Published On: Mon, Nov 3rd, 2014

Venezuela’s economic problems likely to get worse

Maduro_CabelloCARACAS, Venezuela -- With Goldman Sachs forecasting that US oil prices will drop by 10 percent next year from current levels, Venezuela's already dire economic straits seem likely to get worse before they get better.

According to Paul Shortell, a Latin America analyst from the Inter-American Dialogue, writing in the World Politics Review, “With crude oil prices down 25 percent since June and holding at roughly $86 a barrel, Venezuela is getting nervous. Lower prices will put greater strain on Venezuela’s oil-reliant economy as its government struggles with growing macroeconomic imbalances.”

Oil accounts for 95 percent of Venezuela’s exports and nearly half of the government’s revenue. However, two-tier foreign exchange policies and rates implemented by former president Hugo Chavez are causing huge problems for firms doing business in or with Venezuela. Multinational manufacturers have closed down operations and most foreign air carriers have reduced or suspended flights to the country.

Nevertheless, instead of addressing the underlying issues, the country’s government has focused on attacking its critics (both figuratively and literally) and blaming the United States for the recent slump in global oil prices that threatens to choke off the hard currency the country needs to pay its overseas debts, which may precipitate a default on its foreign-currency bonds.

Washington is "flooding" the market with cheaper shale oil to bring down prices and ultimately impact Russia and other oil-producing nations, President Nicolas Maduro said last month.

"The US and its allies want to affect oil prices to harm Russia, which produces around ten million barrels per day, and that is the vital income of their economy," Maduro said.

However, according to Shortell, “A lack of cash should have Maduro sounding the alarm, as Venezuela must pay off more than $28 billion of debt over the next two years. The country’s liabilities continue to mount while foreign reserves hit a 10-year low in October.”

According to Bloomberg News, the cost of protecting Venezuela’s debt against non-payment with five-year credit-default swaps, already the highest in the world, soared 2.13 percentage points last month to a five-year high of 19.89 percentage points.

This level implies a 75 percent chance that Venezuela will default in the next five years.

Harvard University economists Carmen Reinhart and Kenneth Rogoff have also warned that Venezuela is almost certain to default on its foreign-currency bonds.

In an op-ed published on October 16, Reinhart and Rogoff explained that Venezuela is “a major oil-exporting economy that is so badly mismanaged that real (inflation-adjusted) per capita GDP today is 2% lower than it was in 1970, despite a ten-fold increase in oil prices.”

Rogoff and Reinhart place the blame for Venezuela’s current problems squarely on the shoulders of Venezuela’s current president Nicolas Maduro and his predecessor Hugo Chavez.

Venezuela has “$3.5 billion unpaid bill for pharmaceutical imports, payment arrears of more than $2 billion for food, and nearly $4 billion owed to airline companies. Oil production has more than halved since 1997, in no small part because the state-owned oil company has repeatedly defaulted on suppliers and joint-venture partners,” they explained.

The last time oil prices collapsed was in 2009, following the global financial crisis, when Venezuela’s oil basket dropped to around $56 a barrel and Caracas funded itself by raising debt from Wall Street and Beijing. Both were happy to lend. Today, by contrast, Venezuela’s economy is in recession, oil output is languishing, foreign reserves are low and the country is suffering from an import crunch.

With Venezuela’s evident economic problems and the prospect of default on its current debt, it is by no means certain that anyone would be willing to provide additional, new finance today.

Venezuela needs oil prices at about US$115 a barrel to support its economy and Kuwait's oil minister Ali al-Omair has also predicted that prices could drop to around $77 per barrel – US$38 per barrel less than Venezuela needs to survive.

At these levels, PetroCaribe -- the scheme under which Venezuela sells oil to many Caribbean countries through a partial loan arrangement -- will undoubtedly be at risk.

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