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Interview: Patrick Esteruelas on Venezuela's Oil-Based Economy

January 28, 2009

“As much as a victory would buy Chávez a new lease on life, a defeat could end up being the most costly policy mistake he’s made in over ten years in office.”

In an AS/COA interview, Patrick Esteruelas, a specialist in the Andean region with Eurasia Group’s Latin America practice, about the effects of the dropping price of oil on Venezuela’s economy.  “Venezuela can count on a sizeable cushion of reserves and foreign exchange liquid assets to help it ride the current economic down cycle,” he tells AS/COA Online's Managing Editor Carin Zissis. “But not for very long.” Esteruelas also talks about the reasons behind President Hugo Chávez's decision to hold a referendum on the elimination of presidential term limits in February.

AS/COA Online: Speculation has mounted that, with the sharp drop in the price of oil, Venezuela’s economy could be under serious threat. Yet some argue that country’s economy stands well-girded because of the high oil prices in recent years. What do you make of this debate and what are the economic outcomes Venezuela faces as a result of the oil price drop?

Esteruelas: I would say that Venezuela can count on a sizeable cushion of reserves and foreign exchange liquid assets to help it ride the current economic down cycle. But not for very long. By all accounts, Venezuela is destroying assets much more quickly than it’s been building them, given today’s oil prices. The country has somewhere around $60 billion in foreign exchange liquid assets, which include just shy of $30 billion in foreign exchange reserves, just shy of $20 billion in the foreign exchange development fund, and then the rest equitably split along the discretionary government funds and cash dollars held by PDVSA [Petróleos de Venezuela].

The problem is the extent to which the Venezuelan government needs to sustain a high pace of spending in order to buttress Chávez’s overall support at a critical political junction. Because they need to set aside substantial funds towards imports and prevent product shortages returning to the fore, the Venezuelan government is burning through these reserves reasonably quickly and could well end up burning right through them in about 12 to 18 months.

AS/COA Online: Some analysis has predicted that Chavez’s government may well continue social spending this year on programs that have made the president so popular. Do you think that’s feasible and why, with Chávez’s term running through 2012, has his government pushed for a February referendum on term limits?

Esteruelas: First off, I think Chávez has a very short-term view and realizes that at today’s oil prices, with a little chance of a substantial recovery, and with very little leeway on some very hard economic choices ahead of him over the next few years, he cannot afford to look to two or three years from now. He realizes that his support, which is currently somewhere around 55 percent, has probably hit the glass ceiling. He sees that his best shot—to reform the constitution, lifting presidential term limits and avoiding becoming a lame duck before his term finishes at the end of 2012—essentially comes now. That is what has pushed him to try to speed things up and call for a referendum to lift presidential term limits in mid-February. He hopes to take some wind out of the opposition’s sails following its very decent performance in the November 2008 local elections.

The problem of course is that it might cut both ways. As much as a victory would buy Chávez a new lease on life, a defeat could end up being the most costly policy mistake he’s made in over ten years in office. In the event of a defeat, Chávez’s authority will probably weaken irreparably. His ability to contain dissidents within the chavista movement will be undermined severely. The opposition, which is still fragmented and lacks a unifying leader, will have an opportunity to gain additional momentum. With lower prices and declining oil revenues, Chávez will not have the funds and the capital that he has enjoyed in the past to continue buttressing his government’s overall support. This could lead to the quick downfall of his government unless he’s able to manage public expectations and make those hard economic policy choices that he needs to make in order to bring Venezuela back to a sustainable position.

AS/COA Online: In recent years, Venezuela has pledged billions of dollars in foreign aid throughout Latin America and the Caribbean. To what degree has that aid been dispersed and, if it turns out that he cannot make good on some of those pledges, what kind of regional economic impact would that have?

Esteruelas: It’s beyond question that Chávez is going to have to reorder his priorities and focus whatever limited largesse he has today on securing overall support at home at the expense of his diplomatic and regional ambitions. We all expect that Chávez is going to begin ramping back deliveries of cheap oil to Central America and the Caribbean; he will probably formally put an end to projects that PDVSA has hoped to sign up on to build new refineries and infrastructure projects across Latin America. As a result, he’ll probably have less leverage and leeway in the coming years. Those countries that have come to depend heavily on Venezuela’s subsidized oil for help and to shore up the current accounts of their balance sheets of course will suffer. That includes many of the countries that are signatories of the Petrocaribe agreement.

Having said that, given that oil prices have declined significantly over the course of the last seven months, the overall cost of having to import oil from abroad at market prices is not as heavy as it used to be, which is what had prompted them to actually turn to Venezuela in the first place.

Without a doubt, I think that the one country that has come to depend most heavily on Venezuela and would stand to lose the most, should Chávez be forced to cut back all foreign aid, is Cuba. It has looked to Venezuela as its leading provider of financial aid in the aftermath of the decline of help from the former Soviet bloc. But I do think that Chávez will probably try to exhaust all other options before he begins to significantly cut back aid to Cuba.

AS/COA Online: Over the past few days, Chávez met with Colombian President Álvaro Uribe to talk about stepping up trade ties. Relations between the two have been a bit chilly in recent years. What is significant about the timing of this meeting?

Esteruelas: I think that President Chávez and President Uribe have maintained a fairly pragmatic and sustainable relationship over the years, despite having clashed over a number of issues. Even with the spike in cross-border tensions in the last year—in particular over Chávez’s role as a mediator between the Colombian government and the FARC [Revolutionary Armed Forces of Colombia] and Uribe’s decision to pull the plug and essentially leave Chávez aside—both countries have found common ground and worked to sustain what is an important bilateral economic relationship. Colombia depends on Venezuela as its second largest export market while Venezuela depends on a lot of Colombian goods, namely foods and other staples, to keep its supermarket shelves stocked and prevent shortages.

However, the bilateral relations will still be potentially vulnerable, particularly as Chávez finds himself more and more politically cornered at home. Chávez’s MO has always been to play up the notion of an external threat—be it the United States, Colombia, ExxonMobil or whoever else he can use to rally the nationalist vote and solidify the hardcore chavista vote at times of domestic political trouble. I think he will unquestionably use that again should he find himself increasingly questioned at home, potentially using it as a smoke screen to try and avert public attention away from his government’s poor economic track record.