Four years into this catastrophe, to say the Venezuelan economy is in shambles just doesn’t cut it anymore. The dominant narrative is intellectually lazy: just repeating the same negative trend on the same main drivers every year (low oil prices, dollar shortages, deepening controls), adding very little substance to the public policy debate. The main questions – what to do to fix this mess and how to do it – remain untouched.

One of the brave academics looking for answers is Leonardo Vera, PhD. Vera is a full-time Professor and researcher at Universidad Central de Venezuela (UCV), and one of the most respected voices in Venezuelan economics today.

The 30% contraction in GDP in Venezuela during 2013-2017 makes sense when you pinpoint the most recurrent feature of the Maduro administration: there are no dollars for the private sector.

I know how brilliant he is first hand: he taught me Macroeconomics I in my fourth semester and Advanced Macro II in my final semester, and soon became one of the biggest influences in my economic thinking. He’s just one of those gifted teachers who opens whole new vistas in your intellectual horizons: a proper expert in development economics and Post-Keynesian thinking, he helped me understand complex phenomena all around me.

Professor Vera recently published In search of stabilization and recovery: macro policy and reforms in Venezuela, in the Journal of Post-Keynesian Economics.  It sets out a series of reforms needed to bring the Venezuelan economy back into balance. We met last Friday afternoon to discuss it over pastries and tea.

He starts in vintage form,

Stabilization —in the Venezuelan context— must take on more than what’s in the orthodox view of stabilization, which focuses only on bringing inflation and nominal variables down to normality. Given our domestic economy’s huge dependence on access to foreign exchange, bridging the gap in the Balance of Payments should be the cornerstone of a stabilization plan looking to reactivate the productive apparatus.

In his view, the most binding constraint facing the economy now is the huge gap in the nation’s external accounts, brought upon by the double-whammy of lower oil prices coupled with a growing external debt burden. The government’s response to the new reality of slimmer Current Account surpluses has consisted in a near-shutdown of access to foreign currency to the local private sector and an inefficient centralization of imports (final goods, mostly) in detriment to the intermediate inputs local industry needs to operate.

Their practice of big-spender populism and their shortsightedness regarding future oil prices led government authorities to over-rely on external borrowing to cover growing budget deficits and to defend – foolishly – the official exchange rate from an unmitigated wave of capital flight.

“The 30% contraction in GDP in Venezuela during 2013-2017 makes sense when you pinpoint the most recurrent feature of the Maduro administration: there are no dollars for the private sector,” Vera adds with gloom.

“How did this happen?”  I ask, perplexed. “How could Venezuela go from surfing the commodities super-cycle with eleven-figure current account surpluses to a near-crisis in its Balance of Payments?”

“It’s a combination of factors,” Vera explains. “Their practice of big-spender populism and their shortsightedness regarding future oil prices led government authorities to over-rely on external borrowing to cover growing budget deficits and to defend – foolishly – the official exchange rate from an unmitigated wave of capital flight.”

The strain on the government’s finances began before the oil price crash. If you count items such as Chinese Fund repayments, bilateral loans and PDVSA bonds, external debt service already ran well over $15 billion per year in 2011: about a sixth of exports.

The collapse in Brent futures and the debt buildup have worsened both sides of the equation: by 2015, more than 50% of exports went to repay external debt.

“The concern among investors now,” Vera says, “is whether Venezuela will choose a partial or total default on its external debt obligations. Something’s got to give, and there’s no more room for import cuts.”

“But, professor,” I press him, “what do you make of the established view that maintaining debt service is essential for long-term market access? How do you solve the paradox of trying to ease a foreign-exchange constraint by imposing yourself one of its own?”

I’m a bond-trader now, remember — the to-pay-or-not-to-pay debate consumes my work days.

