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American Diplomacy
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April 2003

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Economic and Political Troubles Plague Venezuela by Lowell R. Fleischer

The author is a retired career diplomat with long experience in Latin America.
He expresses concern about the "bleak picture" of Venezuela's "accumulated problems," both economic and political. -- Ed

It seems increasingly clear that President Hugo Chávez intends to use the full resources of the Venezuelan state to fend off demands that he either agree to early elections or to a revocatory referendum, which under the constitution could be held in August, halfway through his elected term in office. Owing at least in part to the failures of the opposition to forge a unified leadership or to offer a viable alternative plan of government, it seems more and more likely that Chávez will be able to cling to power. However, his government will become increasingly weak and isolated, as well as impaired by a volatile social situation and a devastated economy.

Even if a referendum on his rule takes place later this year, it would not begin to solve the country’s accumulated problems. Despite claims by the opposition, and some public opinion polls, that the vast majority of the Venezuelan people has lost confidence in Chávez and would not vote for him in a new election, it is not at all clear that he would lose a recall. For the president to be defeated in the referendum, a greater number of voters would need to reject him than voted in his favor in 2000, when he was elected with the support of thirty-four percent of the electorate or sixty percent of the vote, owing to record numbers of abstentions.

Whatever happens politically in the remainder of this year, the short- and medium-term economic outlook for the country is grim. The fallout from the nationwide strike will extend throughout the year and put additional strains on an economy that has been struggling for several years despite high oil prices. Private economists estimate that the economy could contract more than 20 percent in 2003. It fell over seven percent last year. During the strike, which hobbled the world’s fifth largest oil exporting industry, Venezuela lost over $7 billion. The government-owned Petroleos de Venezuela (PDVSA) is the source of over half of public revenue. Tax collections were also down as thousands of businesses and the stock market closed during the strike.

In a late March speech, President Chávez said Venezuela needs to restructure its foreign debt as it struggles with a severe cash crunch caused by the strike. Venezuela’s foreign debt is about $23 billion, almost one-third of the country’s $63 billion annual GDP. Foreign debt service this year amounts to $5 billion, according to Chávez. In a statement issued after the president’s speech, the Finance Ministry said that the country would not stop paying its foreign debt despite the cash crunch. The ministry said it would not resort to a forced restructuring of public debt, but would propose a voluntary bond swap, among other measures to deal with the cash flow problem.

In a bid to end capital flight, estimated at about $5 billion in 2002, and to protect international reserves, Venezuela halted foreign currency sales in January and then enacted tight restrictions on foreign currency sales. Thanks to recovery in the petroleum industry since the end of the strike and the fact that the new exchange control commission has released only about $5 million for imports, reserves have climbed back to $13.5 billion as of the end of March, far below a high of about $19 billion in November 2001, but above the low of about $10 billion in May, 2002.

The lack of dollar availability is taking its own toll on the economy. According to the Caracas daily El Nacional, General Motors has been forced to stop all production at its local plants due to the lack of foreign currency to buy raw materials. Ford and Toyota have been similarly affected and may have to shut production facilities in April. So far only importers of food, medicine, and other necessities have been permitted to buy dollars to pay for their imported goods. When he announced the exchange controls, Chávez said he would not allow “coup plotters” to have access to dollars and openly suggested that only supporters of his Bolvarian Revolution would have access to foreign currency. Media owners, who have been on the receiving end of Chávez’ vitriolic rhetoric for years, are concerned that their publications and television stations will run out of newsprint, video tape, and other production materials.

The government is said to be considering some modification of the currency control system, including the possibility of keeping a fixed exchange rate of 1600 bolivares to the dollar for priority imports while applying a fifteen to twenty percent tax on dollar purchases for other purposes. Some businesses have been forces to turn to the black market where dollars are being sold for about 2800 bolivares.

