venezuela 1999-2014 macro-policy oil gov

Symposium Article

Venezuela 1999–2014: Macro-Policy, OilGovernance and Economic PerformanceLEONARDO VERA

Universidad Central de Venezuela, FACES, Escuela de Economía, Caracas, Venezuela.E-mail: [email protected]

During the administration of President Chavez, Venezuela registered some celebratedand encouraging socio-economic achievements, however; in the macroeconomic realmthe country underperformed compared with other countries in Latin America of a similarsize. The country, for instance, did not manage to avoid recurrent external crisis, suf-fered from unprecedented net transfers of financial resources abroad and, despite the oilwindfall, has not accumulated a strong level of defensive international reserves. More-over, inflation has been rampant and output growth has been very volatile and, onaverage, poor. This study provides a descriptive account and analysis of Venezuela’smacroeconomic performance and policy experience during the administration of Pre-sident Chavez and his handpicked successor, Nicolas Maduro (1999–2014). It focuses onthe major policy and institutional changes, and on the problems and imbalances of theeconomy to find out and explore the conundrum of Venezuela’s economic under-achievement. We evaluate Venezuela’s exchange rate and monetary policy and the keycommitments of the Central Bank to society. In general the study suggests that macro-economic mismanagement and a failed institutional structure of governance are essen-tial to understand some key imbalances. It seems to be the case that the root cause ofthis macroeconomic mismanagement and poor governance of Venezuela lies in prevail-ing political and economic incentives.Comparative Economic Studies (2015) 57, 539–568. doi:10.1057/ces.2015.13;published online 4 June 2015

Keywords: Venezuela, macroeconomic policy, Central Bank, oil governance, realexchange rate

JEL Classification: E5, E52, E60, N16

INTRODUCTION

The macroeconomic performance and socio-economic progress in Venezuelain the last 15 years represents an interesting development experience that

Comparative Economic Studies, 2015, 57, (539–568)© 2015 ACES. All rights reserved. 0888-7233/15

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encompasses periods of remarkable growth and collapse, external crises,unexpected inflation acceleration and deep and controversial economic andinstitutional reforms designed to establish an ambitious pro-poor platformwithin a short time span. All this happens in an environment in which thepetroleum sector provides the lion’s share of total export proceeds of thecountry while the international oil price jumped from US$16.0 per barrel in1999 to $88.4 in 2014. Venezuela’s exports of oil, at a time of increasing oilprices, enabled the country to post-systematic trade and current accountsurpluses. However, with improved terms of trade, and substantial andpersistent current account surpluses, the country suffered from unprecedentednet transfers of financial resources abroad, was unable to avoid recurrentexternal crisis and, despite the oil windfall, did not accumulate a strong level ofinternational reserves. Moreover, inflation has been rampant and outputgrowth has been very volatile and, on average, poor.

Though during the administration of President Chavez and his successorNicolas Maduro, Venezuela registered some celebrated and encouraging socio-economic achievements, in the macroeconomic realm the country has under-performed when compared with countries of a similar size and level ofeconomic development in Latin America without the oil bonus.

This study provides a descriptive account and analysis of Venezuela’smacroeconomic performance and policy experience during the so-calledBolivarian Revolution, the period since President Hugo Chavez took office in1999. During this time a nationalist revolution, bolstered by the soaring price of oil,redirected and enhanced the presence of the State in the economy as well as therole of public policies. In general the study suggests that macroeconomic mis-management and a failed institutional structure of governance are essential tounderstand some key imbalances. It may be the case that the root cause of thismacroeconomic mismanagement and poor governance of Venezuela lies in pre-vailing political and economic incentives. In particular, we evaluate Venezuela’smonetary and exchange rate policy and the key commitments of the Central Bankand show that a changing macroeconomic and institutional framework created anumber of specific pressures and constraint on the Central Bank.

