It’s been a tragic two weeks in Venezuela. Six people have died at protests and a prominent opposition leader was arrested after student marches escalated into large opposition-led demonstrations. Fierce mudslinging between President Nicolas Maduro and his opponents, the killing of a local beauty queen at a protest on Wednesday and the expulsion of three American diplomats have made for dramatic headlines and prompted international media outlets to question whether the president’s days in power might be numbered.
While alarming, the recent events in the South American country aren’t exactly new. Under former President Hugo Chavez, who died from cancer nearly a year ago, opposition rants against the government were met with daily government diatribes charging its critics of being coup plotters backed by Yankee imperialists. Then as now, students and opposition protesters demanding more security and freedom of speech were met with tear gas and water cannons, American diplomats were routinely chastised, and protesters died on the streets—such as the 19 people killed during an opposition march just before a 2002 coup against Chavez.
Still, concern is growing that the situation may become prolonged and increasingly disruptive. Local blogs and social media—which have become a vital source of information as local television is providing little live coverage of the protests—contain reports of increasingly violent clashes between protesters and national guard troops. Demonstrations are also expanding from Caracas to encompass a greater swath of territory. Clashes in cities such as Barquismeto, Merida, San Cristobal and Valencia may make it more difficult for the government to control its use of force against protesters. “We expect the situation to remain very fluid with continued potential for violent confrontations over the weekend,” Credit Suisse analyst Casey Reckman said.
There’s one clear distinction between the Chavez era and now: the state of the economy. Currency controls and price regulations made doing business a contorted art under Chavez, but it didn’t matter much while he had an oil price boom as a tailwind. But today, those economic restrictions have been in place long enough to take a heavy toll. Inflation is out of control, stores can’t stock basic products and businesses can’t find dollars. What’s more, these ominous economic conditions, which are fueling the current protests, are expected to worsen.
How did the economy get so dire? Let’s begin with consumer prices, which accelerated an astonishing 56 percent in January over the previous year. Government intervention in the economy and chronic underinvestment have created an increasing need for imports, which add to inflation when they’re more expensive than locally produced goods. The central bank has also been printing money to help cover a large consolidated public sector deficit. That practice mostly takes the form of local currency-denominated cash advances to help PDVSA fund non-oil activities it executes on behalf of the central government. This has injected excess liquidity into the economy, putting additional upward pressure on consumer prices, and also increased the state oil company’s debt with the bank to $35 billion at the end of 2013.
The government has tried to shield some segments of the population from the inflationary pressures. Public sector workers have received sizeable wage increases, and lower-income Venezuelans can shop at subsidized supermarkets. But it’s unlikely that the world’s ninth-largest oil producer can forever use crude revenues to shield these groups from the effects of high inflation, according to Reckman. That’s especially true given the country’s decrease in oil production. Even though oil accounts for around 45 percent of the federal budget, PDVSA’s investments in new exploration and production have been insufficient to offset falling output at mature fields. According to PDVSA, crude production fell to 2.9 million barrels a day in 2012 from 3.2 million barrels a day in 2008. Other sources estimate current production to be lower. “That’s the essential question: how compromised is their cash flow already?” Reckman said.
The country currently operates under a dual exchange rate, which values the dollar at 6.3 bolivars for essential goods such as food and medicine and 11.3 bolivars for areas such as tourism and oil investments. The system has so far failed at its intended goal of cracking down on a growing black market for currency, which pays upwards of 90 bolivars per dollar.
Price controls have exacerbated shortages of a wide variety of goods such as toilet paper, corn flour and fish. Some local newspapers even cut sections in their print editions or shut completely because they couldn’t find paper to print on.
Credit Suisse recently lowered its 2014 economic growth forecast to 1.2 percent from 2.7 percent, and projects that government and PDVSA debt will reach 41.9 percent of GDP this year, up from 39.8 percent in 2013. In December, both Moody’s Investors Service and Standard & Poor’s lowered Venezuela’s credit ratings after Maduro forced retailers to lower prices.
Officials have said they expect to launch yet another foreign exchange system next week. That mechanism is expected to allow the private sector to directly trade dollars and dollar-denominated bonds by way of brokers, and would likely draw on a weaker exchange rate than the two currently being used. Reckman says the new system is likely to be a “favorable development” that has the potential to increase foreign exchange flows to the private sector. “This could help reduce goods shortages, support growth and relieve pressure on the parallel exchange rate,” she says.
It remains to be seen whether the worsening economy and the opposition demonstrations it’s helping to fuel, could erode support for the Maduro government. On one hand, the splintered and uncoordinated opposition is actually giving chavistas a reason to band together after their deflating near-loss in last year’s presidential elections
Source: The Financialist, by Credit Suisse
