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Venezuela: Anatomy of an Economic Collapse. Part 2

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USA - February 11, 2019

The Underside of Bolivarian Socialism

All these successes of Chavez's socialism, unfortunately, turned out to be extremely unstable. Statistics decent at first glance, despite the best system for the people, were deceptive.

Even before the fall in oil prices, the country entered a large-scale crisis. In the early 2010s, the budget deficit was above 10% of GDP, and inflation reached 50% per year -- the Bolivarian system had failed.

The Chavismo foundation is not something unique to Latin America, Venezuela in particular. This is a standard Latin American populism, though in a rather radical right embodiment. American economists Rudiger Dornbusch and Sebastian Edwards define it in the book The Macroeconomics of Populism in Latin America as follows: "Policies focused on the resources repartition with neglect to inflationary and fiscal risks, as well as underestimating the economy's response to non-market government measures." Almost all countries in the region have experienced the consequences of such policies.

Venezuela itself, as Caracas economist Annabelle Abadi said, is experimenting with price controls still from 1939. The "novelty" of Chavism is in its n radicalism and the fact that by the second decade of the 21st century Venezuela remained almost the only reserve of economic absurdity in the world.

Venezuela: Anatomy of an Economic Collapse. Part 2

The economic essence of "Bolivarian socialism" is quite simple: no one gets too rich, but there is no poverty. The main aspects are:

·        consolidation of the extracted product in the hands of the state with its subsequent fair distribution

·        concentration of raw materials and land resources in the hands of society, control over them and complete change of development priorities

·        regulated prices for basic goods (precio justo goods)

·        regulated exchange rates of the national currency Bolívar

·        various programmes for the poor; the state finances health, education and subsidizes producers of goods and services

·        expropriation of private business and land (more than 5 million hectares) in favor of the state.

However, unfortunately, with all these advantages, Chavism didn't work. Low prices have led to a deficit. In addition, production was on the verge of extinction: In industry and agriculture, jobs are not created, everything is imported. Goods acquired in precio justo are resold at market prices. However, it's worth considering the fact that the "foreign hand" was the place to be. Chávez was unable to identify "friends and foes,” and some officials with access to cheap rice or dollar were able to reach a higher level and become millionaires, reselling goods at market prices.

The expropriated lands and enterprises under Chávez leadership have become badly bloated and slow. Foreign companies in Venezuela have difficulty repatriating profits.

In connection with many of these factors, the International Centre for Settlement of Investment Disputes (ICSID) outlined its claims on all expropriations during the reign of Chavez, and later Maduro, which reached $17 billion.

The situation was finally brought down by rapidly falling oil prices--the country's main export commodity and currency supplier to the budget.

Venezuela's budget deficit has remained double-digit since 2009 (subsidies are estimated by Bank of America Merrill Lynch economists at 10% of GDP). The hole in the budget was simply plugged with emission, which spins inflation.

The International Monetary Fund -- the savior of troubled states from bankruptcy, as it used to be called -- under the United States auspices initially didn't build a constructive relationship with Venezuela and broke them completely in 2007. We understand why, so no no need to explain this.

At the same time, as Financial Times previously said, the IMF discussed the issue of saving Caracas, which could become more difficult in political and financial terms than saving Greece. According to the Fund's calculations, Venezuela could need about $30 billion of financial assistance per year. Now, this is no longer relevant, but the gradual intervention of the IMF and the US, in general, managed to achieve what we see now.

In addition, the debt problems of the Bolivarian Republic were previously reported by another Fitch Agency, which lowered the sovereign country’s rating to a C. This means a high risk of failure by the state to meet its debt obligations.

Venezuela: Anatomy of an Economic Collapse. Part 2

"Taking into account payments that were not previously made on sovereign bonds relating to the thirty -- day grace period, Fitch believes that this makes a debt default very likely," the statement said.

Humanitarian Disaster

With oil prices falling by half since the end of 2014, all the problems have sharply worsened. Export revenues fell from $74 billion in 2014 to $37 billion in 2015. Imports deflated, but not so much -- from $51 billion to $39 billion. A similar in scale decline has been experienced by many oil-producing countries, but in 2016 in Venezuela, the shortage of goods at "fair" prices became prohibitive.

According to the IMF, GDP fell by 3.9 percent in 2014, 5.7 percent in 2015, and 8 percent in 2016. Allegedly defeated by Chavez, poverty quickly reached record levels as oil prices fell. In 2015, the level of extreme poverty reached 49.9 percent, poverty--23.1 percent (in 2007 it was 8 percent and 28 percent, respectively). In 2014, inflation reached 63 percent, in 2015--275 percent, and in 2016 there is real hyperinflation. The government resorted to the printing press. In 2016, 36 aircraft imported fresh banknotes into the country.

There is no hunger, but there is a shortage of food and other goods at state prices: There is a lack of medicines, rice, flour, soap, sugar, even toilet paper. At market prices you can buy a lot, but for a lot of money. At the same time, for example, the salary of a professor of chemistry at the University in Caracas is 40,000 bolivars or $25 at the market rate, a lot of people receive a minimum wage of $20. Here, by the way, the reason for the Chavism "success" is in reducing poverty: Its level is calculated at the official rate of Bolivar, at the market rate, even the upper middle class is on the verge of poverty. For the purchase of goods by precio justo, poor people have to stand in long lines for several hours just in the hope that something will be brought to the shops. Often these lines turn into riots.