It’s as simple as this: If your economic plan is sound, if the numbers round out (si las cuentas dan), if you show discipline in hitting your fiscal targets, then the market will reward you with sustainable borrowing costs and access to foreign currency. This government hasn’t met any of those criteria; as a result, it doesn’t have access to the capital markets, and ends up in the worst of all worlds: a nation that keeps on paying, but can’t borrow a dime.

Treading carefully into the realm of political economy, I ask about the conflicting interests among government power-players. He dives into my question:

Well, the foreign-exchange constraint needs to be understood in the broader context of the country’s economic institutions. The 2005 reform of the Central Bank Law completely rewrote the explicit contract between PDVSA and the BCV. Since the oil giant has no obligation to send back all proceeds from oil sales to the Central Bank’s reserves, it has become a powerhouse of its own. PDVSA’s oil income distributions, debt service and cash flow from operations have effects that are equivalent to traditional fiscal, monetary and even exchange-rate policies, given its size and strategic relevance. Predictably, it’s possible that the BCV’s policy objectives and PDVSA’s actions are out of sync, or even in straight-up conflict. If there’s any piece of legislation that requires immediate rewriting for the stabilization plan to work, this is my number one pick.

Trying to spin the conversation onto more optimistic terrain, I encourage Vera to go into detail on the last part of his paper, where he proposes a how-to guide to reanimate the economy.

The stabilization plan has to begin way before going into effect; you need money to kickstart any serious effort to fix this mess. You definitely want to secure the support of the multilateral lenders for financing, as the foreign exchange needed in the order of tens of billions of dollars. I suggest asking the IMF for a $20 billion loan to operate the currency market, and sourcing another $10 billion or so from the World Bank, IDB or CAF, specifically towards funding a programme of direct, conditional cash transfers.

And what should be done with the current stock of external debt?

A friendly restructuring should bring the optimal outcome for both the country and its creditors. A five-year extension to allow the government the necessary wiggle-room as it gets its house in order – implying a haircut on current debts, but lower than what’s implied on current bond prices – will work a long way towards easing the foreign exchange constraint.

Research shows that preemptive credit events are usually shorter in duration and entail lower welfare losses

I imagine day one of the stabilization plan combining three key announcements: immediate, overnight liberalization of all prices of goods and services; a well thought out plan to liberalize the foreign-exchange market, aiming for a stable and competitive real exchange rate or SCRER (a stable and competitive real exchange rate — i.e., a managed float of the local currency, aiming to keep it undervalued versus the dollar); and a preemptive debt restructuring plan.

After asking him about the rationale behind the three-legged plan, Vera answers without hesitation,

Research shows that preemptive credit events are usually shorter in duration and entail lower welfare losses; besides, a new government has to take swift action if it wants to establish credibility. Gradualism is uncalled for in this context given the magnitude of the loss in economic activity already suffered. In fact, there’s the likelihood of an ‘expansionary adjustment’, in which the pros of easing the foreign-exchange constraint and reigniting local industry in a competitive environment far outweigh the cons of unwinding the system currently in place. Venezuela is a prime candidate for experiencing such a macroeconomic rarity.

“OK, that makes sense,” I say, perplexed at the thought yet convinced at the explanation.

“Tell me a bit more about how to make the FX market work again,” I press him. “It seems like a very tall order, given our 14-year-old history of rigid price controls and that the official market structure has been dismantled. Not to talk about the immense disparities between the official and the black-market rates. What’s the key for success?”

First of all, you need ammo. This’s what the $20 billion IMF loan is meant for. Remember, swift action: it’s as simple as determining the current value of the SCRER (somewhere between the official and the black-market rate) and directing the BCV as the sole government source of foreign exchange to commit to sell dollars there in potentially unlimited quantities. You need a strong-enough buffer of hard currency to fight against speculators, but you also need to be realistic in the ‘opening’ market rate, and allow the rate to float in line with inflation dynamics to avoid currency overvaluation.

“Of course, there also needs to be a reason to own bolivars other than for transaction purposes,” I chip in, remembering the finance side of the question.

