Venezuelan Crisis: The oil factor

The oil sector is at the heart of the current political crisis in Venezuela in which President Chavez was first ousted by a coup on April 12, 2002 and then reinstated by a counter-coup, only two days later.

Venezuela is the fourth largest oil exporter in the world. The critical importance of the oil sector for the national economy is underscored by the fact that oil generates nearly 75% of Venezuela’s export revenue and 50% of its tax income. Additionally, Venezuela is an important overseas source of oil for the US, accounting for 13% of its fuel imports.

Incidentally, one of the key policy measures adopted by Chávez when he first came to power in a landslide election victory in 1998 was to improve Venezuela’s compliance record among OPEC countries. This implied that Venezuela would assiduously conform to the production quotas agreed upon by the OPEC constituents to avoid overproduction and a downward pressure on prices. The policy had two effects.

On the external front, it acted as a stabilizing influence on international oil prices thereby earning him the goodwill of a section of the OPEC member countries. While this insulated him from external political pressures, it also meant that he could use his newfound influence to manipulate OPEC policy on prices to suit Venezuela’s needs. For example, he engineered a price hike in 2001 by aggressively lobbying to cut production quotas leaving his government with a windfall that was used to increase social spending – a key component of his domestic policy. In fact, the trade surplus helped the country to maintain a strong currency and a low inflation rate, which endeared him to the country’s poor, who comprise nearly 80% of the population.

However, those gains have fast dissipated. A combination of weaker oil prices – in February 2002, the price of a barrel of oil sank to $ 15.50, below the $18.50 assumed in the budget – and an output cut threatens to drag the entire economy into recession. Although, oil prices have surged upwards by nearly 40% in the last couple of months owing to a rise in the geopolitical risk premium, the threat of a recession looms large. The unemployment rate in the economy is currently as high as 15%, raising apprehensions of escalated anti-social violence in Caracas, already one of the most crime-infested cities of Latin America.

Not surprisingly, jittery investors have been siphoning capital out of the country at record rates fearing enhanced exchange-controls. The resultant outflow of capital to the tune of nearly $ 2 billion this year has meant that foreign exchange reserves with the Central bank are at dangerously low levels.

In a bid to shore up reserves, Chávez abandoned the country’s five-year-old crawling band exchange rate mechanism and allowed the bolivar, the local currency, to float. The underlying expectation was that the bolivar, which was estimated to have been overvalued by almost 35%, would depreciate under market pressures, facilitating renewed reserve-accumulation through competitive exports.

At the same time, he also announced a fiscal adjustment package aimed at controlling government expenditures. The new package outlined a cut in government expenditure by 7 % to help close a yawning fiscal deficit estimated by investment banks to come in as high as 7 % of gross domestic product. Additionally he announced a change in the management of the state-owned Petroleos de Venezuela, the oil company that controls oil production in Venezuela. The changeover, he felt, would enable the government to seek greater tax dividends from the PDVSA as the existing management, backed by powerful business interests, was blocking rate hikes. Also, the management was no longer in a mood to abide by the OPEC production quotas, the cornerstone of the government’s foreign policy.

The move, however, alienated the trade unions of the company who were threatened on two counts. On the one hand, a depreciating currency would necessarily entail inflationary pressures in the long run that would squeeze wages. On the other hand, the management changeover signaled the prospects of fresh taxation of wages.

On April 7,2002, workers at the PDVSA started partial strike action to protest against management changes. By April 10, the partial strike had fanned out into a 48-hour strike called jointly by trade unions and business groups, to be extended indefinitely. In the demonstrations that followed, 10 people died, allegedly killed by the President’s supporters. Soon, as inevitable fallout of the President’s organic relationship with the army, the latter was dragged into the conflict. On April 12, 2002, under pressure from a section of the army who blamed him for the deaths during the opposition demonstrations, Chávez resigned. The coup brought Pedro Carmona, a business leader, to power as interim President.

To complicate matters there were indications that the Pentagon had tacitly backed the coup leaders. Unlike his predecessors, who had been content with assured cuts from the country’s oil revenues, Chávez had been actively using Venezuela’s oil resource as an instrument to carve out a foreign policy free of US influence. Towards that end, he fostered a close relationship with the Cuban dictator, Fidel Castro and is said to have agreed to supply oil to Cuba under generous conditions including a payment holiday and soft credit terms. On the same lines, he tried to increase his clout with the OPEC by visiting Iraq’s Sadam Hussain and Libya’s Mohammar Khaddafi, both dreaded by the US. Also, as if to underscore his provocative policies, he publicly declared his sympathies for left-wing guerillas in Columbia.

The White House openly blamed Chávez for his fall from power, and pointedly declined to voice any regret about his downfall. The cat finally slipped out of the bag when the Administration refused to comment on the unconstitutional nature of Chávez’s removal from office.

However, the broad support for Carmona from unions, opposition parties and sectors of the armed forces collapsed within hours after he decreed the dissolution of the legislature and the Supreme Court, suggesting the coup had itself been “hijacked” by a hard core of far-right military figures. A counter-coup was engineered by battalion commanders close to Chávez, reinstating him in power.

Meanwhile in Washington, asked whether the administration now recognizes Chávez as Venezuela’s legitimate president, one administration official replied, “He was democratically elected,” then added, “Legitimacy is something that is conferred not just by a majority of the voters, however.

[Sources:  Financial Times www.ft.com
Business Standard, April 18, 2002
New York Times, April 16, 2002 www.nytimes.com]