Venezuela’s Meltdown Continues

Just a decade ago, much of the political left in Latin America and beyond still admired Venezuela’s ambitious socialist project. They applauded President Hugo Chávez and hailed Venezuela’s socialism as an appealing alternative to market-based approaches. Today, few dispute that it has failed. Venezuela now faces an economic and humanitarian disaster, and the situation is only getting worse.

According to the International Monetary Fund (IMF), the economy contracted ten percent last year, and it is projected to shrink at least eight percent this year. Inflation is forecast to reach 700 percent. All over the country, energy shortages leave the streets in darkness for hours every day. The capital, Caracas, has one of the highest murder rates in the world. And in a country with a barely functioning health system, an estimated 400,000 people have contracted the Zika virus, and the numbers keep rising.

All of this in the country with the highest proven oil reserves in the world. After more than 17 years of what Chavistas called “socialism of the twenty-first century,” Venezuela is even more dependent on oil than it was when Chávez assumed power in 1999. Then, oil accounted for less than 80 percent of all exports. Today, it accounts for 95 percent of exports and at least 25 percent of the country’s GDP. With the price of oil below $40 a barrel—and even lower for the heavy crude that Venezuela produces—the country is running out of hard currency. The fiscal deficit is approximately 17 percent of GDP, and President Nicolás Maduro—Chávez’s handpicked successor, who was elected for a six-year term in 2013—has slashed imports in an effort to preserve scarce foreign currency. In a country that barely produces anything but crude oil, however, the result has been chronic scarcity.

BETWEEN A ROCK AND A HARD PLACE

As the economic crisis worsens, a government default seems increasingly likely. According to Venezuela’s Central Bank, the country’s debt amounts to a staggering $138 billion—equivalent to six years of oil exports. In late February, the government spent a significant share of its available cash reserves to make a $1.5 billion payment, but it still has to cover more than $10 billion this year.

The only way out for Venezuela will be economic reform. Yet so far, the government has proved unable to take serious action.

So far, Maduro has insisted that his government will fulfill its external debt obligations. He even sacked his recently appointed minister of the economy when the minister hinted that a selective default was an option. Yet Maduro’s own negligence and inability to make desperately needed economic reforms have driven the country into an impossible situation. The country lacks the money to pay its debt and buy essential imports. Continuing along the current path is a sure recipe for economic disaster, and the government will almost certainly have to restructure its debt and begin wrenching reforms. The longer the government delays these decisions, the greater the pain is likely to be.

At the center of this intractable situation is the state-owned oil company, Petróleos de Venezuela (PDVSA). Because no one in the international community has much reason to trust in Venezuela, the cash-desperate government has been issuing bonds through PDVSA in an attempt to obtain new funds at lower interest rates. By this point, however, the government has squeezed the company dry. Not only has PDVSA, like the government itself, run out of money to fulfill its own debt obligations, but the government also forces it to finance many of the social programs, such as educational, health, and housing initiatives, that allow Chavismo, the social movement Chávez created, to maintain political support. In 2012, PDVSA contributed almost $44 billion to social welfare programs.

A government default would thus drag PDVSA down with it. Unpaid creditors would seek to impound the oil giant’s global assets: its tankers, refineries, shiploads of fuel, and other properties. A government default would probably force PDVSA to sharply curb its funding of the social programs that are essential for the preservation of the government and of Chavismo itself. The Venezuelan economy would, for all practical purposes, cease to function at all.

If Venezuela is to avoid this outcome, China will have to play a critical role. Over the past decade, it has provided Venezuela with approximately $65 billion in loans. Roughly a third of Venezuela’s debt is owed to China. So far, China has been willing to help keep the country afloat—it wants privileged access to Venezuela’s oil reserves over the long term—with loans in return for oil shipments. But with the price of oil so low, half of the oil Venezuela ships to China every day (over a third of Venezuela’s total production) is used just to repay previous loans.