Venezuela: Anatomy of an Economic Collapse. Part 2

"Exchange rate and price war pages have created an arbitrage economy in which there are too many contenders for the reduced flow of petrodollars," Bank of America Merrill Lynch's Venezuela Viewpoint: the Red Book report notes. "This gave rise to a paradoxical situation: the country with imports of $51 billion in 2014 and $39 billion in 2015 ($1660 and $1200 per capita, respectively) is testing a shortage of basic goods, which are in poorer countries."

The paradox is explained: The goods purchased by officials are massively transported to neighboring Colombia, where they are resold at normal market prices. The Colombian city of Cucuta has long been a center of smuggling, as well as the largest platform for the exchange of bolivars for dollars.

Chavez officials and businessmen close to them cash in on the smuggling. This also includes the so-called oligarchy and army generals controlling the border (drug trafficking). These are the main clans that control decision-making in the country.

Venezuela: Anatomy of an Economic Collapse. Part 2

Another view: Cheap goods with a fixed state price are sold in the markets within the country already at market prices, transported there either by corrupt officials directly or by people who almost professionally stand in line for several hours a day, and then resell the goods on the market, that is the so-called bachateros. For many residents of large cities standing in line and resale are practically the only way to earn.

The deficit with a significant flow of petrodollars is a paradox inherent in socialist economic management. It is also observed in non-tradable sectors of the economy. For example, electricity is supplied with large delays throughout the country. Guri hydroelectric power station produced about 75% of all electricity in the country in 2016, but the drought has led to a serious drop in the water level. President Maduro says it's all about the El Niño weather anomaly.

Before Chavez, there was no energy crisis but during his leadership, this happened often, such as in 2010.

The main power company Electricidad de Caracas under Chavez in 2007 was nationalized and electricity was set at low prices. As a result, intakes jumped sharply (in Colombia, per capita electricity intake is three times lower), because there is almost no need to save a free resource. The average cost per kilowatt-hour in Venezuela in 2014 amounted to $0.03, and in fact much less, as it is converted into dollars at the official, much lower at the time rate (for comparison: in Colombia — $0.10 in Brazil — $0.16, in Chile — $0.15).

Built by Chavez on petrodollars, social housing for the poor Gran Mision Vivienda was not equipped with electricity meters, but was supplied with a mass of electrical appliances at reduced prices precio justo in another social program, the so-called "Mi Casa Bien Equipada." As a result, cheap electricity at bargain prices turned out to be very expensive: Due to interruptions, many enterprises and even partially the Caracas metro are forced to have diesel generators.

De-industrialization was evident in many industries. In 2000, Venezuela produced 21,000 cars a year. In the first half of 2016, only 1,800 tons of steel were produced. In 1980, it was about 2 million tons per year. By 2006 it rose to about 5 million tons and since then began to decline sharply: to 1.5 million tons in 2014 and to 347,000 tons in the first ten months of 2016. Cement production in 2000 was 7.9 million tons, and in the first five months of 2016 only 1.2 million tons were produced.

Decline in Oil Production

The crisis also affected oil production. Throughout the 20th century, Venezuela, like other oil-producing countries, has, to the extent possible, "recaptured" oil revenues from extracting companies. Initially, the government expected only a fee for the concession agreement and a small percentage of the production. Over time, however, governments have claimed an increasing share. In 1943, Venezuela's revenues were divided in half. In 1970, the government received 55 percent. In 1976, the state company Petróleos de Venezuela (PDVSA) was established on the world wave of nationalization of the oil sector.

Venezuela: Anatomy of an Economic Collapse. Part 2

The increase in oil prices in the early 2000s and, accordingly, the growing revenues from oil and gas production caused an increase in the state's claims to the oil sector. Public spending has been rising steadily since Chavez came to power. In 2002, Chavez wanted more control over the main source of government revenue — PDVSA. The company resisted the President, after which several PDVSA top managers were dismissed.

In December 2002, the company's employees organized a strike against Chavez's policy, demanding early elections. As a result, 19,000 workers were dismissed and replaced by Chavez supporters. As PDVSA head Rafael Ramirez, "All who don't support revolution, you can get away in Miami." The relevant Ministry was created, which performed the functions of the management company, and PDVSA had become the largest donor to the social programs of the country.

The company formed the Fund for Social and Economic Development of the Country Fondespa. Between 2003 and 2008, PDVSA spent more than $2.3 billion on various social programs. In addition, the company served as the "employer of last resort" for Chavez supporters.

In 2007, Chavez expropriated the oil assets of ExxonMobil and ConocoPhillips due to the companies' refusal to provide PDVSA with a controlling stake in the Orinoco Delta. Total, Chevron, Statoil and BP agreed to Chavez's terms and reduced their shares to minority.