The study proceeds as follows. In the section ‘A brief tour of Venezuela’smacroeconomic performance’ we present an interpretive set of economicregularities to show that the economic behavior and performance of Venezuelahas differed from its peers in Latin America. We then present an account of theeconomic evolution and performance of the economy and review the role thatpolitics and institutional design played in shaping macro policy. Broadly wedivide the examination into four short periods or phases conditioned on thebehavior of oil prices, the policy choices and some key institutional arrange-ments. The four periods consist of: (a) a phase of intense political turmoil,

L VeraVenezuela 1999–2014

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Comparative Economic Studies

(b) a period of collapse and relatively long recovery leveraged by increasing oilprices and the control of the oil rent, (c)the aftermath of the global crisis, andlastly (d) a short-lived recovery phase followed by severe macroeconomicinstability and troubling governance. The section ‘The challenges for the centralbank: monetary and exchange rate policy’ looks at the role that macro-policymismanagement has played in explaining Venezuela’s mediocre macroeco-nomic performance. We highlight the political and economic constraints andincentives under which both monetary and exchange rate policies have takenplace. The section ‘The seeds of bad oil resources governance’ focuses on theeffects that a very the poor structure of oil governance has produced on themanagement of oil proceeds and stocks.

A BRIEF TOUR OF VENEZUELA ’S MACROECONOMIC PERFORMANCE

Any appraisal of Venezuela’s economic performance between 1999 and 2013must start with some critical macroeconomic regularities. Table 1 presents keyexternal sector indicators for Venezuela as well as average figures for the Latin-American region as a whole. Looking at the current account, it seems clear thatwhile the average current account deficit for the region was nearly 1% of GDP,Venezuela was one notable exception. Having seen oil prices accelerate fromthe early 2000s onward, the country had current account surpluses thataveraged 8% of GDP. As a primary exporter, Venezuela could gain from animproved terms of trade.1

However, unlike other Latin-American countries and despite its recurrentcurrent account surplus, Venezuela did not manage to accumulate largeinternational reserves. Table 1 also shows that the increase in Central Bankforeign assets was only modest despite the sharp persistence in the currentaccount surplus to GDP ratio and the inexorable rise in the terms of trade. TheVenezuelan experience contrasts sharply with that of the region whereinternational reserves increased substantially more.

Why Venezuela did not take advantage of its comfortable commercialposition is not at all clear now. A good starting point, however, is to focus theattention on certain inherent contradictions of the domestic policy mix aswell as on the factors that led to increasing fears of wealth and capital loss. Inaddition, a crucial institutional change that would share honors in this regard

1With the rapid increase of oil prices since year 2000 and up to 2012, Venezuela’s internationalterms of trade improved by about 300% over the period, while the improvement for Latin America asa whole was close to 38%. Though the international financial and economic crisis generated a majorshock and deterioration in the term of trade in 2009, the term of trade recovered rapidly even in thecase of Venezuela.


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was the advent and questionable reform of the Venezuela’s Central Bank Law.The reform altered the balance of power between the monetary authority andthe national oil company (PDVSA) and allowed the government to take ‘excessinternational reserves,’ and deposit them into a special fund, known as theNational Development Fund (FONDEN).

Table 1 shows that during this period, Venezuela could not stop its chroniccondition of an exporter of capital and suffered from unprecedented negativenet financial resource transfers, which have escalated during last decade.The timing of the escalation of net capital outflows coincides with upswing ofthe current account surplus flows, illustrating the so-called ‘revolving door’effect. Negative financial transfers have been driven by greatly divergingmotives and incentives. Substantial political and economic instability, some-thing that seems to be intrinsic to the political model envisioned by Hugo

Table 1: Venezuela versus Latin America – External Accounts

Year Current Account (% ofGDP)

International Reserves(millions of US$)

Net Financial Transfersfrom Abroad a

Venezuela Latin America Venezuela Latin America 6b Venezuela Latin America

1999 2.2 −2.9 15,164 126,582 −2,953 −2,7782000 10.1 −2.3 15,882 126,729 −7,792 2,6792001 1.6 −2.5 12,295 128,803 −6,031 3352002 8.2 −0.8 12,002 134,915 −14,785 −42,2692003 14.1 0.5 20,667 159,482 −8,679 −41,1492004 13.8 1.0 23,497 178,989 −17,037 −67,4532005 17.5 1.3 29,637 202,058 −22,225 −76,8432006 14.4 1.5 36,672 246,467 −22,603 −89,6752007 7.5 0.3 33,477 379,237 −20,155 16,4992008 10.9 −0.8 42,299 413,452 −24,408 −39,1252009 1.8 −0.5 35,000 469,970 −19,968 −31,9672010 5.0 −1.2 29,500 561,510 −25,312 17,7352011 7.7 −1.4 29,889 670,354 −35,543 32,4572012 2.9 −1.8 29,887 726,257 −22,060 19,5002013 1.6 −2.3 21,481 720,050 −23,500 18,2882014c 20,479 752,562 −26,287 26,900Average 8.0 −0.8