The Chinese share of Venezuela’s foreign debt, however, may be the easiest to restructure, thanks to the decadelong alliance between Beijing and Caracas. Given China’s interests in Venezuela, China would probably be willing to extend payments and grant some concessions in return for even greater access to the country’s oil and minerals on favorable terms.

If Venezuela is to avoid a default, China will have to play a critical role.

Yet even reaching an understanding with China may not be enough for Venezuela to avoid the collapse of its economy and a default on the rest of its debt. Private international investors hold most of Venezuela’s government- and PDVSA-issued bonds, and they are much less inclined to strategic patience. As a result, Venezuela will likely go into default this year or next. As it does, it will have to work out a restructuring plan with its creditors. This will not be easy, however. Most Venezuelan bonds do not include collective action clauses, which allow a debt restructuring if a certain percentage of bondholders agree. Without this provision, even a small number of creditors could block a negotiated deal, as Argentina discovered after its own default in 2014. Since 2007, Caracas has had no ties with the IMF, rejecting the institution as an instrument of U.S. imperialism intent on imposing severe discipline on the nation. As a result, should Venezuela default, it will be shut out of the global economic system and, in all likelihood, be unable to export its oil. But if the country does not default, it could just be prolonging an unsustainable situation at an immense economic and social cost

ENDGAME?

The only way out for Venezuela will be economic reform. Yet so far, the government has proved unable to take serious action. In February, Maduro issued a decree proclaiming an economic emergency and announced the first increase in the price of gasoline in 17 years. Thanks to inflation, gas had become practically free for Venezuelans: filling a tank cost less than 50 cents. But Maduro’s move had little impact: gas remains extremely cheap, at about six cents a gallon. This means that domestic consumption remains too high, and Venezuelan drivers use oil that could be sold on international markets at much higher prices. The incentives for smugglers to sell oil to neighboring countries such as Colombia at great profit remain unchanged.

The president also devalued the national currency, the bolivar, by more than 60 percent, hoping to reduce the wide gap that exists between the official rate and the black market exchange rate. But most of the economy still uses an exchange rate that trades at over 100 times the official value, and the peculiar system of multiple exchange rates has contributed to the acute shortages of basic goods. Maduro’s economic reforms have thus been utterly inadequate.

On the political front, the government is finally paying the price for its chronic economic mismanagement. The opposition coalition won an impressive majority in the National Assembly in last December’s parliamentary elections. Although Maduro has used his control of the judiciary and other key institutions to resist attempts to curtail his power, even moderates within the opposition (such as Henrique Capriles, two-time presidential candidate and governor of Miranda, one of Venezuela’s largest states) are now advocating a referendum or a constitutional amendment to remove him from office as soon as possible.

Supporters of Chavismo, in turn, have accused the opposition of orchestrating an “economic war” alongside foreign actors to plunge Venezuela into even deeper chaos. Such accusations have no merit, but they show that any semblance of cooperation between the executive and the assembly to alleviate the country’s economic collapse is, at least for now, far-fetched.

As a result, there will likely be little progress so long as Maduro remains in office. For now, he appears unwilling to step down under any circumstances. But one potential path forward could involve the resignation of Maduro and his replacement with a more competent and moderate Chavista, such as the vice president, Aristóbulo Istúriz. Political compromise with the opposition is crucial. Otherwise, if violent social unrest breaks out, the military would need to play an increasingly influential role as arbiter. The depth of the economic crisis and the suffering of the Venezuelan people suggest that the country is close to breaking point.

Unfortunately, things will probably get worse before they get better. But the international community should be ready to step in as soon as the Venezuelan government requests help. At the very least, countries must prepare to ship food, medicine, and other basic goods to help ease the country’s ongoing humanitarian crisis. International financial institutions should be preparing contingency plans to assist Venezuela if the government commits to real reform. Above all, Venezuela’s neighbors have to take a much more active role. And support should include measures to promote political reconciliation. Venezuelan society is bitterly divided. Even in the most optimistic scenario, it will take many years to overcome such rancorous divisions.

Ultimately, however, a solution must come from within. It is Venezuela’s democratic institutions, as damaged as they are, that still hold out the best hope for the future.