Venezuela On The Brink

The looming collapse of the Venezuelan economy provides an interesting case study. While many aspects of its crisis are typical in Latin American balance of payments crises (such as large fiscal deficits financed in foreign currency), there are other aspects that are peculiar to Venezuela.

The principal peculiar feature is that Venezuela (unlike all other Latin American economies) makes nothing and imports everything. The only export and the only source of government revenue is oil. The price of oil fluctuates, and oil production has been declining despite large reserves. If Venezuela were a capitalist country following orthodox policies, it could adjust to current account imbalances via the price mechanism: as oil revenue fell, the currency would depreciate and imports would be reduced by rising prices. In extremis, the currency could fall far enough that non-oil exports would develop and import-substitution would occur.

However, markets do not function in Venezuela. It is a socialist economy with a fixed exchange rate and domestic price controls and subsidies. The currency cannot depreciate, and hence demand is managed by rationing and shortages. An orthodox economist would prescribe a steady pace of currency depreciation and steadily rising domestic prices. However, the Chavista regime was elected by and is supported by the poor who depend upon cheap imported staples and cheap domestic gasoline. The regime has been unable to adopt a conventional adjustment program and is instead heading toward a classic--and potentially catastrophic--foreign exchange crisis.

Venezuela’s liquid dollar reserves are extremely low and its access to the international debt market is limited to concessional loans from China and/or Russia. The bolivar has fallen to one US cent on the black market, versus the official rate of sixteen cents.

Moody’s assigns a rating of Caa1 to Venezuela’s dollar bonds, which means that they are at risk of default. On September 15th, Moody’s said that the Caa1 rating “reflects increasingly unsustainable macroeconomic conditions, including high inflation and multiple exchange rate regimes. As government policies have exacerbated these problems, the risk of an economic and financial collapse has greatly increased….Despite the government's relatively small external financing requirements, rising government liquidity risk reflects the deterioration of market access and elevated borrowing costs on Venezuela's external debt. Foreign exchange reserves have fallen to very low levels”.

So it would appear that the central scenario for Venezuela would be the exhaustion of foreign exchange reserves, default on external debt, collapse of the currency, and substantially higher real domestic prices. The ability of the government to provide its people with subsidized staples would be greatly curtailed, with potentially dire consequences for political stability.

With respect to the prospects for external support, the standard IMF/World Bank adjustment package seems unlikely given the kind of policy changes that would be required. Additional loans from China and/or Russia could postpone the crisis further, but would not resolve it. The underlying problem can only be addressed via severe domestic austerity, which would have undesired political consequences.

The regime has imported many Cuban officials to staff its security services, and it has been moving steadily in the direction of overt dictatorship. Opposition politicians have been jailed and the press is under siege. But it is unclear to me whether the state of affairs is such that the regime could survive an economic collapse in the way that the Castro family has. It should also be pointed out that Venezuela supplies Cuba with the cheap oil on which it depends for survival. That supply could be jeopardized if it meant subsidizing Cubans at the expense of the Venezuelan masses. Thus, a Venezuelan crisis would likely be followed by a Cuban crisis, which is a further reason why there will be no IMF bailout since the US would welcome regime change in both countries.