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Jan 31, 2013 | 11:30 GMT

Venezuela Begins Its Controversial Economic Reforms

Venezuela Begins its Controversial Economic Reforms

With Venezuelan President Hugo Chavez out of the country to receive medical treatment, Vice President Nicolas Maduro is leading the Venezuelan government's push to implement critical and overdue economic reforms. The government plans to address a number of challenges, including adjusting the currency exchange system, boosting the government's oil revenue and possibly even raising fuel prices, a maneuver that has led to massive unrest in the past. If mismanaged, the reforms could destabilize the country, but Caracas believes it must act now to keep the economy from deteriorating further.

Uncertainty has surrounded Venezuela's leadership since Chavez arrived in Cuba on Dec. 11 for treatment after his cancer came back. Despite concerns that infighting among Chavez's inner circle might weaken the government in Chavez's absence, a team of ministers including National Assembly President Diosdado Cabello and Foreign Minister Elias Jaua appears to have overcome internal differences for now. A series of events in recent days and weeks has underlined the ministers' determination to deal with a number of economic problems that the government has long acknowledged but felt were not politically feasible to tackle until after the Oct. 7 elections.

Economic Troubles

Food shortages have hit the capital and a shortage in dollars has sent the parallel (gray market) exchange rate to new lows. The Venezuelan government's levels of subsidization, which were already high, grew steadily throughout 2012 as the ruling United Socialist Party of Venezuela campaigned for Chavez's reelection. These expenditures — many of which are directly controlled by Venezuelan state energy company Petroleos de Venezuela — have strained government resources, sending international borrowing up throughout the year. Although these fiscal expenditures reportedly declined in the wake of the October election, the government still has a serious cash flow problem despite high oil revenues.

The biggest immediate problem is pressure on the reserves at the Venezuelan Central Bank. The bank is struggling to meet demand for foreign currency while simultaneously transferring billions of dollars to the state's general fund. Changes made this week to laws regulating how Petroleos de Venezuela transfers windfall oil revenues to the government will see the Central Bank receive an additional $2.47 billion in 2013, and government officials are using that influx of cash to assure Venezuelans that dollars will soon become more available to facilitate the import of a range of basic consumer goods.

The move comes amid a national debate about the possible devaluation of the country's currency. The parallel market in Venezuela is selling dollars for 18-20 bolivars. The low value on the parallel market drives up demand for dollars at the cheaper official rate of 4.3 bolivars to the dollar and makes it imperative for the Central Bank to release only limited amounts of foreign currency to avoid draining its reserves. If the additional funds do not satisfy this demand, the government may have no choice in the near term but to devalue the bolivar.

Venezuelan Economy and Finance Minister Jorge Giordani has publicly opposed devaluation out of fears that it could increase inflation, the official rate of which decreased to around 20 percent in 2012 but has run as high as 30 percent in previous years. In addition to increasing the amount of revenue it hopes to pull from the energy sector, the government might require gold mining companies to sell gold to the government, according to reports from Venezuelan newspaper El Nacional on Jan. 28. On that same day, Ramirez announced the opening of three additional gold blocs for exploration.

Perhaps most startling is a report from the website, which frequently reports leaked information from the regime's inner circle, alleging that the government is concerned enough about the country's economic situation to seriously consider raising the domestic price of gasoline. With enormous pressure on Petroleos de Venezuela to subsidize government economic activities, it makes a great deal of financial sense to raise the price of gasoline. Petroleos de Venezuela has a limited ability to absorb the costs associated with a very low domestic price of gasoline, which is sold for around 2 U.S. cents per liter. While a reasonable option in financial terms, the move could pose serious political challenges.

The State Oil Company's Role

For better or worse, Petroleos de Venezuela plays a pivotal role in the Venezuelan economy. Since the early 20th century, when commercial exploitation of Venezuelan oil began, the oil sector has absorbed nearly all investment into the country. Likewise, government revenue has depended on the national oil company, which has over the past century experimented with a variety of ways to manage the resource. The belief that the country's oil wealth should be spread among its citizens is widespread in Venezuela. That sentiment has for decades driven populist policies, including austere price controls on refined petroleum fuels.

Some small adjustments to the price of gasoline have occurred over the years, most recently in 2000. The most significant attempt to raise the price of gasoline came in 1989, at the end of a decade of economic turmoil and at a point when the government could no longer afford to absorb the cost of subsidizing fuels. In one of his first acts as president, Carlos Andres Perez announced an austerity package created in partnership with the International Monetary Fund. The changes included drastic reductions in state subsidies on a range of goods, including transportation and most notably fuel. Further changes included currency devaluation and raising interest rates to 35 percent.

The changes were deemed necessary because, under the leadership of Perez's predecessor, Jaime Lusinchi, social spending policies had drained government coffers and eroded the oil industry's ability to subsidize the country. The elimination of fuel and other subsidies sparked riots that lasted several days, left several hundred people dead and injured thousands. Known as the "Caracazo," the Caracas riots of 1989 left a lasting impression on the Venezuelan public and continue to serve as a warning to Venezuelan politicians regarding the potential costs of unpopular economic choices.

The situation leading up to the 1989 reforms was not terribly different from the challenges facing the Venezuelan government today. In this context, any report that Venezuela's top leadership might seriously consider raising gasoline prices is notable. But today's politicians know how real the possibility of violence is. Consequently, if the government is indeed serious in considering these reforms, any major cuts in spending or changes in the subsidization of fuel and other basic goods will be done in a gradual and targeted manner.

Chavez is reportedly recovering, but his role in governing is unclear and likely limited. Still, the Maduro-led government will be able to use the ailing president, even in absentia, to minimize public opposition to these gradual changes. Venezuela is already dealing with significant food shortages and deteriorating infrastructure, and the risk of domestic unrest should not be underestimated. Some sort of leadership transition over the course of the next year still appears likely, and Maduro and his allies, in order to use Chavez's popularity to support the moves, will try to enact these economic reforms before Chavez is removed from the political stage.

The current changes under way demonstrate the Venezuelan government's belief that it can secure additional resources. Its options also include foreign direct investment or loans from friendly countries like China and Russia. Indeed, Caracas announced Jan. 30 that Russian oil firm Rosneft will invest $10 billion over eight years in Venezuela's Junin 6 oil block, where Rosneft will take the lead in a consortium, partnering with PDVSA. But relying on foreign direct investment and on the potential for future increases in oil and gold income is a long-term strategy. In the meantime, the government will likely be pushed to make changes to currency exchange rates and boosting revenue within the next several months.

Venezuela Begins Its Controversial Economic Reforms
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