“Bank deposits with liberalized rates can do the trick in the short term,” he shoots back. “You’d need to develop capital markets to attract a greater flow of FDI and portfolio investment, but that’s a long-term goal and beyond the scope of a stabilization program.”

All moving parts start to click together in my head. There’s just this one pending issue.

Professor, these measures make a lot of sense. But what about inflation? You’re talking about a sizeable one-off shock, plus the impact of inertial inflation and a persistent fiscal deficit that doesn’t look as easy to fix. What has to be done in that front?

Vera actually cracks a smile as he explains the next bit.

“Here’s when the plan gets tricky,” he says.

In theory, you can kill two birds with one stone: if the government dramatically increases the price of dollars sold in line with the SCRER, fiscal revenues will jump likewise, getting rid of the main reason why the government’s been printing money so aggressively in recent years. However, devaluing the official rate will only improve the fiscal balance if we manage to get an external surplus (ie. Greater dollar revenues than dollar outflows); that’s where the 5-year loan extension comes in. Each part helps towards improving the external and fiscal balances in the short term will reduce the need for monetary expansion to plug the holes in the government’s books.

This new currency plan needs to be thoroughly explained and discussed with the public; it requires a massive change in the way Venezuelans think about their currency, the economy and their role in it.

About inertial inflation: it’s true, that’s a tricky issue to deal with. In Venezuela, persistence in inflation is mostly due to staggered price adjustment mechanisms. Prices of goods and services change at different points in time, mostly as a response of price hikes by other market participants in a sort of distributional conflict. The Law of Fair Costs and Prices made the situation worse by adding an explicit indexation mechanism; ironically, setting a cap on profit margins at a flat 30% means any price increase in an intermediate good is reflected tit-for-tat in the price of the final product, without the cushion provided by changing profit margins.

That right there is Professor Vera’s number two pick for legislation that needs to be changed ASAP. But number three is the trickiest:

Venezuela can apply the Brazilian experience of the 1990s under Fernando Henrique Cardoso and adapt the Plan Real. The idea would be to create a new currency, but first using it only as a unit-of-account and pegging it to the dollar, in order to guide expectations towards the SCRER. This new currency plan needs to be thoroughly explained and discussed with the public; it requires a massive change in the way Venezuelans think about their currency, the economy and their role in it. It’s going to test the resilience of the new government undertaking the plan, but with a potential upside: if successful, it will result in a massive boost in political capital. Cardoso easily won his presidential bid after the Real seamlessly entered the economy under his watch, bringing inflation to a screeching halt, down from four to single digits in little over a year. This is the kind of victories that shape the political landscape forever, for good.

Professor Vera, deep down, is an optimist: and to hear him talk about his stabilization plan in this way gave me a lot of hope for the future. There’s a way to bring the country back from the abyss.

All we need is a change of heart.

 

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Russian-Venezuelan. A Santiaguino who left his heart in Caracas, Daniel is currently rehabbing from his addiction to High Beta and is pursuing a masters' degree in economics at Universidad Católica de Chile. Views are his own.

20 COMMENTS

  1. Thanks for this, I will check the paper out later.

    I’m concerned about the balance sheets of domestic banks. With their assets showing negative real yields, fully opening up the exchange market can lead to a big bank run (I think this is why Miguel Angel Santos has argued for keeping the capital account closed during the adjustment period).

    • If I get it right, this is addressed in page 6: «…to avoid large and potentially destabilizing capital flight,
      in a transitional period, controls on financial transactions should be removed
      only gradually as the pace of the whole stabilization program shows results in progress».

  2. “All we need is a change of heart.”

    Not the change I was thinking of…

    I like the proactive nature of Vera’s plan. He gets right to fixing the source of the problems instead of just treating the symptoms.

  3. Agriculture. I think any plan is flawed without a serious effort to jump-start the country’s agricultural sector. Food production and meaningful employment, two things the country is currently largely doing without.

