Venezuela's Crisis of the 1980s - The Tontine Coffee-House

In the 1970s, many countries were hobbled by the energy crises of 1973-74 and 1979. Of course, some made out very well. Oil producing countries spurred along by ‘resource nationalism’, particularly those that did not themselves slash production to keep prices elevated, saw an oil windfall transform their economies. However, oil is a volatile basis for prosperity.

Various oil producing nations suffered tremendously when the oil windfall evaporated amidst the 1980s oil glut; the Soviet Union arguably collapsed for this very reason. Yet, the experience of Venezuela and its lenders in the 1980s is remarkable because of just how swiftly conditions there changed. The country’s credit was ruined well before oil prices reached their lows of that decade. It wouldn’t even be Venezuela’s only experience of this sort in recent history.

Oil Boom

Venezuela was a beneficiary of the first oil shock of the 1970s. During the energy crisis, oil prices rose from just $2.05 per barrel of Venezuelan crude oil in 1970 to $9.30 in 1974. This transformed the government’s financial capacity as state revenues rose from under $4 billion in 1973 to almost $10 billion in 1974. The oil windfall accelerated economic growth and in the years between 1974 and 1978, the economy grew by an average of 5% per year.

Francisco Fajardo Highway, El Rosal, Caracas, 1978. Image courtesy of ArchivoFotografíaUrbana | Photograph by Ramón Paolini “Caracas. A doble página”

Presiding over this era of plenty was Carlos Andres Perez, President of Venezuela since March 1974. He sought to use the windfall to diversify the economy away from a reliance on oil alone and his attention was caught by the steel and aluminum industry. Perez nationalized Venezuela’s steel industry in 1975 and hoped that the country could graduate from being merely an exporter of iron ore into a sophisticated producer of steel products.

Venezuela’s oil industry was nationalized the following year. The country’s oil had been controlled by Dutch Shell, Esso, and Gulf which together accounted for four-fifths of production. It was now in government hands through Petroleos de Venezuela. Production capacities within these industries increased but at tremendous fiscal cost and waste and inefficiencies increased as well.

Still, the country was enriched by oil money. By the end of the decade, prices for Venezuela’s Tia Juana Light crude oil reached $25.50 per barrel. Oil accounted for 70% of government revenues and 26% of GDP. This money was invested in infrastructure projects, education, agriculture subsidies, and public health. The government subsidized wages in other industries and public sector employment doubled during Perez’s administration.

To limit domestic inflation, much of the oil wealth was invested abroad through a sovereign wealth fund, but inflation was nonetheless high. To keep the money invested in overseas markets, Venezuela extended loans to other Latin American countries and international organizations like the International Monetary Fund. Make no mistake though, Venezuela was still borrowing lots of money to fund it’s social and industrial initiatives even if it was investing abroad as well.

Despite the windfall at its disposal, Perez’s party was nonetheless defeated in subsequent elections and Luis Herrera Campins, rather than Perez’s successor, would take office in 1979. Under Campins, some of the economic interventions of the prior government, like price controls and interest rate controls, were removed. However, the expansion of the state’s responsibilities continued as oil prices reached a peak of $32 per barrel in 1980 after the second of the two oil shocks of the 1970s.

Problems

Economic problems began to reveal themselves in the early 1980s. For one, the state-owned enterprises were losing money and the government was spending large amounts of money, much of it borrowed. Indeed, despite the oil windfall, the government still needed to borrow from abroad to pay for the nationalizations and social spending of the prior decade. Now, the bubble began to deflate. Oil revenues peaked in 1981 at $19.1 billion, around which point they comprised 95% of total exports. Oil revenue fell 20% the following year.

The national debt had also been rising. Venezuela possessed the fourth highest debt burden in Latin America at a time when many other countries there were in fiscal disarray. Besides the state itself, the state-owned enterprises also conducted their own borrowing, largely hidden from the public for much of the 1970s. A large share of this debt was borrowed via short-term loans and a debt crisis already underway in Mexico would make it difficult to refinance this given the diminishing investor appetite for Latin American sovereign borrowers. In the past, Venezuela had benefited from AAA credit ratings from both the major rating agencies, Moody’s and S&P, allowing it to borrow at just 0.75% above LIBOR, the London Inter-Bank Offered Rate, but this was quickly becoming irrelevant.

