Venezuela's Maduro Faces Rough Months Ahead

7 MINS READOct 22, 2014 | 09:00 GMT
Venezuela's Maduro Faces Rough Months Ahead
People line up outside a supermarket to buy food in Caracas on April 2.

High levels of social spending and decreasing oil prices will make managing Venezuela's already troubled economy more difficult. Significant financial trouble, such as defaults on foreign debt or significant social spending cuts, is not yet imminent, but a long period of depressed oil prices will make such problems more likely. Venezuelan President Nicolas Maduro's administration will continue trying to stem inflation and shortages, but a likely cut in spending could affect the ruling party's popularity.

Recent events confirm that economic and political problems will increase for Caracas in coming months and into the next year. On Oct. 20, capital fund Skye Ventures announced that it would seek a lien on Citgo, the wholly owned U.S. subsidiary of Venezuela's state-owned energy firm Petroleos de Venezuela (PDVSA). The announcement is part of a decade-long case in which the fund has attempted to recover the value of state-issued bonds it holds, now valued at an estimated $1.5 billion. A lien could allow Skye Ventures to retain possession of Citgo assets in the United States until Venezuela pays its debt. Citgo is worth between $7 billion and $15 billion, according to various sources.

The Skye Ventures case comes as Venezuela's financial stability is increasingly in doubt. Although the debt is a small percentage of Caracas' overall finances — approximately one to two weeks' worth of imports — Venezuela's high social spending and depressed global oil prices mean that the government has reduced cash flow.

The main driver of Venezuela's increased financial instability in coming months will be the falling price of oil. By the second week of October, the average price of Venezuelan crude oil fell to less than $78 per barrel from an average of $98 the previous year. Oil exports account for more than 90 percent of the dollars coming into Venezuela. With this cash flow set to slow, upcoming arbitration and debt payments will play a larger factor in Caracas' economic decision-making. Venezuela cannot simply ignore the payments, since assets abroad (including Citgo) could be subject to seizure through court orders if it does so.

If the reduction in international oil prices persists, Venezuela will have to contend with all of its current economic and political problems, but with even less of a financial cushion. As a result, the government will likely have to make difficult decisions about what it chooses to fund. Such a cutback would likely affect social spending, which would cause voters to shift away from the ruling United Socialist Party of Venezuela, thereby intensifying friction within a weakening government.

Social Spending as a Political Tool

As part of his efforts to shore up public support, former President Hugo Chavez redirected billions of dollars in oil revenue toward funding social projects and direct transfers of money to political supporters. This redistributive policy ensured high levels of public backing for Chavez's administration for more than a decade.

However, this system created an unsustainable situation. Since 2004, oil production has declined from about 2.8 million barrels per day to between 2.1 million and 2.3 million barrels per day. This drop in production, exacerbated by the financial losses incurred by virtually giving away gasoline domestically (the official price is approximately 7 cents per gallon), weighs heavily on PDVSA, which has had to maintain spending to allow the ruling party to remain in power.

The Venezuelan government's model of securing support from potential voters is showing strains. Government revenue is already well below the level necessary to maintain its spending. According to several estimates, Venezuela needs the global price of oil to stay between $120 and $160 per barrel to meet its current spending needs. Although Venezuela ostensibly has a balanced budget (in which it calculates the price of oil at an artificially low $60 per barrel), during the presidencies of Chavez and Maduro, Venezuela has run a fiscal deficit in which additional appropriations are used to plug gaps in the budget. Such spending (which is mostly directed at funding PDVSA and other state-owned enterprises) has increased steadily in recent years and jumped from 111 billion bolivars ($17.65 billion) in the first eight months of 2013 to 280 billion bolivars during the same period in 2014. Most likely, the main reasons for this increase are the need to keep pace with rampant inflation and the imperative to prop up faltering state businesses.

Money Supply and Inflation in Venezuela

Money Supply and Inflation in Venezuela

This increase in spending has led to a sharp rise in the amount of bolivars in circulation over the past several years, which in turn has exacerbated Venezuela's inflation. In August, the government acknowledged a year-on-year increase in inflation of more than 60 percent as the overall money supply increased by about 58 percent. During the past four years, the country's monetary supply has increased from about 285 billion bolivars to more than1.5 trillion bolivars. This expansion, along with shortages caused by food smuggling and bottlenecks in imports, will continue spurring Venezuela's inflation.

The government's continued financing of a faltering budget worsens existing problems. However, Caracas will not be able to cut back on public spending (which officially stands at around 12 percent of PDVSA revenue) or halt corruption within companies that receive dollars for funding imports without facing political consequences.

Maduro's Limited Tools

Maduro most likely knows the current economic strategy is unsustainable, and will probably continue using the limited tools available to him to stem the steady increase of inflation, alleviate some food and goods shortages, and avoid the seizure of strategic assets like Citgo. He will continue pursuing existing policies, such as high levels of deficit spending. His small-scale efforts to root out corruption in companies that receive government funding for imports are also likely to continue. Throughout the year, the central government has removed import firms believed to be shell companies set up for the purpose of embezzling dollars allocated by the state without actually importing any goods. Although this campaign will continue, it will shy away from targeting any key officials likely to be involved in such corruption.

If low oil prices last more than a few months, Venezuela will try to shore up its precarious foreign currency reserves. Several sources are available for extra funding, but these will become increasingly limited. For the past several months, Venezuela's reserves have fluctuated between $21.6 billion and $19.7 billion. Due to its cash flow problems, Venezuela maintains a small part of these (usually less than $2 billion) in cash reserves, which are immediately available for funding government spending. The bulk of the reserves are held in gold, with an estimated value of $15.1 billion, at the central bank. Venezuela can sell this gold to raise more cash, but this would likely be a desperate move.

Venezuela also will continue relying on the National Development Fund and Chinese loans, though declining oil production puts these under an increasing threat. The National Development Fund was created to administer money from PDVSA separately from the national budget, but it is now estimated to have less than $2 billion. With steadily declining oil production, Chinese loans will become more difficult to obtain, although China has not yet moved conclusively to reduce funding for Caracas. The potential sale of Citgo, which previously appeared to be less urgent, likely will become a priority if Venezuela faces a greater financial challenge.

Maduro's Coming Political Difficulties

Venezuela's economic problems soon could become political problems for the Maduro administration. A cutback in spending would undoubtedly alienate voters, and Maduro's already fragile approval rating — which hovers around 30 percent — would worsen. The United Socialist Party of Venezuela likely would continue fragmenting along personal lines, although it is unclear whether there are any politicians within the ruling party or the opposition capable of capitalizing on such dissent. According to an unconfirmed report, the government is trying to mitigate the fallout from its declining popularity by rescheduling legislative elections originally slated for November 2015 to April or July of that year.

Over the next year, Venezuela will take some tentative steps toward straightening its financial situation. PDVSA will begin offering a restructuring plan to bondholders holding debt that will mature in 2016 and 2017. If PDVSA does not restructure, it will have to pay $18.5 billion in debt payments and interest from 2015 to 2017. The restructuring plan is likely a result of the government's concern that these payments will outstrip Caracas' ability to pay from its increasingly depleted public finances and off-budget funds. If Caracas cannot successfully carry out the debt swap, then the possibility of difficult domestic decisions concerning spending will become more likely.

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