    • That’s harina de otro costal. This plan doesn’t get into such details, just lays the overall framework for macroeconomic stabilization, as its title suggests.

  4. IMF loan at same time as market liberalization (dollar exchange rate, petrol, etc) is probably the only way, but the political cost would seem to be unbearable. Do people in the country still believe that “SOMOS UN PAIS RICO”??

  5. These ideas are to be commended , in time they will require substantial ammendment (not because they are wrong but because life is too rich and complex not to put unexpected obstacles on even the best of plans) . In any event they provide a platform from which to start planning a rational recovery plan…. not take us back to the Venezuela we have lost (that would be unrealistic) but to stop the rot and give us a better footing from which to gradually improve on our current situation…….!! congrats on allowing for a well grounded discussion of the steps ahead …….upon our release from the trauma that now oppresses us ……!!

  6. The way I read it, this plan does exactly that by liberalizing the exchange rates immediately. This will make it more economical to import the things that are needed to grow food and produce food locally, than to import food directly.

    • I understand the liberalization of exchange rates, increasing imports, etc. What I think many are failing to understand is that the agricultural sector has been almost completely destroyed. Farms and ranches are under seige with what equipment, animals, and infrastructure remain being stolen on a daily basis. I’ve got clients telling me that even their barbed wire fences are being stolen.

      In this area, once a major producer of corn, there is no seed, fertilizer, herbicide, etc arriving and no one is receiving credit to plant either. I’ve never seen it this grim.

  7. There is an “E” in the economic equation, Expectations. Venezuelans own $200 – $300 Billion dollars in the world economy, of which a sizeable portion could be quickly reinvested in the country. The country has to have a legal framework that makes sense.
    The chavismo misery could be history in as little as 5 years. In the interim, debt restructuring and above all: A moratorium on any “discretionary spending” (mainly arm/weapons purchases – sorry Russia). Slimming the FANB to the minimum, disbanding the GN and renovating/empowering local and state police departments.
    How many of our expatriates would not return for the challenge of building a better Venezuela? Actually, the question should be: Who would not?

  8. Nice theoretical article offering sound economic policies. Problem is.. did he mention the word Corruption even once? Yet it’s the Elephant in the room. By far. That’s the main reason Chavismo has destroyed Venezuela: to steal.

    “I suggest asking the IMF for a $20 billion loan to operate the currency market, and sourcing another $10 billion or so from the World Bank, IDB or CAF, specifically towards funding a programme of direct, conditional cash transfers.”

    Sure but most of those billions would quickly disappear. Even under a new MUD government. Or do we dream that MUD officials are going to be honest? Did forget how much AD and Copey stole for 4 decades?

    Unless there is a very strong government fighting corruption, these measures won’t work, and the economy will be in shambles for at least 30 years. Look at Brazil, it’s also a mess, even without a dictatorship, and with more sound economic policies. Why? You guessed it. The elephant in the room . The big C. Most Venezuelans – at all levels – are corrupt one way or another. Tough habit to break.

    • It is hard to get either optimistic or pessimistic Venezuelans to acknowledge that the three Cs that destroyed Venezuela are not only Chavez, Castro and Carter, but corruption, comfort, and complacency. As much as I dare to hope that liberty from communism will be achieved this time — and as much as I like seeing such a concrete and hopeful roadmap to economic health — I regret that I still hear so many Venezuelans who still do not seem to have learned what the past 18 years might have taught them about themselves, their attitude towards the poor, and their arrogant sense of entitlement. I would love to be wrong, but I am not yet seeing the way out … I agree with Poeta that we don’t yet seem to be at a place where we can assume corruption will not continue to be a big factor.