% Increase 1999–2014 35.05 494.52

Accumulated1999–2014

−299,338 −256,867

aThe net transfer of resources equals net capital inflows (including non-autonomous, errors and omissionsminus the balance in the factor income account (net interest and profits). Negative quantities indicateresources transferred abroad.bIt refers to the 6 bigest economies of the region excluding Venezuela.cFor 2014 figures are preliminary.Source: Economic Comission for Latin American and the Caribbean, ECLAC


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Chavez, played a part. Moreover, monetary and exchange rate policy did notprovide the needed support. Capital outflows were also fueled by the large-scale accumulation of resources in FONDEN.

The domestic side of the economy also shows striking contradictions.Venezuela shares with the region the remarkable recovery in socio-economicindicators of the standard of living. Poverty rates in Venezuela which wereclose to 50% in the late 1990s, registered a sharp drop to 23% in 2012(Table 2). Contrary to what some observers may think, Venezuela’s singulargood performance in terms of socio-economic indicators is not just a case of agrowth dividend. GDP growth has been poor even with a very favorablemovement in the terms of trade. This does not mean that poverty, inequalityand well-being have not been affected by the commodity boom. The massiveresources from oil-production and exports available to the government wereused, as in the past, for important efforts to increase social spending. From2004, centralized and extra budgetary public expenditure on education, health,

Table 2: Venezuela versus Latin America – Seleted Macroeconomic Indicators

Year Inflation Based on CPI (onannual average)

Real GDP Growth Povertya

Venezuela Latin America Venezuela Latin America Venezuelaa Latin Americaa

1999 23.57 9.28 −6.0 0.6 49.4 43.82000 16.21 9.47 3.7 4.4 44.0 -2001 12.53 7.20 3.4 0.7 44.4 -2002 22.43 8.57 −8.9 0.5 48.6 43.92003 31.09 11.09 −7.8 1.7 - -2004 21.75 7.25 18.3 5.9 45.4 -2005 15.95 6.39 10.3 4.5 37.1 39.72006 13.65 5.34 9.9 5.5 30.2 36.22007 18.70 5.46 8.8 5.6 28.5 34.02008 31.45 8.14 5.3 4.1 27.6 33.52009 28.59 5.60 −3.2 −1.5 27.1 32.92010 29.06 5.75 −1.5 5.9 27.8 31.12011 27.15 6.68 4.2 4.4 29.5 29.62012 21.11 5.75 5.6 3.1 23.9 28.22013 56.20 7.60 1.3 2.8 32.1 28.12014 b 63.40 9.30 −3.0 1.1

Mean 27.05 7.43 2.53 3.08

Standard Deviation 14.17 1.74 7.36 2.31Variance 200.69 3.02 55.65 5.44

Multiannual Change(1999–2013)

−17.3 −15.7

aPercentage of Poor People based on data and calculation provided by ECLAC.bFigures for 2014 are preliminary.Source: ECLAC


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social security, housing, and social development and participation rose. Thisnew emphasis entailed the development of large-scale poverty reductionprograms which were not very much under the conventional supervision orcontrol of the Central Government. Over time, the abstract concept of‘socialism’ became associated with the strategy of redistribution.

Growth was not only far from satisfactory, but it was also very volatile.Table 2 also shows that Latin America as a whole experienced a smoothdecline in the dispersion of annual growth rates while the Venezuelaneconomy passed from periods of moderate growth to periods of severerecessions and (occasional) intense booms. As a consequence, growth volati-lity is much larger in Venezuela than in the rest of the region. Measured by thestandard deviation of GDP growth, Venezuela is almost three times as volatileas the rest of the region, a group of economies typically thought of as volatile.

