geopolitical risk ratings firm

Venezuela: Maduro’s Troubles Mount


      One Year Ahead Five Years Ahead

Risk Category
Political Risk 44.5 44.5 41.5 54.0 43.5 61.0
Financial Risk 35.5 42.5 35.5 43.5 28.5 44.0
Economic Risk 28.5 22.5 22.0 24.0 21.5 32.0
Composite Risk 54.3 54.8 49.5 60.8 46.8 68.5
Risk Band High High V. High  Mod. V. High  Mod.

Government Stability
Maduro’s Troubles Mount
Political risk is continuing to rise, as the failure of President Nicolás Maduro’s administration to bring relief from skyrocketing inflation, widespread food shortages, and disruptions to electricity and water supplies is contributing to worrisome social tensions and cracks in the unity of the governing United Socialist Party of Venezuela (PSUV). Multiplying economic and social problems point to the clear need for a change in policy direction, but the deeply unpopular president appears to lack the confidence in his own authority required to implement painful reforms.
A recent Cabinet reshuffle aimed at quieting dissent within the PSUV saw the replacement of Rafael Ramírez as both minister of oil, a position he had held for more than 10 years, and head of the government’s economic team. Ramírez was widely regarded as the most influential advocate of reform in the administration, having pushed for a devaluation of the country’s battered currency earlier this year and a reduction in generous fuel subsidies that are severely straining government finances. His removal from an economic policy-making role suggests that Maduro is not planning to deviate significantly from the current course in the near future, despite building pressure for change within the broader population.
A campaign of street protests initiated by student organizations in February grew in intensity through May, frequently resulting in violent clashes. However, demonstrations have been more sporadic in recent months, in part owing to the government’s increasingly intolerant posture toward those it describes as “troublemakers.” The surfacing of a video that purportedly shows two student activists who were recently deported by Colombia discussing plans to carry out armed attacks on military targets in hopes of destabilizing Maduro’s government has been seized upon by government hard-liners as proof of their claims that opposition activists pose a threat to national security.
On that basis, the government is unlikely to adopt a less heavy-handed approach to the protests, which have resulted in somewhere in the neighborhood of 3,000 arrests since mid-February. The most recent bout of demonstrations in mid-September resulted in another 64 arrests.
One month earlier, US senators Robert Menendez and Marco Rubio introduced a bill authorizing the freezing of assets owned by Venezuelan officials accused of committing abuses against anti-government demonstrators. The UN and international human rights groups have identified numerous cases of abuse on the part of the police force, and the presence of numerous military figures in the Cabinet—including Rodolfo Marco Torres, who replaced Ramírez as the economic policy chief—creates the potential for an aggressive push by Washington along this front to directly affect top officials in Maduro’s administration.
The US has already imposed visa restrictions on some two dozen government officials and business figures accused of laundering money obtained from the drug trade and fraudulent government contracts in the US. Moreover, Venezuela faces adverse rulings by the International Center for Settlement of Investment Disputes (ICSID) over the nationalization of oil facilities that could result in liens on Venezuela’s assets in the US.
The government in Caracas has long engaged in diplomatic sparring with the US, which former President Hugo Chávez repeatedly accused of plotting against his regime, a charge that Maduro has made, as well. But Venezuela has been able to purchase substantial good will elsewhere in the hemisphere through the sale of its oil on very generous terms to cash-strapped governments throughout Latin America and the Caribbean. However, with Venezuela’s economy badly weakened, the supplies of oil made available under the Petrocaribe pact has fallen to a five-year low, forcing participating nations to seek out more expensive alternatives, while bracing themselves for the real possibility that the program will be suspended entirely.
In short, virtually all of the underpinnings of Chávez’s much-touted Bolivarian Revolution are wobbling, and, in some cases, already crumbling. Pressure on the regime is building from below, within, and outside, and Maduro, lacking his mentor’s charisma, personal authority, and force of will, is struggling mightily as he attempts to hold the structure erected by Chávez together. In the absence of steps to shore up the foundation, it would seem to be only a matter of time before the edifice comes crashing down.
Deepening Economic Malaise
Venezuela has the world’s largest oil reserves, but is incapable of realizing the potential of its oil wealth on its own, and foreign investors have been scared off by the heavy-handed policies enacted in the name of Chávez’s socialist revolution. Oil output has declined steadily, falling by 27% between 2005 and 2013.
With out-of-control inflation eroding household spending power, and the growing risk of serious political instability reinforcing the dampening effect of an inhospitable business climate on private investment, any chance of producing even minimal positive economic growth hinges on the contribution of the public sector. That, in turn, is highly dependent on the volume of oil-sector revenues, which, given the dim prospects for an increase in output, will mirror the movement in global oil prices.