      • Well, other factors include the deep erosion of education, and a massive brain drain of many of the best professionals (At least 2 million) . It continues today. Most will probably never return. Health issues, but above all the moral fabric of society everywhere was deeply damaged. Almost everyone seems to be a thief of sorts these days. Or at least into some shady deal.. There’s no such thing as a clean, educated society unless it’s Sweden or Finland, but for Venezuela the doom, crime, and misery will be very long. Puro malandro everywhere – not just the Chavistas, they come come the hills, from every city or town.

        And what do they produce? A bit of coffee and some mangoes? What infrastructure have they built since the 50’s?

        You can have all the Economic ideas and cute, elaborate theories on paper out there, but if the general population is poorly educated and crooked, ‘some’ recovery will take a long, long time. If it ever happens in our lifetime.

        The damage is done. And it was very deep, at all levels. The economic crisis will continue for decades: no moral values, poor education and massive corruption. Regardless of what a few intellectual educators concoct in some fancy words.. Sometimes a mango is just a mango and when most of the trees are rotten.. I’ll boldly guestimate that about 70-80 of the entire, general population (el pueblo) is either criminal or corrupt in some way, and poorly educated. including most of the MUD.. So make your predictions.

        • ” … but above all the moral fabric of society everywhere was deeply damaged.” I am reminded of this every time I see an instagram video of people screaming vulgarities at each other, and every time I contemplate another Venezuelan family whose members are tossed across the continents. Not the moral and socual fabric of the Venezuela I knew. Can that be be recuperated in the midst of so much hatred?

  9. The economy can be fixed without having to instantly convert every one of Venezuelas 30 million people into moral models and perfect capitalist entrepeneurs………apply parettos principles ,probably you need to fix 20% of Venezuelas core economic activities and enroll 10% of its population in those activities , for that you create a small well run archipielago of select organizations , with the greatest impact on the economy and you re half way there , the all or nothing approach is naive , you go slowly step by step , expanding on the few good things you have , ink spot style . Ive seen it again and again how change starts small and methodically amplifies its effects until a large change is effected .

    A well functioning economy can tolerate certain margins of corruption , the things is not to erradicate it totally but to control it so its doenst damage whats important ……..coruption is not just the result of an inner drive in peoples mind but a system of external social incentives which retrofeed on the drive strenghtening it , magnifying its scale of operation ……you create the external controls and desincentives and the drive shrivels ……., past govt corruption didnt stop Venezuela (or many other countries from achieving great economic growth ( think of how the US economy grew during the time of the great robber barons) , but you do have to create the controls that make corruption more difficult to function , more effective at controlling it and your closer to keeping it in check.

    Long term the problem with the frayed moral fabric of family life has to be addressed , the irresponsible parenthood , the abandoned children , the prosmicuity of marginal people ….and that means going strong on punishing irresponsible parenthood , in undertaking a big effort at checking population growth ………!!

    • Agreed, you can’t make a tropical man to think a New Zealander (least prone to corruption), but with small quality steps, the ship can be righted. People have to trust their government institutions.
      As the economy improves and the conditions improve for the lower income segments, lower birth rates (and abandoned children) are to be expected. This has been experienced in other developing countries. In a few years, Venezuelas’ rate may even be similar to Mexicos’ current growth rates ( as of 2015 estimated at only 1%).
      Venezuela is underpopulated…But a comprehensive decentralization plan is needed to disincentivice people from flocking to the cities’ poverty belts.

  10. “…liberalization of all prices of goods and services; a well thought out plan to liberalize the foreign-exchange market…” WTF does that mean? And “…managed float of the local currency…” by whom?! Oh right, the same crooks as now: “…the BCV as the sole government source of foreign exchange…” Why not allow anyone and everyone to freely engage in forex? It’s the classic marxist claptrap, you couldn’t say the phrase “free market” if your life depended on it.

    “All we need is a change of heart.” Zig and zag long enough and eventually one bumps into something true.

    Two of the 800kg gorillas in the room: Entrenched large scale official theft, and cultural hate toward the rule of law and others’ rights. Without creating a radically different culture and criminalizing corruption, Venezuela will have nothing.

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