As pressing and relevant as GDP growth trends and volatility is theexperience of chronic and high inflation. Table 2 shows the steady decreaseof the inflation rate in the continent, at least if we compare with the levelinflation registered at the beginning of the sample. The case of Venezuela, ofcourse, catches the eye. By many standards, Venezuelan inflation has been oneof the most intractable economic issues facing the country.2

This bird’s eye view of the relative macroeconomic performance of theVenezuelan economy does not explain why Venezuela’s external and domesticmacro performance did not show signs of improvements despite substantialincrease in oil export proceeds. We explore some details by dividing the periodinto four successive episodes.

The rise of political turmoil, institutional uncertainty and capital flight(1999–2002)The first facet of the Venezuela’s economic problems involved the boldexperiment in a non-consensual project of radical transformation that led toproblems of conflict and governability. Subject to a sharp environment ofdomestic conflict, the country could not fully reconcile the external balancewith a system of fixed exchange rates and free convertibility. Monetary andexchange rate policy were not in any sense designed to deal with the domesticpolitical turmoil. Moreover, government authorities and the Central Bank,obsessed with inflation, held the exchange rate stable as a nominal anchoragainst inflation and this, instead of helping, exacerbated the crisis.

From the beginning in 1999, the agenda of Hugo Chavez embodied aproject of radical transformations inevitably associated with an intensification

2 The time span of inflation has been unparalleled: inflation has exceeded 10% per annum everyyear since 1979 following a very irregular or volatile pattern.


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of the political conflict. As soon as he was elected President, Chavez convokeda constitutional assembly to introduce far-reaching changes to Venezuela’spolitical system. The resulting new constitution of 1999 was designed with theaim of deepening social and economic rights but also presidential powers.3 InNovember 2000 the government majority in the National Assembly grantedPresident Chavez year-long decree powers and he forged ahead with hisradical reform agenda. A set of 49 laws that pretended to bring Venezuela’slegal framework up to date with the new constitution and far-reachingeconomic and business reforms were presented a year later. The reformsraised questions about future property rights and contract enforcement and theoutcry against these laws was immediate. Fedecamaras, the country’s largestchamber of commerce, which unites most of Venezuela’s big businesses,complained that the laws were anti-business, undermined private propertyrights, and were passed without consulting them or anyone outside govern-ment circles. Venezuela’s main union federation, the Confederation of Vene-zuelan Workers (CTV) quickly joined the fray arguing that the laws were alsoharmful to workers. The result of the vehement opposition to the governmentby union workers (around CTV) and the business community (aroundFedecamaras) was that the two organizations called for a ‘general strike’ on10 December 2001.

But it was not only the package of 49 laws and the resulting general strikethat added fire to Venezuela’s conflict and uncertainty. Another crucial factorwas that the economy suddenly slowed down as the price of oil decreased inthe wake of the September 11 terrorist attack on the United States. Thegovernment was forced to adjust its budget and cut back spending in all areasby at least 10% (Wilpert, 2007). The impact was almost immediately notice-able, as GDP growth started to fall and unemployment began inching upwardsin the fourth quarter of 2001.

A new conflict was whipped up with the new hydrocarbon law approvedin January 2002. Chavez’s moves to consolidate power in the oil sectorprovoked new opposition among labor and business groups and led them tounite against his attempts to control the oil sector.4 In April 2002, Venezuela’slargest labor union staged a general strike to support a walkout by oil workersover PDVSA management changes. The strike sparked a countrywide protest

3 The Constitution of 1999 strengthened the power of the Executive by extending the presidentialterm from 5 to 6 years, providing the possibility of re-election for one more period, and strengtheningthe power of the president over the Armed Forces. There was increased centralization with lessautonomy for regional and municipal powers, PDVSA and the Central Bank.

4 The new hydrocarbon law included higher fiscal taxation and royalty rates, reserved allmedium and light crude upstream development for PDVSA, and allowed the oil-state company to ownat least 51% of all present and future concessions.


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and galvanized support from anti-Chávez factions in the military. On April 11,the President was forced temporarily to relinquish power though he wasreinstated by the military two days later.

