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Jan 25, 2018 | 14:55 GMT

7 mins read

For Venezuela, There's a Little Light at the End of the Tunnel

A collective in a hilltop shantytown in Caracas created its own currency, the panal, to fight chronic shortages of cash in inflation-ridden Venezuela.
(FEDERICO PARRA/AFP/Getty Images)
Highlights
  • Venezuela's inflation will accelerate in 2018 due to reduced access to foreign currency and the rapid growth of the country's monetary base. 
  • Any post-Maduro government will inherit a country with a heavily reduced oil sector, with an overstaffed public sector and with currency control mechanisms that encourage the misuse of government oil revenue.  
  • Controversial austerity measures are likely to encounter resistance from government workers and members of the United Socialist Party of Venezuela.

After the turn of the millennium, Venezuela enjoyed a windfall thanks to high oil prices that bankrolled massive public spending. Fast-forward a decade, however, and the situation is bleak: An insolvent central government and high inflation are impoverishing a whole generation of Venezuelans. The current situation will likely force any new administration to attempt major structural reforms to stabilize the economy over the next decade, beyond the current stopgap measures of slashing imports and printing more bolivars.

In the short term, the overriding political question centers on whether embattled President Nicolas Maduro will step aside to allow others to begin addressing the crisis. But even after any immediate solution to Venezuela's political impasse, the country's leaders will face the difficult task of fixing a broken economy. Venezuela's leaders may succeed in taming inflation within the decade, but they are likely to bequeath a country that is deprived of much of its energy revenue, professional talent and political stability.

A Long To-Do List for Reformers 

Inflation is rising ever more quickly in the country, putting food and medicine beyond the reach of ordinary Venezuelans. In 2017, year-on-year inflation was 2,600 percent, according to estimates by the opposition-controlled legislature. The figure, however, is likely to rise throughout 2018, because a drop in imports, reduced access to foreign currency and the rapid expansion of the country's monetary base through the printing of new bolivars will all spur faster inflation. According to the International Monetary Fund, year-on-year inflation in 2018 could exceed 4,500 percent. Such high levels of inflation will continue to drive people to emigrate, will discourage foreign direct investment and other economic activity, and will lead to greater security problems, such as more looting and armed robberies. In fact, the country's economic catastrophe could evolve into a full-blown humanitarian crisis as increasing numbers of citizens seek a better life in neighboring states and as food becomes scarcer and more expensive.

If Maduro vacated his position, a new president and government would likely impose corrective measures to resolve the country's economic imbalances. Any solution to its inflationary woes will include measures to balance the country's budget (the budget deficit is running at approximately 20 percent of gross domestic product) and to downsize its overstaffed public sector. Another key task that awaits prospective economic reformers is the elimination of currency allocation mechanisms. The government's policy of strictly controlling the distribution of foreign currency has driven up the value of the dollar on the black market and consumer prices for food, medicine and other essential items. Authorities have so far hesitated to terminate the controls, probably because they provide an important source of profit for officials. The government has likewise been loath to slow the printing of bolivars because any such action would necessitate a heavier austerity program, which would result in mass public sector layoffs and would shrink the federal budget. 

The Oil Well Runs Dry

But even if Venezuela succeeds in dampening hyperinflation, the country will find itself in the unenviable position of attempting economic recovery with a diminished energy sector. Oil production — which paid for everything from imported luxury goods to periodic handouts to the poorest citizens for decades — will likely continue to drop below its current lows. Venezuela produces about 1.9 million barrels of crude oil per day (almost half of what it produced in the late 1990s), and that output is expected to decline in the coming years, although the exact figure will depend on the amount of financing the state oil company, Petroleos de Venezuela (PDVSA), can obtain and the degree to which global oil prices recover. Declining oil production is a side effect of the social policies pursued by the ruling United Socialist Party of Venezuela (PSUV) in the early and mid-2000s, when the party effectively created the conditions for the state and private citizens to spend the oil windfall of the era, setting aside little for a rainy day. Currency control mechanisms, which were originally designed to exercise greater control over the flow of foreign currency to businesses and private citizens, became gateways to mass corruption due to the misallocation of government revenue. According to one estimate, corrupt individuals who fraudulently obtained dollars misappropriated approximately 28 percent of all oil revenue between 2003 and 2012. Instead of being used to finance imports, the money was embezzled.

Venezuela's serial loan defaults will also create a problem for any new government; ultimately, Caracas may have to settle with creditors on billions of dollars in outstanding debt, including the Chinese government and private bondholders. Settling these debts will entail years of legal battles and negotiations between the government and its creditors. Outside of oil production, Venezuela has historically pursued few economic activities that can fund high levels of government spending. Accordingly, by the time the country is back on the path to recovery, it will find itself eking out an existence with the lowest prospective oil revenue in several decades to fund such services as security, electricity, sanitation and roadwork. Investment in such public works as roads, electricity and sanitation will also trail the standards set by its neighbors. At the same time, any new government is likely to attempt to impose stricter conditions on the use of PDVSA revenues for social spending.

Even as Venezuela drags itself out of recession, it will have relatively few economic opportunities to offer its citizens.

Even as Venezuela drags itself out of recession, it will have relatively few economic opportunities to offer its citizens. Oil and natural gas will remain by far the largest source of foreign revenue, though growth in that sector will directly benefit few Venezuelans. Even if the country's extremely low salaries (the monthly minimum wage currently amounts to $3 at the black market exchange rate) attract some investment, such problems as poor transportation networks, rampant crime and an unreliable electrical grid will deter all but the most determined new investors in low-end manufacturing, retail and services. Larger foreign companies that have remained in the country throughout the crisis (such as auto manufacturers and food producers) will slowly recover, but the likelihood of continued endemic poverty will limit their ability to sell more valuable products, such as cars, to consumers in the country.

The Political Pushback that Awaits

Political tumult is also likely to accompany Venezuela's period of economic stabilization. The country's opposition is too weak to force Maduro from power, so any departure will depend on the president negotiating a deal with the U.S. government or a military coup by dissidents within the armed forces. If Maduro leaves power in the coming years, a new government will likely feature a hodgepodge of opposition and PSUV figures grafted on to a bureaucratic structure heavily linked to individuals within the current ruling party. Such a government would seek to implement economic recovery measures, but reversing the course on specific measures is likely to ignite great controversy. Any moves to fire nonessential government staff from the large public sector will likely spark protests and become fodder for the PSUV in an attempt to roll back the reforms. PSUV officials could also resist the elimination of well-oiled mechanisms for corruption, such as the currency allocation mechanisms. And because such graft has become so deep-rooted, any robust reforms to end such activity could fail.

Hyperinflation, violence, economic mismanagement and political turmoil are all likely to drive many of Venezuela's best and brightest overseas and impoverish those who stay in the decades to come. Acknowledging that the only way to go is up will compel any new government to implement painful reform measures to improve the perilous state of the economy, but the harmful consequences of today's inflation will live long into the future, relegating Venezuela's coming generations to a worse standard of living — regardless of any government's best efforts.

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