In the early 1980s, the economy began to slide as well; the average annual change in GDP between 1979 and 1983 was -1.3%. Unemployment rose and remained high at around 20% throughout the early 1980s, the highest levels on record. So too was inflation, which stood around 15% per year on average between 1979 and 1982. The country was also a victim of corruption, which seemed widespread. Public spending during the boom years, as now, was routed to kickbacks and graft.

Finally, Venezuela was in the midst of a balance of payments crisis as exports fell with sliding oil prices and imports increased substantially. Capital was also flowing out of the country as many became concerned about the government’s ability to refinance maturing government debt. Some $2 billion left the country in January and February 1983 alone, well above normal levels of outflow.

Crisis

The outflow reached crisis levels. In response to the balance of payments issues, the Venezuelan bolivar was devalued in February 1983 and currency controls were put in place to regulate conversions between the bolivar and the U.S. dollar. The old fixed rate was maintained for repayments of debt and purchases of essential goods from abroad while other transactions had to be made at less favorable exchange rates. The government also defaulted on its foreign debts of $27.5 billion, of which some $18 billion in interest and principal would be due through the end of 1984. The state negotiated to restructure them; foreign banks accepted this but required that the International Monetary Fund make fiscal recommendations for Venezuela to follow.

Imports fell amidst the currency controls and weakening economy, helping to correct the ‘imbalance’ of payments. Austerity policies were introduced and strikes, already common, became larger. Nonetheless, inflation fell from 21.6% in 1980 to 3.3% in 1983, as a result of monetary and fiscal restraint and a weakening economy. Incomes, consumption, and investment also fell, driving GDP lower by almost 5%.

Recovery

The Venezuelan government generally agreed with the IMF’s recommendations. At tremendous cost, the country’s foreign currency reserves survived intact. Reserves had actually ended fiscal year 1983 at a higher level than where they started. The fiscal deficit had also fallen from 25 billion bolivars in 1982 to 9.5 billion bolivars in 1984. The new presidential administration of Jaime Lusinchi replaced that of Campins in 1984. The new head of state still had plenty of problems to solve. Inflation made a return and the economy was stuck in rough shape. The structural problems of the state-run industries remained.

Lusinchi implemented more measures to bring about an economic recovery, continuing to guide policy down the general direction set out by the preceding government. His objectives were to restore investor confidence, remove price controls and subsidies, such as one on gasoline that cost the government $850 million per year, reschedule debt repayment and reduce the national debt, restore a suitable balance of payments, and boost the productivity of Venezuelan agriculture and industry. To this end, some state-owned companies were liquidated or reorganized. Still, this did not entail an unlimited liberalization of the economy. Import restrictions remained and wages and interest rates were subject to strengthened controls.

Legacy

As that of Campins, Lusinchi’s program found mixed success. Progress was made in negotiating new repayment timetables with foreign banks in 1984 and 1985. However, there was no immediate and strong economic recovery; no recovery at all would come until 1986. Also, Lusinchi was given special powers to address the crisis, enabling him to rule by decree; it was questionable whether Venezuelan democracy itself survived the crisis.

In the end, Venezuela’s travails did not really end in 1986. Oil prices plummeted early in the year and the country had to request an emergency loan from the Inter-American Development Bank (IDB).

There was also a subsequent devaluation in December 1986 under which the official exchange rate varied between 7.5 and 30 bolivars to the U.S. dollar depending on the underlying transaction. The devaluation allowed the government to finance its deficits by selling its foreign exchange holdings at a better price in bolivar terms. In the end, Venezuela never drove its foreign currency reserves all the way down to zero and so it was hardly the worst afflicted Latin American debtor in this era. Still, Venezuela merely hobbled along.

Lesson

A year before its 1983 devaluation and the country’s default on its foreign debts, Venezuela was rated AAA by both Moody’s and S&P. The oil-producing country benefited from a windfall most can only dream of. Yet, oil can be among the most vulnerable foundations for prosperity. Remarkably, Venezuela’s oil money still wasn’t enough to cover its ambitious and costly social and industrial objectives, so the country borrowed more money and borrowing on the basis of resource income is perilous. Need further proof? Consider that Venezuela’s experience in the 1980s is almost as haunting a tale of how quickly a nation’s fortunes can change as … Venezuela in the 2010s.

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Venezuela’s Crisis of the 1980s