Venezuela’s Economic Reckoning is Coming Sooner Rather Than Later

The collapse in oil prices over the last several months has put Venezuela in a dire situation, increasing the likelihood of a severe economic meltdown over the coming months. While Venezuela’s economy has steadily deteriorated over the last two years, largely as a result of a severe currency misalignment and wildly expansionary fiscal and monetary policy, the 40% drop in energy prices is rapidly accelerating the size and scope of its economic troubles. Whereas before the government had years to necessary structural adjustment measures, now it only has mere months at best.

Multinationals need to brace themselves for a significant worsening of operating conditions in Venezuela over the coming weeks and months. The two most likely scenarios that FSG envisions are:

A managed adjustment:

The Venezuelan government finally accepts that a significant economic adjustment is necessary and severely devalues its exchange rate, and significantly cuts reduces gas subsidies and government spending by more than 20%. This will lead to a severe contraction in the economy, with a short-term jump in inflation.

  • Impact on stability: This scenario would lead to severe unrest, significantly worse than in previous protests, increasing the likelihood of a change in government, most likely toward a successor Chavista government or a civil-military coalition government
  • Impact on multinationals: If these measures are credibly enforced, multinationals should expect a severe deterioration in the disposable incomes of consumers and a drop in demand from local companies and retailers. Government spending will fall significantly, as will investment, until the economy begins to stabilize, likely after a severe period of political and social unrest. Any recovery is unlikely to materialize until well into 2016 and beyond

A disorderly adjustment:

The government attempts to tighten exchange rate controls, price controls, and deploy other heterodox measures with limited cuts to government spending or changes to exchange rate policy. This doubling down on current policy will prove as ineffective, leading to growing pressure on government finances, and a squeeze on the supply of dollars that further chokes economic growth in Venezuela.

  • Impact on stability: While this approach may delay unrest for a few more months (potentially beyond legislative and state elections set for the second half of 2015), this scenario will also eventually lead to a severe drop in the purchasing income of consumers. This is due to the fact that while mandatory wage hikes will mollify average Venezuelans over the short term, wage hikes could push rising inflation into hyperinflation that will destroy purchasing power over the second half of 2015
  • Impact on multinationals: This scenario will likely lead to further controls on operations, additional deterioration of economic conditions, and a complete lack of access to dollars for those exporting products into Venezuela. Prospects for an economic recovery will be significantly delayed, with companies committed to a long-term presence in Venezuela likely having to take a 5 to 10 year horizon for any significant returns from the market

FSG recommends multinationals begin developing contingency plans ahead of what we see as an inevitable spike in instability in Venezuela over the coming months. For more information on our contingency planning services for Venezuela, contact us.

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