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Monday, May 2, 2016

Venezuela's Long Path To Recovery

Venezuela's Long Path to Recovery

    
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Summary

Venezuela is mired in an ever-deepening socioeconomic turmoil. As oil prices languish, accelerating inflation and sharply reduced imports are fueling significant frustration with the government. And, of course, Venezuela has more than low oil prices to blame for its economic collapse. In recent years, the government has financed its large budget deficits by printing more currency, spurring the highest inflation in the world at around 300 percent. Currency controls in place since 2003 have encouraged the inefficient allocation of foreign currency and the outright waste of dollars through corruption. Meanwhile, President Nicolas Maduro's administration has repeatedly put off implementing austerity measures to address the situation, fearing the high political cost of such action.
While countless discussions have focused on how Venezuela slid into decay, less has been said about how the country might begin laying the groundwork for economic recovery. For Venezuela, the path to recovery will likely be a long one. Restoring some balance to the nation's severely depleted public finances will likely take years. Even if the president is recalled by popular vote or forced by his party to resign, the next government will inevitably have to bear the political cost of the adjustments. Therefore, despite a new government's potential assurances that Venezuela is on the road to recovery, the country is expected to remain a difficult place for foreign firms to conduct business for the next few years.

Analysis

The sheer magnitude of Venezuela's economic and political plight explains many of the difficulties it will face in recovery. To a great extent, the country's current crisis is the product of short-term political thinking in Caracas. In the past decade, oil windfalls led to highly populist policies, such as heavy fuel and electricity subsidies, as well as immense social spending on health care and housing. Price controls on food discouraged local production, increasing Venezuela's reliance on imports.
As a short-term electoral tactics, these policies worked. But once oil prices began to plummet in 2014, their flaws started to show. Between 2014 and 2015, export income at state-owned energy firm Petroleos de Venezuela (PDVSA) decreased by 40 percent, leaving Venezuela with little choice but to slash imports to deal with the crisis. By nearly halving imports over the past year and a half, Caracas averted near-term financial disaster. But these cuts came at the cost of public approval. Venezuela's electorate demonstrated its discontent in December 2015 when the opposition Democratic Unity Roundtable coalition won legislative elections by a landslide. Moreover, persistent and pervasive opposition to the government reflects the public's enduring dismay.

A Party's Prospects

Venezuela's political situation presents an equal challenge. After former President Hugo Chavez died in 2013, control of the government fell more or less to a committee of elites, of which Maduro was but one member. And as the country's new leader, Maduro inherited a political structure in which the armed forces hold considerable political and bureaucratic power. The situation was tenable so long as the government was not threatened. But with Venezuela's economic decline, the political future of its leadership became more and more tenuous. For the United Socialist Party of Venezuela (PSUV), the principal concern is likely the threat of social unrest if the country's economic crisis continues unmitigated. Consequently, the coming years will probably entail Chavismo leaders crafting a survival strategy for the 2019 presidential election. Some facets of that plan have already emerged, as governors and members of the Venezuelan military's high command have called for the president's resignation.
The question now for Venezuela is how exactly a transition will proceed. If unrest over increasingly frequent and lengthy electricity blackouts, inflation and food shortages spreads across the country, Maduro's detractors may redouble their efforts to force him from office — if only to deflect public anger from the party as a whole. Otherwise, the PSUV's best interest may lie in attempting to forestall a transition until 2017, when power would pass to the vice president. This approach would allow the PSUV to retain the presidency until 2019 without risking early elections in which the opposition could assume power.

The Road to Recovery

Ultimately, Venezuela's prospects for economic recovery will depend on how the economic crisis unfolds in the months to come. A default on PDVSA's foreign debt later in 2016 — something that is far from inevitable — would usher in a lengthy, disruptive court battle with foreign bondholders. In turn, this could scare off potential investors and further shut Venezuela off from capital markets. Because the country relies on oil-related products for 95 percent of its export revenue, such an outcome would severely complicate Venezuela's recovery. Barring a sharp rise in oil prices, the specter of default will likely continue to haunt Caracas. In November, the country will have to tender nearly $3 billion in debt payments.
Furthermore, if a new government does come to power, it will face the virtually impossible task of bolstering the country's flagging finances without resorting to socially disruptive measures, such as hiking up the price of public utilities or gasoline. Since such steps will be unavoidable, frequent protests and general discord may well be a feature of a new administration's tenure. A Venezuelan recovery will probably also include requests for assistance from international lenders, although in the near term that kind of aid will be difficult to acquire. Without greater financial transparency and a major shift away from purely populist economic policies, international lenders are not likely to help Venezuela. Additionally, Venezuela harbors ideological enmity toward some international lenders: In 2007, Chavez renounced the International Monetary Fund and the World Bank as imperialist. But this could change if a new government comes to power. 
Thanks to Venezuela's oil-dependent economy, few areas beyond the energy sector will present lucrative opportunities for investment in the coming years. Even if a new government were to offer incentives or guarantees, the fact remains that the country's faltering electricity production, failing public utilities, high crime and underdeveloped private sector will discourage investors in the near term. Though the prospect of relatively low-wage expenses may lure some investors — at the black market rate, one dollar is worth more than 1,000 bolivars — Venezuela's many systemic shortcomings, as well as its pervasive corruption and onerous labor regulations, will present intractable barriers to investment.
Investors trying to enter Venezuela will encounter several major obstacles in a post-Maduro economy. A financially depleted PDVSA, whether in default or not, will limit the state's ability to optimally fund imports. Meanwhile, political instability and a dilapidated economy will pose structural challenges for future governments. Given the country's financial straits, a successor government will certainly have to bear the cost of imposing long-overdue austerity measures. In short, political and economic uncertainty will be a fact of life in Venezuela for years to come.