From Bad to Worse

President Nicolás Maduro’s desperate effort to sustain the socialist framework he inherited from the late Hugo Chávez in 2013 is careening toward failure, as a steep fall in global prices for oil, the main source of the government’s income, has exposed fully the systemic weaknesses caused by years of economic mismanagement. With no sign of an imminent rebound in oil prices, the government is edging ever-closer to a debt default that could spell the end of Chávez’s “Bolivarian revolution”. In order to balance its budget, the government requires a minimum oil price of $117.50 per barrel, one of the highest “break-even” prices in the world. Maduro has lobbied within OPEC for production cutbacks aimed at pushing the market price higher, but his pleas have fallen on deaf ears, as Saudi Arabia has opted for a strategy of maintaining a high level of output in order to retain market share. Venezuela is scheduled to make $11 billion in debt payments in 2015, but the real crunch will come in October, when a payment of $5 billion falls due. At that point, Maduro may be forced to choose between approaching multilateral lenders for help, unilaterally cutting back on generous subsidies and other social spending programs, or defaulting on the sovereign debt. None of those options is politically palatable; whichever path he chooses, the president will face a high risk of the splintering of his legislative support, dangerous social unrest, or possibly even both. Consequently, the risk of Maduro being forced from office before the official end of his term is growing. More significantly, the probability that he will remain in office and be able to count on the reliable backing of a majority of lawmakers in the National Assembly, even for the next 18 months, is less than 50%. Regardless of the outcome of the 2015 legislative elections, it is highly unlikely that a Chávista candidate—whether Maduro, or, more likely, an alternative deemed to be better suited to preserving Chávez’s revolution—will win the presidential election in 2018. Whether a victorious centrist or center-right candidate elected in 2018 will be in a position to form a majority coalition committed to liberal reform will depend to a large degree on the outcome of this year’s legislative elections. As such, the probability of that scenario is just 40%, but would rise in the event of an opposition victory in September 2015.

Repairing Economic Damage Will Take Time

The deteriorating state of the economy highlights the urgent need for increased investment, especially in the all-important oil sector. In the later stages of his presidency, Chávez courted foreign firms to assist state-owned PDVSA in developing the massive Orinoco reserves, but foreign investors adopted a wait-and-see attitude following Chavez’s death, and the Maduro administration has done little to convince them to proceed. The easing of restrictions on foreign participation in Mexico’s energy sector and planned changes to foreign investment rules in Cuba will create competition for FDI, and Venezuela has little chance of coming out on top unless the Maduro administration takes steps to undo many of the changes made under Chávez, particularly with regard to the tax and ownership structures of the sector, and convince investors that it is prepared to honor its contractual obligations and abide by the norms of international dispute resolution. A reformist government elected under crisis conditions later in the forecast period will enjoy some freedom to make the necessary changes, but it is doubtful that Maduro will get the process started in the interim. Given the current level of oil prices, oil investors would probably not show much enthusiasm even if Maduro adopted a more welcoming posture, a consideration that will likely discourage the president from doing so. Achieving sustained moderate growth over the medium and long term will require a combination of a recovery in global oil prices and healthy inflows of new investment. Assuming the former condition is met, the election of a government committed to addressing the structural weaknesses of the economy will have a beneficial effect on confidence and investment flows, creating a basis for significantly faster growth in latter part of the forecast period.

                             Forecast Summary

SUMMARY OF 18-MONTH FORECAST

REGIMES & PROBABILITIES
Maduro
45%
Divided Government 35% Military-Civilian 20%
RISK FACTORS CURRENT  
Turmoil High Same Same MUCH MORE
Investment
Equity High SLIGHTLY MORE Same Same
Operations Very High SLIGHTLY MORE Same MORE
Taxation High SLIGHTLY MORE SLIGHTLY LESS Same
Repatriation High Same Same MORE
Exchange High SLIGHTLY MORE Same SLIGHTLY MORE
Trade
Tariffs Moderate MORE SLIGHTLY MORE SLIGHTLY MORE
Other Barriers High Same SLIGHTLY LESS SLIGHTLY MORE
Payment Delays Very High Same SLIGHTLY LESS SLIGHTLY MORE
Economic Policy
Expansion Very High Same Same SLIGHTLY MORE
Labor Costs Moderate SLIGHTLY MORE SLIGHTLY MORE Same
Foreign Debt High SLIGHTLY MORE MORE MORE
SUMMARY OF FIVE-YEAR FORECAST

REGIMES & PROBABILITIES
*Reformist Coalition 50% Divided Government 30% Military-Civilian 20%
RISK FACTORS BASE  
Turmoil Moderate Same SLIGHTLY MORE MORE
Restrictions
   Investment High SLIGHTLY LESS Same SLIGHTLY MORE
   Trade High SLIGHTLY LESS Same SLIGHTLY MORE
Economic Problems
   Domestic High SLIGHTLY LESS SLIGHTLY MORE MORE
   International High SLIGHTLY LESS SLIGHTLY MORE MORE
   * When present, indicates forecast of a new regime