The biggest question mark with regard to Venezuela’s economic well being in the years ahead is the health of PDVSA, which has nearly 40,00 employees and $50 billion a year in sales. The government-owned petroleum firm, the largest in Latin America, is in deep trouble financially and operationally as a result of Chávez’s continued politicization of the company, investment cutbacks, and the government’s insatiable need for additional revenue. PDVSA had 2001 revenues of $46.2 billion from its worldwide operations, which produced a net profit of $4.33 billion. The company paid a total of $7.07 billion in royalties and income tax to the state and another $4.77 billion in dividends.

There is no agreement on how much oil Venezuela is producing today or how much spare capacity PDVSA has. The Venezuelan government says that since the strike ended it has reached its OPEC output target of 2.8 million b/d and, if needed, could push its output to around 3.5 million b/d by sometime in April. Given the crippling impact of the two-month oil strike, dissident oil workers, opposition political leaders, and even some OPEC officials say the government’s figures are hardly credible. According to these sources, at most PDVSA is producing about 2 to 2.4 million b/d and is unlikely to be able to increase that output any time soon.

Both PDVSA and the Venezuelan government have befitted from recent high oil prices. The average price for Venezuelan crude in 2003 has been over $29 a barrel. It was $22 in 2002, $20 in 2001, and about $25 in 2000. Every $1 drop in the average price of oil reduces revenue by about $1 billion a year and vice versa. In 1974 oil contributed $1540 per person to the government and represented more than 80 percent of total government revenues. Twenty years later it contributed just $200 per person and accounted for less than 40 percent of total fiscal revenues. Oil accounts for about a third of the country’s gross domestic product. Venezuela now accounts for just three percent of global production, down from ten percent in the 1970s.

Before Chávez’s election, PDVSA was embarked on an ambitious expansion program, but with repeated cutbacks, the company’s production capacity has declined to the point that it needs foreign investment more than ever. However, because of the political and economic uncertainty, as well as the new hydrocarbons law that took effect on January 1, 2002, potential investors are likely to take their money elsewhere, especially if a freed Iraq is also competing for investment. The Venezuela American Chamber of Commerce (VenAmCham) recently cited the hydrocarbons law introduced in 2001, as one of the pieces of legislation that could threaten private property. This law “provides no explicit guarantee of respect for property rights, contractual obligations on existing contracts and conditions in the petroleum industry,” the business association said in a letter to President Chávez.

Energy analysts say that due to investment declines PDVSA has lost nearly one million barrels per day of capacity since 1999. Venezuela has the largest oil reserves outside the Middle East and so has the potential to recover. Recovery of that lost capacity, however, is likely to take three or four years and billions of dollars. According to industry estimates, bringing back 100,000 barrels of capacity requires $1 billion – money the company does not have. A pickup in the fortunes of the company is not likely as long as Chávez is president.

The investment environment is likely to remainunfavorable for the foreseeable future because of the lack of a clear regulatory framework and policy uncertainty. Telecommunications, hydrocarbons and mining may be the only exceptions, and there are difficulties even in these areas. In an early September letter to President Chávez, the VenAmCham said that crime and political violence, including “mob rule” in parts of Caracas are seriously damaging business and foreign investment. “There is a climate of increasing insecurity, both judicial and as regards the physical integrity of human resources and assets, which is seriously limiting the ability of our affiliates to conduct business in Venezuela,” the business organization said.

Most analysts firmly believe that structural fiscal reform is required to place public finances on a more sustainable footing. Prior governments have failed to institute such reforms and the political environment is not conducive to reform now. Progress will not be possible without a broad political consensus that does not now exist.

Chávez is not the architect of the many economic problems facing Venezuela today, but he has done little to resolve these long-standing difficulties, and in many cases has exacerbated them. Together with the country’s political troubles, these economic difficulties add up to a bleak picture for the remainder of the year and, perhaps, for some time to come.


Dr. Fleischer is a senior associate at the Center for Strategic & International Studies in Washington, D.C., and chair of Andean Studies at the Foreign Service Institute. He is a graduate of Ohio Wesleyan University and holds M.A. and Ph.D. degrees from the University of Connecticut.

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