Oil-poor and on the brink of default: Is change imminent in Venezuela?

On December 11, Bloomberg News reported that swaps traders are more certain than ever that Venezuela will default on its debt as falling oil prices add pressure to already-strained government finances and drive the country’s bond prices to a 16-year low.
And earlier this week, the U.S. Congress voted to impose sanctions on Venezuelan officials found to have violated the rights of political protestors during the demonstrations that began last February. That political unrest continues, most recently reflected in the indictment of opposition politician Maria Corina Machado over an alleged plot to assassinate the president.
All of this is unfolding in the context of Venezuela’s rapidly shrinking foreign reserves, a reality that has been exacerbated by this year’s 38 percent decrease in oil prices—a five-year low. As of Monday, December 8, they had fallen below $67 per barrel. And Morgan Stanley cut its 2015 forecast, predicting that prices could average as low as $53 per barrel in 2015 (down from an earlier estimate of $98).
Venezuela in particular faces interesting challenges with this price drop, as its national income dwindles and its economy slowly grinds to a halt. Among the largest global producers of oil, Venezuela has the largest reserves in the world (totaling something in the range of 300 billion barrels of crude oil). Oil comprises some 95 percent of Venezuela’s total export earnings. And given the political instability and economic stagnation the country already faces, the International Monetary Fund (IMF) estimates that the Venezuelan government requires an average prices of about $120 per barrel of crude oil to balance its budget.
So where does Venezuela stand? What makes it so vulnerable to the current fluctuation? And what can we expect moving forward?
Q1: What’s the current economic situation in Venezuela?
A1: The first half of 2014 was marked by widespread protests and the government’s overtly repressive efforts to diffuse them—a reality that left more than 40 dead and hundreds injured.
But the second half of 2014 has largely been framed less by political unrest and more by the increasing economic pains and rising speculation that Venezuela could default on its debts.
For months, Venezuelans have struggled with crippling scarcity that makes finding necessary products—everything from toilet paper to vital medicines—harder each day. And inflation recently topped 60 percent, driven by years of strict currency controls on the part of the government.
The country’s two foreign exchange systems have heavily distorted the purchasing power of dollars and bolivars (Venezuelan currency) in the country. This continues to fuel a parallel black market currency exchange (which currently sells dollars at several times the rate on the official market), to say nothing of the growing informal economy.
And intimately tied to this is the troubling state of Venezuela’s foreign reserves. Just last month, they hit an 11-year low of about US$19 million, driving the government’s need to continue borrowing heavily from its allies.
Q2: What can we expect in the near future?
A2: These economic challenges are not necessarily new ones for Venezuela—but unprecedented (and unpredicted) fall of oil prices could throw a wrench in the gears. The administration of Venezuelan president Nicolás Maduro has seem largely focused on keeping the country afloat—and little more—but even that becomes more difficult as oil prices continue to drop.
The resulting heavy cut in export revenue may force President Maduro to continue economic reforms that will likely receive a lukewarm reception, at best, from a population accustomed to extensive social welfare programs enabled by the country’s vast oil wealth.
Recently, President Maduro announced a 20 percent cut in spending on “unproductive” expenses—though he was careful to point out that “necessary” social programs would not be impacted. And his administration is likely to consider changes to the existing foreign-exchange mechanisms, as well.
The government has another tool at its theoretical disposal, as well: cutting subsidies for domestic oil consumption. Venezuelans enjoy some of the most sharply discounted oil in the world—a privilege the population is well used to. Though cutting those subsidies could save some sorely needed cash, there’s also the real possibility that doing so would backfire, sparking social unrest not unlike that seen earlier this year.
Ultimately, the big unknown is the likelihood that Venezuela could default on its debt—though the implied probability of default is currently 93 percent, the highest in the world. According to Thomas O’Donnell of the Freie Universität in Berlin, Germany, “major bond rating agencies as well as foreign bank analysts responsible for advising clients on Venezuelan bonds have not seen default as imminent.” Still, many traders predict an 83 percent chance that the country could default in the next half-decade.
And that confusion is only deepened by recent moves on the part of the Maduro administration. Earlier this fall, the government announced that it would seek a buyer for Citgo, Venezuela’s U.S. oil subsidiary, and its three refineries—only to retract the statement soon after. O’Donnell explains:
“This Citgo drama—and the general paralysis of the Venezuelan oil sector—are part and parcel of the general paralysis of the Maduro administration in addressing the country’s economic crisis—a paralysis driven by alarm at its eroding electoral support and the possibility that any adjustment might spark a popular backlash.”
Q3: What are the global implications?
A2: Venezuela’s ailing economy and any unrest it might encourage are by no means necessarily limited by the country’s borders. Rather, these issues have the potential to carry far-reaching implications for the region and beyond.
Among the most common concerns is the vulnerability of the Petrocaribe oil program, through which Venezuela provides aid to many countries in Central America and the Caribbean in the form of deeply discounted oil. The program’s collapse would, without a doubt, send shockwaves throughout the hemisphere—particularly in those countries most dependent on Venezuelan assistance, like Cuba.
Aside from Petrocaribe, global financial markets would scramble to adapt, as well. Venezuela’s bonds have fallen to levels not seen since 2009—currently valued at just over 50 cents to the dollar—as investors pull their money out of the country.
And Venezuela’s ability to stay afloat thus far has led it to depend heavily on its allies—especially China, which has lent over US$50 billion to the cash-strapped country since 2005. But increasingly, analysts worry that the Chinese government may back away from its commitments in Venezuela, concerned that the mismanagement of Venezuela’s economy and oil sector could bode ill for China’s energy security.
Conclusions: This year has been a challenging one for President Maduro. The protests helped to shine a spotlight on the country’s economic challenges—not to mention its political instability and the questionable human rights record of the current government.
The country’s economy will likely keep spiraling downward. Scarcity and inflation will continue to drag down standards of living throughout the country—and default is more likely than ever as oil prices continue to plummet.
And Venezuelans are more dissatisfied than ever, with a recent poll by Datanalisis putting Maduro’s approval rating under 25 percent. The economy is tanking, dissatisfaction is on the rise, and there’s a long road until the next presidential elections in 2019. So while the form of change remains to be determined, it seems that conditions for political overhaul could be falling into place.

Carl Meacham is director of the Americas Program at the Center for Strategic and International Studies in Washington, D.C. Ian Kowalski, intern scholar, and Jillian Rafferty, program coordinator and research assistant, both with the Americas Program, provided research assistance.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Carl Meacham