Luis Zambrano Sequín, Professor of economics at the Andrés Bello Catholic University, Caracas, Venezuela (translated from the original in Spanish with the assistance of David L. Ortega, Associate Professor at Michigan State University)
Characterizing the shocks
Venezuela is the victim of two severe, and simultaneous, external shocks, which further aggravate its already precarious situation: the coronavirus pandemic, originating in China, and the petroleum price war unleashed by the governments of Saudi Arabia and Russia.
The pandemic, by itself, has profoundly and rapidly affected both supply and aggregate demand in all countries. A brief list of the most relevant impacts includes: breakdown of global supply chains and slowdown in the world economy; abrupt drop in international trade flows; collapse in the price of raw materials, especially in the case of oil (which has also been affected by the price war between the main producers); sudden contraction in the flows of business and tourism travel; drastic reduction of financial flows and the sudden reversal of the movement of capital (capital outflow seeking safer havens); depreciation of most currencies and simultaneous appreciation of the US dollar; and a significant drop in transfers and remittances sent by migrants to their families.
The oil price war, for its part, has aggravated the already dramatic drop in oil revenues in Venezuela, as a result of the production collapse of hydrocarbons and their derivatives that began in 2016. This oil shock will probably last longer than the one associated with the pandemic.
Naturally, these events will have a significant negative effect on economic growth and poverty levels, especially in countries with little capacity to implement adjustment and compensatory measures. Forecasting agencies have drastically lowered their outlook for the growth and employment rates expected for this and next year. In the case of Venezuela, for example, it is forecasted that, as a result of these events, GDP could contract 12.5% in 2020, instead of the 8.5% initially forecasted (Credit Suisse, 05/17/2020).
Actions being taken
Measures are being taken everywhere to reduce the impacts of these adverse shocks, especially those caused by the pandemic. The effects of these measures remain to be seen and differ from country to country, since they depend on multiple factors that characterize each particular situation. The initial conditions, the degree of openness of the economy, the structure and sector diversification, and the ability to make economic policy are elements that, to a large extent, will determine the impact, speed and the way in which each country will emerge from the crisis.
The immediate objective of the measures is to mitigate the economic and health impact of the pandemic and protect, above all, the poorest and most vulnerable. To this end, social isolation has been used in all countries in the hope of flattening the infected curve and avoiding the immediate collapse of infrastructure and health services. However, it should be noted that these types of measures have a negative impact on economic activity, income and employment, making them unsustainable over time.
At the same time, the resources allocated to public spending on health have increased, where it has been possible, despite the fall in tax revenues as a result of the paralysis of economic activity. There is widespread belief in national tax authorities that budgetary austerity would only exacerbate the economic impact of the pandemic and would be an obstacle to the ongoing health crisis.
Given the type of shock, characterized by its progressively systemic nature and the limited ability for monetary policy in many economies, there is a growing consensus on the crucial role that fiscal policy plays in the current situation. But not everywhere, and especially in the Venezuelan case, there is leeway to apply compensatory and expansive fiscal policies.
In economies where there is fiscal slack, including several Latin American ones, policy measures have been announced focused on: monetary transfers, wage subsidies in public and private companies and reduction of the tax pressure on companies and individuals. These measures have been complemented by interventions in the foreign exchange and currency depreciation markets, liquidity supply to banks, special credit lines for small and medium-sized enterprises, and easing of controls and regulations on the financial system and the rest of the sectors.
Can these types of measure be applied in Venezuela?
Venezuela, before these crises, was already in the midst of an unprecedented humanitarian crisis. Without international reserves, hyperinflation, internal political instability, a deep institutional crisis, and a progressive international isolation, product of the lack of legitimacy of the regime against a significant fraction of the international community.
To a large extent, this problem has been more the product of failures of the applied economic policies, than of external shocks previous to the ones we are considering here. These policies substantially reduced the stock of productive resources (human resources, private and public capital, basic infrastructure, agricultural space, among others), affecting the level of potential GDP (the permanent capacity to produce goods and services and generate employment locally). Of course, more recently, international sanctions imposed on the regime have increased previous restrictions.
The fall in oil and domestic tax revenues, the “default” in the service of the external debt, the decline in international reserves, the paralysis of the financial system, the deterioration of infrastructure and basic services, the shortage of fuel, among other factors, they translate into a lack of flexibility in order to efficiently apply policy measures that minimize the impact of the pandemic and the effects of the petroleum price war. There are no public savings funds, there is no possibility of monetary policy, the level of international reserves is minimal and the economy has dollarized to levels that have voided the use of exchange rate policy.
In this context, the government has been announcing measures. The first of them is to try to transfer part of the adjustment costs to the private sector: suspension of the payment of capital and interest on loans granted by banks, suspension of the payment of rents, and inability to dismiss workers from companies. An extremely weakened private sector, without access to credit and in an economy that has not only contracted by 60% in the last 5 years, but has no certain prospect of recovery.
A second group of measures have clearly had a fiscal impact: monetary transfers to low-income individuals, payment of a portion of wages and salaries to selected small and medium-sized companies, and tariff exemptions for companies in sectors classified as being priority. But given the conditions in which public finances are found, it is expected that the government will resort to issuing money as a fundamental means of financing the expansion of fiscal spending associated with these measures. The result is not difficult to envision: higher inflationary pressure and depreciation of the exchange rate. In the current circumstances, there is no other alternative.
It should be noted that the government, given the institutional crisis, is not capable of guaranteeing an adequate targeting of policies, being forced to make overall decisions, largely arbitrary, increasing fiscal costs and the inefficiency of the measures in question.
In this context, it is highly likely that social and political tensions will be exacerbated as the virus spreads and the petroleum price war deepens.
Venezuela cannot get out of this impasse without significant, massive and rapid international aid. The priority remains: reducing external restrictions and recovering oil production. But it is certainly more difficult to move in this direction today than it was just two weeks ago.