At the end of August, the price of crude stood at $92.22 per barrel, while the year-to-date average was $96.72, compared to full-year averages of $103.42 and $99.49 in 2012 and 2013, respectively. The actual effect of the price decline on overall economic performance is unknown, as the central bank and the national statistical agency have not published data for key variables in several months. However, it is probably fair to interpret the reluctance of state agencies to share the numbers as an indication that the picture painted by the data is rather ugly.
Extrapolating from the available data, which shows that a decline in the average price for crude of somewhat less than $4 per barrel was accompanied by a deceleration of real GDP growth from 5.6% to 1.3% between 2012 and 2013, the fall in the average price by $2.77 so far in 2014 suggests that the economy is contracting, particularly given the absence of evidence to indicate that the non-oil economic is making a positive contribution.
On September 9, the central bank released inflation data for the first time since May, revealing that the consumer price index rose by 63.4% (year-on-year) in August. The average inflation rate for the first eight months of the year was 60.2%.
The government has attempted to stem inflation with price controls. However, the maintenance of low prices for basic goods has contributed to a sharp rise in the smuggling of items such a milk, sugar, and toilet paper into neighboring Colombia, where they can be resold at a price that is in some cases 10 times higher than what they cost in Venezuela. The Maduro administration estimates that 40% of the country’s basic commodities are smuggled to Colombia, resulting in losses of some $3.7 billion and, by exacerbating domestic shortages of the items, counteracting the disinflationary intent of the controls.
As with other elements of the economy, the exact state of government finances is uncertain. In early September, Maduro ordered the consolidation of all off-budget funds into a single account, with the aim of improving transparency, but the announced total of $750 million was greeted with a chorus of skepticism.
One source of concern with regard to Venezuela’s fiscal health is the enormous cost paid by the government to provide the population with by far the lowest retail prices for fuel anywhere in the world. Gasoline sells for $0.05 per gallon at the official exchange rate of 6.3 bolivars to the dollar. At the black market exchange rate, which has surged above 80 bolivars to the dollar, the cost is less than $0.01.
To put that in perspective, Venezuelans can fill their gas tanks for less than it costs to purchase a bottle of water. Not surprisingly, motorists make no attempt to conserve fuel, and wasteful consumption merely adds to the cost of the subsidy, which totaled about $12.5 billion (equivalent to roughly 11.5% of budgeted spending) in 2013.
According to analysts, pump prices would need to increase 25-fold just to cover the production costs incurred by the state-owned oil company, and even then the retail cost would be less than one-half the market price. An increase of that magnitude is out of the question, and Maduro has stated that he favors a gradual increase in prices.
Officials have suggested the possibility of a 17% hike, but raising them at all with inflation already running above 60% would be a dangerous move. Although many Venezuelans acknowledge that there is plenty of room to raise fuel prices without feeling much of a pinch, an increase would likely result in higher transportation costs, which would be felt especially by poorer Venezuelans.
A fuel-price hike implemented in 1989 touched off rioting that culminated in the massacre of dozens of protesters by the military, a still-vivid memory for many Venezuelans, including government officials. Not even Chávez was bold enough to tackle fuel subsidies.
The fact that Maduro is even hinting at such a move has given rise to speculation that the fiscal accounts are in a worse state than anyone is letting on, which has prompted discussions about the possibility that Venezuela might be at risk of defaulting on its debt. The president has assured that his government is both willing and able to meet its debt commitments, which include a payment of $4.5 billion that falls due in October, and asserted that default is not an option.
But it is not inconceivable that the various political and economic pressures pushing on the administration could become intense enough to convince the president that default is not his worst option. In early September, Ricardo Hausmann, a former chief economist at the Inter-American Development Bank who at one time served as Venezuela’s minister of planning, and Miguel Angel Santos, a Harvard economist, co-authored an opinion piece in which they argued that a managed default might offer a way for Venezuela to fix its troubled economy without first enduring a wrenching crisis that could inflict long-term economic and political damage.
Maduro responded with outrage, calling Hausmann a “financial hit man” who was attempting to plant a seed of doubt in the minds of investors in order to sow instability in Venezuela. But the alarmed response of the markets to the opinion piece, which receded in the wake of Maduro’s reassurances, suggests that investors did not view the proposal to be too outlandish to take seriously. Given the challenges he faces, the time may come when Maduro comes to the same conclusion.


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