Economic Policy Could Determine the Political Results in Venezuela

The opposition in Venezuela has stepped up its campaign to remove President Nicolás Maduro from office, having announced — in accordance with its numerous divisions — that it would pursue a three-pronged strategy: a constitutional amendment to shorten the president’s term of office; a recall referendum, as permitted under the constitution; and “protests.” The first tactic was struck down by Venezuela’s Supreme Court, as it would be in any country — you can’t change the legal term of a president who was already elected for a certain number of years. For the recall referendum, the process of gathering signatures is under way.

The government, meanwhile, clearly needs to fix the economy if it is to regain popularity. The opposition, which has a large majority in the national legislature, has made it clear that it will not cooperate in any such efforts. On the contrary, it has acted to block the government from spending money.

But there is quite a bit that the executive branch can do to fix the economy even without the cooperation of the legislature. For some years now, I have emphasized that the exchange-rate system is the most important problem, and this is something that can be fixed rather quickly. The country currently has two official exchange rates: one at 10 bolivares fuertes (bs) per dollar (called DIPRO), and another which is currently at about 370 bs per dollar (DICOM). The latter rate is supposed to be a floating exchange rate, but this is not practical since the vast majority of the government’s dollars are given away at the official rate of 10, and so there is very little to supply the DICOM market. Then there is the black-market rate, which is currently over 1,100 bs per dollar.

This system of a fixed, overvalued exchange rate with a huge black-market premium has trapped the economy in an “inflation-depreciation” spiral. As the price of the black market dollar rises, importers who do not have access to dollars at the subsidized rate have to pay more, thus driving up inflation. As inflation rises, more people want to put their money in dollars, which pushes the black market price of the dollar up further, and the spiral continues.

To exit from this trap, the government needs to switch to a floating exchange rate. The late President Hugo Chávez actually did this in February 2002, allowing the currency to float without currency controls. Despite enormous political unrest — this was just two months before the U.S.-supported military coup — the Central Bank’s international reserves actually rose from that point, until the opposition oil strike cut off oil revenue later that year. Reserves had been falling considerably before the float, which indicates that perhaps this capital flight was at least partly due to fears of devaluation.

Chávez’s decision to float the currency was in some ways part of a switch from indirectly subsidizing imports, through the exchange rate, to a system of direct subsidies to the target population: using government revenues for the misiones, to provide healthcare, education, and subsidized food. This is especially important in a country where much of the business class is hostile to the government: it does not make sense to give importers a huge subsidy and be confident that it will end up being used for its intended purpose. And with a black-market rate now more than 100 times the official rate, the incentives for overinvoicing, cheating, corruption, smuggling and capital flight are so enormous that they are effectively impossible to curtail.

The economy has already gone through a massive adjustment to the situation of lower oil prices. Imports for the first two months of this year are down an estimated 40 percent from four years ago. Government spending, adjusted for inflation, is down by nearly half from four years ago.

World oil prices have already begun to rebound significantly, from a low of $28 in January to $48 today. The U.S. Energy Information Administration projects world oil prices at $79 by 2020. And about a quarter of Venezuela’s oil revenues currently go to pay debt service to China; we can expect that the Chinese government will grant some relief for these payments, at least until world oil prices go back up. Also, Bank of America Merrill Lynch estimates that the government has about $52 billion in foreign assets that it can sell or securitize now, which is more than enough to cushion any transition to a functioning exchange rate system.

But perhaps more importantly, a country that has trillions of dollars in assets that the world wants — about 300 billion barrels of oil reserves, plus hundreds of billions of dollars in gold — should never suffer from balance of payments problems no matter what happens to the price of oil. The Venezuelan government could raise cash from selling oil that would not be pumped out until years from now. In the long run, Venezuela is going to have to diversify its economy away from oil production in any case. It does not make sense to suffer through years of recession and balance of payments problems when oil prices slump, if the government can sell assets. And any economic strategy for diversification is also going to need money for infrastructure, as the current electricity crisis — which of course has multiple causes including a record drought — illustrates.

Not to mention the political instability that the current economic problems inevitably invite. As in Brazil, where the opposition is currently taking advantage of a recession to launch an illegitimate impeachment, “regime change” has always been close to the hearts of an important sector — sometimes the majority — of Venezuela’s opposition. That is the third prong of the current opposition strategy, euphemistically called “protests,” which in 2002, 2013 and 2014 turned into violent attempts to topple the government. And in each case, Washington was firmly in support of these efforts. In 2013, the opposition refused to accept the results of a presidential election — results that were not in doubt — and took to the streets with violent protests. The U.S. government backed them by refusing — although it stood alone in the hemisphere and in the world — to recognize the results of the election. The Obama administration’s policy of supporting regime change in Venezuela has continued to this day, with renewed economic sanctions and various public relations efforts aimed at undermining the government.

The Venezuelan government faces many challenges, but none so important or urgent as economic recovery.