Venezuela: Tough Choices Ahead

STR/AFP/Getty Images

Venezuelan President Hugo Chavez

With crude prices fallen and international credit unavailable, Venezuela will have to start making some difficult decisions. Higher taxes and fewer subsidies may accompany a reduction of Venezuela’s international obligations as the country seeks to shore up revenues and cut costs, and unrest could result.

The ongoing global economic slowdown has taken a swipe at oil prices, which rose above $140 per barrel in 2008. Although Venezuela’s viscous crude trades at a heavy discount to average global oil prices (and thus Venezuela has been hit even harder by falling prices than many countries), the government relies on oil revenues to cover the full swath of everyday expenses. These expenses have grown under the administration of Venezuelan President Hugo Chavez, whose populist policies have dramatically increased the hand of the state in Venezuela’s economy.

The price of Venezuelan crude is hovering around $32 per barrel, raising the specter of a severe economic crisis in the South American country. The Venezuelan government is struggling to chart a course that will satisfy populist policy needs without bankrupting the country. Despite government officials’ avowals, it is only a matter of time before Caracas will have to start cutting back on social spending and raising taxes. This means hardship for Venezuelans who rely on the government to sustain subsidies and run national companies — and hardships for Venezuelans could mean destabilizing unrest for the country as a whole.

Currently, Venezuela’s budget for 2009 counts on oil production of about 3.6 million barrels per day (bpd) to be sold at a price of $60 per barrel, which the government has calculated should amount to a contribution of about $77.2 billion to the government budget of $167.4 billion. (This does not encompass the entirety of oil spending for the country, as Venezuelan state-owned energy company Petroleos de Venezuela [PDVSA] bankrolls several social programs through its own budgetary system, calculated separately from taxes and royalties.)

In reality, the actual income from oil even at $60 per barrel would be lower (around $60 billion), because Venezuela’s oil output is really only about 2.8 million bpd. The discrepancy is a result of the continuing exhaustion of PDVSA’s resources through revenue appropriation for social programs, and the lingering effects of the gutting of PDVSA’s staff in 2002 following a coup attempt against Chavez for which PDVSA employees were partially blamed. The government-reported production levels are closer to pre-coup levels, but in reality (according to international observers, such as the International Energy Agency) production never came back up. Roughly extrapolating from the budget numbers and actual output, and assuming that prices stay at $32 dollars per barrel for the rest of 2009, the budgetary shortfall for Venezuela could range as high as roughly $50 billion, or 30 percent of the total budget.

The trouble is magnified by the fact that the 2009 budget is already a step down from actual 2008 spending levels. Despite the original 2008 budget of $137.5 billion, actual spending in 2008 rose to $183 billion alongside rising oil prices (and facilitated by substantial borrowing by the Chavez government).

But as 2009 starts, not only has oil revenue fallen dramatically, but the international credit system has dried up, with Venezuela’s low credit rating moving the country to the back of the line. Should spending emergencies arise, Venezuela’s access to loans to cover short-term expenses will be extremely limited in 2009, further pressuring a government that routinely exceeds its budgetary boundaries.

In order to deal with the budget crisis, Venezuela’s financial planners are attempting to nibble around the edges of expenditures without touching the core of the ruling party’s policies: social spending. Chavez’s political mandate depends on the redistribution of the country’s oil wealth to Venezuela’s poor. But the severity of the budget crisis will almost certainly threaten his ability to keep up social spending.

Cuts have already begun to be made throughout the Venezuelan government, including an increase in nonpayment of government contractors and new restrictions on foreign exchange. These cuts are relatively politically painless to implement.

Cuts to international programs are also an easy out for Venezuela. The country announced just this week that it will no longer offer cheap heating oil to impoverished U.S. citizens through its U.S.-based energy company, Citgo. PetroCaribe — a program that Venezuela has used to finance around $2 billion worth of fuel supplies to Caribbean states — is also at risk. Designed to increase Venezuela’s influence and power in the region and challenge the United States, these programs have helped to stretch Venezuela thin. Venezuela will also have to limit the degree to which it supports its regional allies such as Argentina, Bolivia and Ecuador through fuel subsidies and bond purchases.

Tax hikes could be a next step for the country. Currently, Venezuela’s sales tax sits at about 9 percent, and according to Stratfor sources in Caracas, there are indications that the government could raise that to as high as 12 percent. Other taxes, such as a bank deposit tax, could be an option (though this carries the risk of inducing even greater capital flight).

The government can gain more breathing room by putting off payments to the owners of firms Venezuela is still in the process of nationalizing. Nationalization moves — such as the takeovers of facilities owned by steelmaker Sidor, Mexican cement company Cemex and the Banco de Venezuela — would require compensation under the original terms of the nationalization, but outright seizure of the assets remains an option.

Speculation has risen as to whether or not Venezuela will implement an across-the-board currency devaluation. The logic for this move would be to facilitate payments on debt denominated in domestic currencies, boost Venezuela’s export sector and potentially make the country a more attractive destination for foreign direct investment (FDI). Venezuela could pursue a two-tiered exchange system, with an effective devaluation of the Venezuelan bolivar fuerte targeted at specific goods — like nonessential, luxury items — to discourage imports.

However, a full-fledged currency devaluation would carry more risks than benefits. There is very little that Venezuela could do to make itself reasonably attractive for FDI, short of a complete overhaul of its governing system, up to and including the presidency. Furthermore, the dangers of the inflation that would be caused by devaluation could easily outweigh these benefits.

The real risks for Venezuela will be any cuts it has to make in social programs. Stratfor sources in the Venezuelan government have indicated that cuts to health care programs — particularly subsidies on pharmaceutical drugs — could be top targets. In addition, the government may reduce the fuel subsidies that keep domestic fuel prices extremely low.

Additionally, the government (either directly or through PDVSA) controls major portions of a number of critical industries, including hospitals, food distribution, food production and electricity production. If oil prices persist at such a low level, or if they fall further, corner-cutting in these critical industries may be necessary.

Though it is difficult to plot an exact course of action, these measures are likely options for the Venezuelan government as it works to curb spending. The dangers for Chavez lie in reneging on his promises of income redistribution and social policies. If he is unable to come through on these promises, his already faltering political support could come crashing down, and the potential for destabilizing social unrest is high.