to supply China with oil in exchange for obtaining credit. This limits current and future revenues from oil exports. Furthermore, the government is dependent on financial markets. In the event of default and loss of access to international capital, the state would have to liquidate assets of the state oil company PDVSA, on which its economy relies.
3. Key reforms for Venezuela’s future?
· Restoring institutional stability
Venezuela is currently experiencing a severe political crisis. The opposition-controlled National Assembly is not recognized by the government. On July 30, a Constituent Assembly (CA) was elected to draft a new constitution. The opposition considers the CA to be unconstitutional, particularly because the people were not consulted by referendum on the holding of this election. The protests have left around 100 people dead and thousands injured. No economic recovery will be possible without first resolving the political crisis.
· Rethinking the management of oil revenues and fighting corruption
During the oil boom, Venezuela did not save money to cope with a possible fall in prices. Thus, the authorities did not contribute to the Macroeconomic Stabilization Fund (FEM), whose objective was to protect tax revenues from fluctuations in oil prices. Instead, oil money was used to finance various projects through the National Development Fund (Fonden). However, its operations are opaque, as it falls under the exclusive jurisdiction of the executive branch without any oversight by the legislature. In addition, the state oil company PDVSA has accumulated a growing external debt to its suppliers (USD 20 billion) and no longer has sufficient resources to invest in its facilities, which is causing problems in the refining process. PDVSA’s resources are being used by the state to finance public spending. As a result, oil production has reached historically low levels (1.9 million barrels per day). To meet domestic demand, the country imported $13 billion worth of oil between 2010 and 2014. It is therefore necessary to rehabilitate the FEM, regulate the Fonden, and limit the withdrawal of resources from PDVSA so that it can modernize its infrastructure.
· Diversify the economy and create a business climate favorable to private sector players
The country must diversify its productive apparatus. It is therefore necessary to encourage companies to invest more, given that real investment fell by 18% in 2015. The removal of price and exchange controls, the protection of companies against the risk of expropriation, and the relaxation of the import licensing system would allow companies to regain some room for maneuver.
· Reorient monetary and fiscal policy
To combat inflation, the government should pursue a more restrictive monetary policy and stop financing the fiscal deficit through money creation. Furthermore, the risk of default is high. The country faces risky upcoming maturities (USD 2.8 billion in thesecond half of 2017 and USD 7 billion in 2018). It is therefore necessary to reduce public spending while limiting the negative impact on the poorest households, which survive largely thanks to public assistance.
Conclusion
The fall in oil prices has highlighted the flaws in the Venezuelan economic model that has prevailed over the last 18 years. Dependence on oil exports and the dominance of the public sector have led to the economic crisis currently affecting Venezuela. It is difficult to envisage a way out of the crisis in the short term. The country will have to face many challenges, such as restoring political stability, combating hyperinflation, ending price controls, and diversifying its productive apparatus. However, these measures could themselves have recessionary effects in the short term, and the political context does not currently seem favorable to their implementation.
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