Low Oil Prices Continue to Hurt Venezuela

3 MINS READDec 12, 2014 | 10:00 GMT
Low Oil Prices Continue to Hurt Venezuela
The Venezuelan bolivar currency is presented next to the U.S. dollar

The Venezuelan economy continues its downward spiral as 2015 approaches. Faced with rising domestic expenses that it can no longer meet through dollar income from oil exports alone, Caracas has accelerated measures to increase its money supply since 2012. The central bank has also printed more bolivars to keep up with spending obligations. This expansion of the monetary supply has spurred inflation, which was already exacerbated by government foreign exchange mechanisms and smuggling to Colombia, making food and goods less available to consumers in Venezuela. The decline in global oil prices that began in September has compounded these troubles.

Venezuela's government has traditionally distributed foreign currency in its economy through the Sicad I and the Sicad II mechanisms. Before August, the Sicad I auctioned about $880 million per month and Sicad II disbursed around $50 million per day. The distributions were not large enough to meet the country's needs though, and the country's demand for U.S. dollars continued to grow.

The global decline in oil prices has only increased Venezuela's troubles, further damaging the country's already struggling public finances. The price of the Venezuelan crude oil basket plummeted from a high of about $100 per barrel in June to around $60 per barrel in the second week of December. Likely the result of reduced cash flow, the Sicad I has not held an auction since Oct. 15, and the Sicad II is currently disbursing around $20 million daily.

The sharpest effect of this dollar shortage has been on the value of Venezuela's national currency. The black market value of the dollar has skyrocketed to almost 180 bolivars per dollar as dollar-hungry Venezuelans attempt to buy foreign currency. Increasing numbers of buyers have apparently resorted to the black market. The shortage of the bolivar has rapidly driven up inflation in recent months, making it increasingly difficult for businesses to acquire dollars and budget for future operations.

The current situation puts the Venezuelan government in a difficult financial position. Caracas will have to find a way to decrease expenditures to retain as much cash as it can, likely resulting in a cut to domestic subsidies. The government will also have to increase the revenue it receives from sales of oil abroad, and cutbacks in shipments of crude oil and petroleum products to Petrocaribe and Cuba are also plausible. As a last resort, the government could choose to gradually raise the price of fuel at home.

Some of the options come with significant costs. A fuel price increase or a cut in subsidies could spark protests or resistance from public officials who illegally sell gasoline abroad. On the other hand, inaction is also not an option for the government. Leaving the country's shortages and inflation to fester could spark wider public unrest, and inaction could also lead to electoral defeat for the ruling United Socialist Party of Venezuela in the 2015 legislative elections. Since the unity of the party depends on its ability to win elections, a loss could accelerate divisions between the party's elites.

Consequently, Caracas will continue making increasingly desperate adjustments to its economic policy throughout 2015, all carried out in the hopes of forestalling social unrest or eventual decisions that could result in regime change. The government could move to devalue the bolivar or cut public spending in 2015. State oil company Petroleos de Venezuela and the Venezuelan government will also likely continue their attempts to restructure $12.5 billion in debt payments that are due in 2016 and 2017 with the goal of reducing its debt burden and likelihood of default. Measures such as selling large sums of gold from the central bank reserves or even defaulting on foreign creditors to continue satisfying domestic constituents would indicate increasing desperation from the government.

Ultimately, the future of the Venezuelan economy, and therefore the government's stability, will depend on oil prices. A prolonged period of low global oil prices will increase political pressure on the Venezuelan government, and will in turn raise the likelihood of social unrest or internal challenges to President Nicolas Maduro in 2015.

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