Venezuela buckles up for oil price turbulence

Venezuela buckles up for oil price turbulence

Only just avoiding default in October, Venezuela now tries to get public budgets in order to keep investors on board. Yet, a major debt crisis is still the most likely scenario.

Venezuelan president Nicolás Maduro pushed through a number of economic reforms on 18 November, with the aim of slashing the budget deficit and reducing market imbalances. But the relatively market-friendly policy changes are desperate measures in desperate times. With oil prices falling, the exchange rate under increasing pressure, and bond yields soaring, Maduro has little option but to bring some financial moderation.

Balancing act

The new law, which raised some taxes and established special economic zones, among others, may be too little too late. Investors are getting out of the country’s bonds in droves, while the balance of payments worsened over a fall in the oil prices. And Maduro risks being outflanked by the left-wing faction of his party, the Partido Socialista Unido de Venezuela (PSUV).

His is therefore a careful balancing act in the face of an adverse economic climate. In the meantime, Venezuela is unlikely to become a more attractive investment destination.

In October, the country narrowly avoided a default, deciding to pay investors at the last minute. But government bond yields have rocketed in the month after, reaching their highest point since 2008. And then the oil price collapsed. With most of the state’s income coming from its oil exports, this dealt a major blow to an already deficit-driven budget.

The government stated that it would assume a $60-per-barrel local oil price for the 2015. But it still projected a 35% increase in spending next year, on top of Venezuela’s already outlandish expenditure. Maduro also met with his fellow PetroCaribe leaders, a cheap-oil programme for the region led by Venezuela, suggesting that cuts in subsidised oil are imminent.

From bad to worse?

Venezuela’s predicament is clear and present. From here, the situation will evolve into one of three scenarios. First, a guided rebalancing of the economy, as happened in Greece during the euro crisis, is still a possibility – although it would not be painless. Second, a major debt crisis and default, but with the constitutional order intact, is beginning to seem more likely by the day. This could resemble Argentina’s default in 2001. Lastly, a major crisis with a full rupture of democracy is a remote but possible scenario.

Guided rebalancing will involve the implementation of further measures to cut the deficit, increase the government tax take, rebalance the balance of trade, rein in inflation, and other austerity measures.

The problem: these measures will hurt exactly Maduro’s constituency, consisting of poorer voters who rely heavily on subsidised goods and services. Moreover, the left-wing flank of his governing party is vehemently opposed to such measures, threatening Maduro’s reign.

At any rate, the adjustment accompanying such a rebalancing will not be pleasant – but neither will any of the other scenarios. But if Maduro manages to persuade his partisans and voters of the necessity of further measures, and if he is able to successfully implement them, he may just be able to avert a full-fledged crisis. For business, this would be the most favourable outcome. With the passing of each day, however, this option is becoming increasingly unlikely.

A major debt crisis would happen if the government would not implement any further measures, providing that oil prices do not rise significantly again and Venezuela does not get further help from abroad. Both the government’s own staunchness and opposition from within the PSUV could lead to such a situation.

If bond yields stay as high as they are, and balance-of-payments problems keep stacking up, there will come a time that Venezuela can simply not pay up anymore. This would involve a deep, prolonged economic crisis, with other countries in the region affected to some extent as well. But if the government is able to keep key institutions onboard, such as the army and the police, then it could avert an overthrow of the constitutional order. This scenario seems by now the most likely.

A constitutional crisis would involve intervention by the army, or massive protests and riots, with Venezuela’s brittle political institutions collapsing – and possibly giving rise to a dictatorship. Although the most damaging of all outcomes, this does not seem likely yet, with the army firmly on Maduro’s side.

Brace for impact

Whatever happens in Venezuela, it is unlikely to be pretty. The political landscape and investment climate will remain unpredictable for some time, and any business in Venezuela is thus inherently risky.

That said, any outcome other than a full democratic breakdown will eventually grant opportunities as well. Argentina had some of its best years after the 2001-2002 default, and countries such as Greece are slowly but surely recovering from their financial quagmires. It is too late for a soft landing in Venezuela, but the government can still avoid a high-altitude crash.

Categories: Economics, Latin America

About Author

Sjoerd ten Wolde

Sjoerd has worked as a political analyst and journalist in Brazil, Colombia and Ecuador, with a focus on oil and gas. He is currently pursuing a Master's degree in quantitative political science at the London School of Economics and holds a Master’s degree in Economics. He speaks fluent Spanish and Portuguese.