What Broke Venezuela’s Economy and What Could Fix It

(Bloomberg) -- Venezuela’s economic situation is unthinkably bad, especially for what was once South America’s richest nation. Hyperinflation, plunging oil production and unpayable debts will confront whoever wins the current struggle for control between Nicolas Maduro and Juan Guaido, both of whom claim to be president. But recovery plans are already being drafted inside and outside the country. Here’s a look at how Venezuela fell and at some of the ideas for getting it back on its feet.

Declining oil production

Crude accounts for 98 percent of Venezuela’s exports and funds the social welfare programs that once formed the core of the government’s agenda. A decline in output that started under previous President Hugo Chavez has accelerated in the past few years, with production falling to a seven-decade low of 1.3 million barrels a day in 2018, from about 3 million barrels a day when Chavez came to power in 1999. This collapse has helped sink the broader economy, which is estimated to have shrunk by about half over the past five years.

How did we get here?
The initial fall in output was caused by insufficient investment in and poor management of the oil industry, resulting in shortages of equipment and supplies, corruption that siphoned off resources, and a brain drain of skilled workers especially after a two-month strike that ended in 2003. Output took a precipitous downturn in August 2017 in part because U.S. sanctions restricted Venezuela’s ability to borrow from American investors or access U.S. financial markets. In January, new penalties effectively blocked Venezuela from exporting crude to the U.S., its biggest customer. Those sanctions also barred U.S. companies from selling Venezuela the petroleum distillate it needs to dilute its heavy crude, further hindering its ability to export.

What can be done?
The U.S. presumably would lift its sanctions if Maduro, Chavez’s chosen successor, were to be ousted and Guaido, the head of the National Assembly, to assume real power. Guaido has announced his picks for new boards for the state oil company, Petroleos de Venezuela SA, and its U.S. refining arm, Citgo. They include industry veterans whose credibility could help attract the investment needed to expand exploration and production. An investor-friendly Venezuela could expect to tap financing from the International Monetary Fund and World Bank, Wall Street, foreign oil companies and Venezuelans moving money back into the country. To achieve economic stability in the longer term, Venezuela would need to reduce its vulnerability to boom-and-bust commodity cycles by using oil revenue to invest in other industries.

Inflation

The nation’s inflation rate is running at an eye-watering annual rate of 373,000 percent, according to a Bloomberg index that tracks the price of a cup of coffee in Caracas. Soaring prices are producing hunger, leading thousands to flee Venezuela every day, with 3 million already living abroad.

How did we get here?
Annual inflation averaged 23 percent under Chavez, but the 2014 crash in oil prices made things much worse. Unlike many petrostates, Venezuela hadn’t used the go-go years to create foreign reserves or a sovereign wealth fund to fall back on. Rather than increase taxes or cut spending, the Maduro government has financed itself by cranking up the central bank printing presses. That has ballooned the supply of the national currency, the bolivar, which has lost more than 99 percent of its value since 2013 and is virtually worthless. And it’s ignited ever-accelerating inflation. The government has imposed price controls, but the rules have discouraged local production. Venezuelans are forced to turn to a burgeoning black market for basic consumer goods, food and medicine at many times the government-set prices.

What can be done?
Among the top priorities is reducing the budget deficit. No plan will get inflation under control unless this is accomplished. Because the government stopped providing statistics several years ago, no one knows the true size of the deficit. Estimates range, but the CIA put it at 46 percent of gross domestic product in 2017. Venezuelan economist Ricardo Hausmann of Harvard University, an informal adviser to Guaido, has proposed that the IMF loan Venezuela more than $60 billion over three years. A loan of that magnitude would allow the central bank to stop printing bolivars. To restore incentives for saving and investment, one approach would be to replace the bolivar with the U.S. dollar or another stable, widely convertible currency. So-called dollarization is currently employed in Ecuador. Another option is for Venezuela to peg its currency to the dollar, as Brazil did in the mid-1990s, in order to both stabilize the currency and stem hyperinflation.

Debt

Shrinking oil revenue means Venezuela’s external debt has continued to pile up, reaching $157 billion last year, or about 150 percent of gross domestic product. The country defaulted on a portion of its debt in 2017, and creditors are demanding more than $9 billion in overdue payments. In addition, Venezuela owes billions of dollars to companies including Canadian miner Crystallex International Corp. and U.S. oil giant ConocoPhillips to settle disputes over the government’s nationalization of their assets.

How did we get here?
For years, Chavez borrowed on the expectation that oil prices would remain high, and Maduro has been unable to dig the country out of the red. The U.S. government has imposed incremental sanctions that have squeezed the country’s finances and cut it off from international capital markets. Normally, when a government can’t pay its obligations, it negotiates a restructuring of its debt. Maduro has said he hoped to do that, but U.S. investors and banks constitute a large cross-section of Venezuela’s creditors and sanctions prevent them from participating in a restructuring.

What can be done?
Even under a Guaido government, negotiating a restructuring would be a tall order. Hausmann has said creditors will have to take a major haircut so that a new government is left with enough money to take care of the everyday needs of Venezuelans and reactivate the local economy. Hundreds if not thousands of funds would have to go along. Russia and China, both major creditors, have their own accounts -- billions of dollars in loans -- to settle. Legal challenges could take years to resolve. A future government might get out of paying debt issued in the past couple of years because it was sold without the authorization of the opposition-controlled National Assembly, whose approval is required by the constitution. However, the benefit would have to be weighed against the cost of irritating creditors at the start of what figures to be an arduous renegotiation process.

The Reference Shelf

• A photo essay on how 20 years of Chavismo dragged Venezuela into its crisis.
• An interview with Ricardo Hausmann, who runs Harvard University’s Center for International Development.
• QuickTake explainers on the standoff between Maduro and Guaido, Venezuela’s collapse, its fights with Exxon and Conoco, and its struggle against default.
• A Council on Foreign Relations report explains the economic, financial and humanitarian crisis.
• A New York Times magazine article on Venezuela’s descent into crisis.
• A Congressional Research Service report on Venezuela’s challenges.
• Opposition scholars blog about Venezuela’s problems at Caracas Chronicles.

--With assistance from Ben Bartenstein.

To contact the reporters on this story: Eric Martin in Mexico City at emartin21@bloomberg.net;Patricia Laya in Caracas at playa2@bloomberg.net

To contact the editors responsible for this story: Daniel Cancel at dcancel@bloomberg.net, Robert Jameson, Lisa Beyer

©2019 Bloomberg L.P.