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Change and Challenge: Venezuelan Economy Shows the Darker Side of Falling Oil Prices

by Abby Larson on January 29, 2015

Venezuelan Economy

2014’s remarkable decline in oil prices, dropping from over $100 a barrel to in the $40s in recent weeks, continues to drastically impact the global economy as we enter a new year. The plunge in the price of oil has benefitted the world economy itself, boosting the global GDP by about 0.2 percent. Heavy oil-importers like the United States and China as well as agriculture-dependent nations like India stand poised to profit, but oil-exporting economies are facing a more negative effect. While countries like Saudi Arabia are enduring the low prices thanks to saving the windfall they enjoyed during the $100 per barrel era, nations without these backup reserves like Russia, Iran, and Venezuela are feeling the sting.

If you have delayed payments in oil rich but economically poor countries like Venezuela, you are likely feeling the impact directly and profoundly—even if the prices at the pump seem deceptively promising. Here, we will focus on the economic and social state of Venezuela, and in an upcoming post, we will delve deeper into the challenge of recovering debt.

Inflation and crisis

It’s no surprise that the economy of Venezuela, host to some of the largest known crude reserves in the world, is extremely reliant on oil. Oil revenue finances 95 percent of the government’s budget, and as the price continues to fall, the Venezuelan economy is shrinking along with it. In 2014, the economy shrank by a negative 4.4 percent, and the total economic output of goods and services is expected to shrink a further 6.2 percent in 2015. The government, running on a 14 percent GDP deficit, has decided to fill the fiscal hole by printing more currency. This, in turn, has led to an alarming increase in inflation.

Officially, the inflation rate in Venezuela is 64 percent, but on the black currency market, the rates can go as high as 179 percent. In an attempt to curb inflation, the socialist government has encouraged stores to lower their prices to unprofitable levels. As a result, the stores must rely on government subsidies to work. When the subsidies still aren’t enough, companies which would lose money selling at official prices either leave their stores empty or sell their products with a high markup on the black market. Food and basic goods are in short supply, and Venezuelans are standing in line for hours to buy basic goods such as milk, soap and diapers. Stocks are low, tensions are high, and street protests seem imminent. Unpopular president Nicolas Maduro has vowed an economic “counter-offensive” to fix his nation’s woes, attempting to secure an infusion of cash from Russia and, in particular, China.

Chinese credit offers crucial relief at a heavy price

Like the above-mentioned windfall savings that shielded Saudi Arabia during the oil plunge, Venezuela is sitting on its own massive foreign reserve, about $22 billion total. While an impressive figure, less than $2 billion of that is in liquid, readily deployable cash. The rest is earmarked for foreign creditors, of which China is the largest lender. China began lending massively to Venezuela in 2007, providing more than $45 billion to the struggling nation, $20 billion of which is still outstanding. Of the 2.5 million barrels of oil Venezuela claims to export each day, at least 600,000 barrels go to China with more than half of the amount earmarked for loan repayment. The terms of the loan and the uses of the money are opaque to say the least, and the Venezuelan public has little information on where the funds are actually going.

President Maduro has seemingly found success in his recent quest for more investment. After a meeting with Chinese president Xi Jinping, Maduro announced an additional $20 billion deal between the two nations. While he gave no further details, and Beijing has yet to confirm the transaction, Maduro promised that the money will be used for housing, technology, and infrastructure projects. However, it’s unclear whether the sum is a fresh arrangement or simply part of a pre-existing oil-for-loans deal, or if the Venezuelan government will even be able to use the funds for imports or debt repayments. Despite the uncertainty, Xi remarked that China’s relationship with Venezuela is the beginning of a plan to invest $250 billion in Latin America over the next decade in an attempt by Beijing to increase its influence in a strategically important region.

Venezuela’s post-crash path to recovery

Whether you call it a recession, a crisis, or a full-on collapse, Venezuela’s economy is in a precarious position and faces a long road to recovery. Without drastic change, derivatives traders are betting that there’s a 75 percent chance Venezuela faces default within a year, and a 95 percent probability it will happen within five years. Maduro, whose approval rating has fallen to 22 percent, has several options on the table. Re-establishing an autonomous central bank and creating a single, unified exchange rate system could curb inflation, while reducing public expenditures and burdensome bureaucracy could provide oxygen to the private sector.

In the last decade, South America experienced a transformative economic boom that saw massive reductions in poverty and a bright economic outlook for many Latin American countries. While neighbors like Brazil and Peru enjoyed unprecedented growth and financial stability, Venezuela faces an uphill climb to keep up. Only time will tell if the struggling nation can make the drastic shifts in policy necessary to ensure a stable, prosperous future

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