Venezuela: Down, But Not Out

The macroeconomic problems in Venezuela do not mirror the situation in the Ukraine.

BY WALTER T. MOLANO

The anniversary of President Hugo Chavez’s death coincided with street riots, as well as the meltdown of the Ukraine.

Immediately, a tidal wave of reports and articles heralded the imminent demise of President Nicolas Maduro. Clearly, things are not going well for the former bus driver. There are widespread shortages, due to the application of draconian exchange rate controls. Almost a third of the basic consumer basket is in short supply.

Inflation is soaring, more than doubling during the past year to an annual rate of 56 percent. Venezuelans are desperate to take their money out of the country, tripling the parallel exchange rate to 83 from a level of 24 a year ago. International reserves have dropped by a third, and hover close to the $20 billion mark. This leaves the country with an import coverage ratio of less than 5 months, which is a relatively low number.

Moreover, the economy is flat lining. The combination of low growth, high inflation and shortages of basic goods makes for an explosive environment. Hence, it is little wonder that people are taking to the streets. There have been more than two dozen deaths and scores of people have been injured. The government has responded forcefully, using riot police to put down the protests.

Yet, a closer look at the situation shows that severity of the macroeconomic problems in Venezuela do not mirror the situation in the Ukraine. Furthermore, the imbalances in Venezuela are relatively easy to fix.

VENEZUELA AND PDVSA

For all practical purposes, Venezuela is an oil producing company with a national anthem. The country’s woes start with PDVSA. However, its solution also sits with the national oil company. PDVSA was always a highly politicized entity, with a great deal of independence. For most of the 1980s and 1990s, it was the nation’s kingmaker, with the ability to shape policy and the national agenda.

However, Chavez’s decision to sack most of the company’s senior personnel and technicians in 2003 transformed the institution. Losing its independence, it became the principal instrument for the president’s foreign and domestic policies. In 1998, Chavez complained that the company’s payroll of 45,000 employees was too large, and that he would do something about it. Unfortunately, he expanded the payroll by adding another 100,000 workers. The company was also affected by the departure of so many skilled technicians, leading to an 18 percent decline in oil production.

Furthermore, Chavez decided to create new PDVSA subsidiaries to further his social programs. For example, he created PDVAL for the distribution of food products, poultry and pork processing and the construction of low income homes. These projects sapped the company’s resources, reducing the amount it had for additional production. Another major problem is the ridiculously low gasoline prices. At a price of about a nickel a gallon, there are no incentives to use gasoline effectively. Millions of gallons per year are smuggled into Colombia. Since 2011, daily gasoline consumption has jumped 37 percent to 329,000 barrels per day. Therefore, there is a lot of slop in PDVSA that could easily be cleaned up.

AVOIDING A SUDDEN COLLAPSE

At the same time, Maduro’s popularity is hovering close to 40 percent. It is true that many of his supporters are turning against him, due to the shortages and economic slowdown. Nevertheless, he still remains in firm control of the governmental apparatus. The military has been extremely loyal and firmly ensconced in their barracks. There is also a sense that the opposition does not want to push too hard. They are asking for the Catholic Church to serve as a mediator in order to defuse the tensions. A sudden collapse of the Venezuelan government would do no good. It would destabilize the economy and society, thus imperiling the country’s ability to service its external obligations. Moreover, it’s not certain that a change in government would improve the country’s prospects. A painful recession looms on the horizon whenever the government decides to reform the oil sector and reduce the energy subsidies.

Last of all, there is a fair chance that a new government could repudiate the external debt—since almost all of it was issued by Hugo Chavez and his successor. Probably, the best scenario for bond holders is that the government continues to look for patches to shore up its finances, such as the recent Chinese loan for oil transaction of $5 billion.

In other words, Venezuela may be down, but it is not out.

Walter Molano is head of research at BCP Securities.