However, it's still worth considering that the above companies were American, and Chavez didn't want to have anything to do with the enemy who repeatedly tried to interfere in the life of Venezuela. The country was so divided that people did not know what was better: To remain loyal to their leader or to trust loud America, which has repeatedly promised to lead the country out of the crisis.

Maybe Chavez was right in his day, and if the people had been more faithful, it wouldn't have happened.

Venezuela has the world's largest proven oil reserves: According to BP Statistical Review of World Energy, it amounts to 46.6 billion tons (17.5 percent of global reserves). But these huge reserves, located mainly in the Orinoco Delta, are difficult to extract due to the high density of the oil (Oil Sands). Resource development requires technologies that are generally available to large international companies.

Squeezing foreign companies out of the country was not in vain: Oil production in the country fell from 3.2 million barrels per day in 2001 to 2.6 million in 2015. In addition, Venezuelan oil is now trading at a huge discount to WTI (the main American grade). In May, it reached 25 percent (previously, the Venezuelan mixture was trading at approximately the same level with WTI, and in 2011-2013 with a premium to WTI).

Venezuela: Anatomy of an Economic Collapse. Part 2

In this way, Venezuela very much recalled Qatar, which was under blockade. It also relied on the purchase of goods from Saudi Arabia, but unlike Venezuela, small Qatar was able to find alternative means of supply. In Venezuela, the food simply disappeared from all the shelves.

"There are several reasons," said Daniel Urdaneta, strategist at Knossos Asset Management in Venezuela. "Firstly, the production of light and low-grained varieties is gradually replaced by production from fields where oil is worse. Secondly, after departure of a number of foreign oilfield services companies, it's more difficult to maintain the required level of quality. Third, Venezuelan suppliers have difficulties with Bank financing and insurance and have to provide discounts to customers."

Oil revenues in Venezuela dropped, and it was necessary to pay off debts. "Oil export revenues at current prices (about $50/ Barr. WTI) is about $3 billion, net sales, excluding lower of $1.5-$1.8 billion a month," Urdaneta said. "Moreover, the average monthly expenditure on payment of debts is $750 million.”

It is not a trivial task to calculate the amount of debt to GDP; it is not known at what rate to calculate it. Urdaneta estimates Venezuela’s debt at 200 percent of the GDP.

According to the IMF, the traditional current account surplus from 2015 was replaced by a deficit of 7.8 percent of GDP in 2015 and 3.4 percent in 2016. Apparently, this is a consequence of the decline in oil prices and the deterioration (from a surplus in 2000-2010 to zero in 2015) of the trade balance. Although again, Venezuelan statistics are extremely inaccurate because of the multiplicity of courses.

Why doesn't Venezuela default because of the critical situation inside the country? PDVSA has sufficient assets abroad, particularly in the US, including a major oil refinery, Citgo Holding Inc. In case of default, they will be arrested, and the cash flow will suffer greatly and it will be extremely difficult for the company to sell oil. In addition, PDVSA buys light crude oil grades in the US , in order to mix with their ultramarine varieties. That is, this process will be more difficult to implement.

However, if the price of oil falls to $30/ Barr. the balance may change and the risks of default will increase. But even at $50/ Barr. the company cannot cope with payments on debts. On October 6, 2016, PDVSA announced a swap of its bonds, offering holders to replace the securities with maturity in 2017 with other securities with maturity in 2020. at the same time, the US assets of PDVSA (50.1 percent of Citgo Holding Inc.) became the pledge of the bonds with a new maturity.). 39.4 percent of the holders agreed to the deal, as a result, PDVSA will reduce payments in the period 2016-2017 by 2.799 billion and increase them by 3.367 billion in 2020, excluding interest payments.

Then It Gets Worse

In 2002, protesters, including the business elite, deprived Chavez of power for 47 hours. In response, he consolidated it even more, destroying almost all independent organizations, including the liberal media. He appointed loyal judges to the Supreme Court, who now support President Maduro. Society was divided into opponents and supporters of the regime.

When PDVSA oil company employees went on strike, Chavez fired 18,000 of his employees, appointing people loyal to him to their positions. Then Chavez distributed oil revenues among the closest circle of confidants. In 2011, $500 million was withdrawn from the Pension Fund of the state company using the financial pyramid method, but no one was punished. Company work was broken. A year later, an oil refinery exploded, there was no money left for its repair, and 40 people were killed.

In the end, cash reserves were depleted and development projects stalled. The Venezuelan economy was left without a financial cushion.

Venezuela: Anatomy of an Economic Collapse. Part 2

It is not known how long it would have lasted, but Hugo Chavez died in 2013. His closest follower Nicolas Maduro became the president, promising to continue the course. In fact, it was the beginning of the end.

Oil prices soon collapsed, and with them the entire well-being of the state, based on petrodollars. Such a fate awaited not only Venezuela, but it became the bloodiest example of how "oil populism" ends. In the fall of the economy, first Chavez, and then Maduro accused the imperialists, the West and separately the United States. Against this background, Venezuela became a loyal ally of Russia and Cuba. At the same time, Chavez financed Colombian rebels from the FARC.

Author: USA Really