Venezuela faces rapid decline in Forex reserves

Context

• Venezuela, a country with enormous oil is currently facing rapid declining foreign exchange reserves, poverty and hyperinflation projected at 720% this year and 2069% next, according to the International Monetary Fund.

Major crisis

• Under President Nicolás Maduro, Venezuela has been experiencing an acute shortage of food, medicine and other vital supplies.
• Venezuela is in the throes of a political crisis that is inseparably linked to its shaky economic situation.
• In January 2017, according to estimates by the Finance and Economic Development Commission of the National Assembly (AN), it was predicted that inflation will close this year at 679.73 percent.
• The economic crisis is hitting Venezuela’s public health system the hardest. In the country’s public hospitals, medicine and equipment are increasingly not available.

Role of Oil

• A quarter of Venezuela’s GDP and 95% of its export earnings are from crude oil, the price of which has plunged since 2014 when it was trading at over $110 per barrel to under $30 per barrel last year.
• As a consequence, Venezuela’s GDP and U.S. dollar reserves fell; the country has just $10.2 billion in reserves.
• As money was also in short supply, the government started printing cash, a factor contributing to spiraling inflation.
• Venezuela has borrowed at least $55 billion from allies in recent times.
• As the price of oil fell, more oil was required to honour the oil-for-financing deals and Venezuela has not been able to keep up with these shipments.
• Maduro has been criticized for prioritizing debt servicing over feeding his people.

How did the Chávez regime contribute to this situation?

• Hugo Chávez came to power on the promise of setting up a modern socialist republic and bringing inclusive growth to Venezuela, which had low growth, high inflation and high levels of poverty.
• He nationalized over 1,000 companies, funded welfare programmes and cash transfers to the poor from oil revenues, and offered an economic and political counter-narrative to what the U.S. proffered.
• All this earned Chávez wide popular appeal; poverty declined, employment increased as did college enrolment.
• However, Chávez’s rule was marked by an increasing authoritarianism and a gross mismanagement of the country’s oil.

Dismantled economy

• Venezuela didn’t save any of the oil revenues, which came pouring in because of booming oil prices for the decade up to 2014.
• Neither did it invest the cash in other industries or diversified investments via a sovereign wealth fund.
• The economy was over-concentrated in oil while other sectors became uncompetitive and unproductive; the economy became dependent on imports.
• A regime of excessive price controls meant a misallocation of resources and a fixed exchange rate created opportunities for corruption among the regime’s elite.
• Many of these problems have been compounded since Mr. Maduro took charge in 2013.

Tension rising

• A series of events has further heightened tensions between the government and the opposition and led to renewed street protests.
• Key was the surprise announcement by Supreme court on 29^th March that it was taking over the powers of the opposition-controlled National Assembly.
• The opposition said that the ruling undermined the country’s separation of powers and took Venezuela a step closer to one-man rule under President Nicolas Maduro.
• The court argued that the National Assembly had disregarded previous Supreme Court rulings and was therefore in contempt.

Recent developments

• The current wave of marches, the most sustained protests against Maduro, has sparked regular clashes in which youths and National Guard troops exchange volleys of rocks and tear gas.
• On July 30, Venezuelans were called on to choose the members of a new National Constituent Assembly that will be tasked with drafting a new constitution.
• President Nicolas Maduro claimed victory in the election, which he says will help save the country from political and economic disaster.
• Colombia, Mexico, Peru and other nations joined the US in saying they did not recognise the results of Sunday’s election. However, old allies Bolivia, Cuba, Nicaragua and Russia stood by Maduro.

Consequences

• With Venezuela’s crisis, the state is incapable of paying back its debt, and the majority of its oil exports are paying for previous loans.
• The best way for Venezuela to avoid government default is then to count on China’s will to have a privileged ace ss to its oil reserves over the long term and to restructure the debt it owes to China.
• Venezuela’s situation as a country with large natural resources, which suffers from an economic crisis, is not unique and is more commonly known as the Dutch Disease, named in 1977 after the economic stagnation the Netherlands went through after the discovery of large gas reserves in 1959.
• Relying too heavily on its gas exports, the Netherlands’s currency appreciated, which in turn discouraged economic diversification and development of domestic industries. This situation makes the country in question highly vulnerable to external shocks and at the mercy of volatile international markets.
• Venezuela has no exports that it can talk of now. Oil was its bread and butter. But now, the absence of exports has leads to the debate whether the government or the economy- which one will fall first

Why India should be worried?

• India is the third largest importer of oil after Saudi Arabia and Iraq.
• India import about 11.4% of their crude oil. An unreasonable rise in price of the imports or a complete cut-off of the import is what the Indian government should be worried about.
• Reliance Industries Limited has about a 15 years contract (which is still ongoing) to import 40,000 barrels in Venezuela.
• A country which is not able to provide a decent level of living to the citizens can hardly be trusted with any commitments what so ever.
• The Venezuelan currency has lost its value in the international market, making things uglier for both- themselves and their importing countries.
• India has proposed to offer a barter system of exchanging oil-for-drugs to recover the millions of dollars owed to the Indian pharmaceutical companies.