In this environment of political instability, the existing exchange rateregime (a currency-band) was put to the test as the domestic currency (thebolivar) came under pressure. Still working in a context of full convertibilitywith a fixed exchange rate, monetary authorities had to deal with capital flightand currency overvaluation both driven by an environment of political andeconomic instability and by the exchange rate policy.5 Thus, during 2001 and2002, when the country suffered a serious governability crisis and strongcapital flight, Central Bank authorities decided to defend the currency peg butwithout major success.6

Though in year 2002 the Central Bank (in conjunction with the govern-ment) decided to adopt an auction system for foreign exchange with exchangerate flexibility and promote an increase in interest rates, the float collapsed inDecember 2002 when the 2-month oil strike crippled the country’s exportsector. By January 2003, it was impossible to regulate auctions and they weresuspended. On 5 February 2003, the external crisis was recognized andPresident Hugo Chávez and the Central Bank authorities enacted exchangecontrols pegging the bolivar to a high parity with the dollar once again.

Collapse and immediate recovery with rising oil prices and increasing oilrent control (2004–2008)The strike called between late 2002 and early 2003 triggered sharp decreases inoil production and exports. Moreover, with the introduction of exchangecontrols in February 2003, non-oil activities were severely affected; the short-age of foreign exchange had a serious dampening effect on private-sectordomestic production. GDP plunged by 27.6% in the first quarter of 2003 andVenezuela’s fiscal position rapidly deteriorated as a consequence of the strongreduction in oil revenues and the fall in non-oil activities.

As a part of an effort to contain the effects of the crisis, President Chavezreplaced his right-hand man and minister of planning Jorge Giordani with aneconomist, Felipe Perez Martí, and named another qualified economist, TobiasNobrega, as finance minister. Facing a severe economic downturn the new

5 It is important to point out that the system of frequent small devaluations attached to theprevailing crawling-band regime was seen by the Chavez’s administration, and especially by theminister Jorge Giordani, as excessively inflationary. Indeed, nominal exchange rate stability was seenas a fundamental nominal anchor against inflation.

6 Frenkel (2004) has correctly pointed out, that Latin American countries that in the last 30 yearshave focused their exchange rate policy primarily on controlling inflation, have created unsustainablecurrent account and external debt trends that have led to crisis followed by maxi-devaluations.


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economic team decided to avoid the characteristic procyclical bias in publicfinance and introduced a sizeable increase in public spending. Financing thefiscal expansion was not a major problem since the exchange controls providedthe needed domestic liquidity funds to issue and place further public debt, andto finance the growing fiscal gap.7 Further contributions came from revenuesobtained by the Central Bank that were transferred to the public accounts.

But the fiscal expansion was not sufficient to offset the output effects causedby the import compression associated with the foreign exchange control. Eventhough, the recovery in oil production and exports, together with theseexchange controls, boosted the country’s international reserves from $14 billionto $21 billion between the beginning and end of 2003. Import compressionoperating largely through adverse effects on the supply side was a critical factorunderlying the slide into deep recession. As a result, the government found itselfin a new dilemma. On one hand, it wanted to increase public expenditure inorder to fight the economic downturn and on the other hand, it attempted toengineer a higher trade balance surplus by restricting the supply of importedinputs. Given the supply side difficulties associated with import restrictions toredress the external sector problems, it is natural to ask whether other policieswould have offered more favorable macroeconomic tradeoffs.

After 4 years in power which included endemic political confrontationswith opposition groups, a thwarted coup d’état, a series of strikes, a severeexternal sector collapse and an economic downturn, Chávez faced a decline inhis popularity that posed a threat to his stay in power. In May 2003, the majoropposition groups agreed to pursue their goal of removing Chavez through arecall referendum. However, when the referendum took place in August 2004,President Chávez’s supporters defeated his recall with a 59% vote. Thus,though the president’s approval ratings were low in July 2003, popularitysteadily increased from 31 % to 56 % in 1 year (McCoy, 2006).

Three major factors explain Chavez’s recovery to win the recall referen-dum in 2004: the sudden recovery of world oil prices, Chavez’s control overthe oil rent, and the emergence and crucial political impact of his new andpersonally controlled distributive programs.8

Control of the oil industry along with the windfall because of priceincreases, gave Chavez’s administration more leverage over funds as well asadditional resources to introduce new social policy innovations. The innova-tions were a wide set of publicly funded social development programs – the

7 In addition, given the impossibility of investing in the foreign exchange market and thesluggishness of credit operations, banking institutions invested quite heavily in governmentsecurities.

8 As a matter of fact, the economy began to recover as the world price of petroleum climbed fromUS$29 per barrel in August 2003 to US$41 per barrel in August 2004.


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Missions – that were characterized by a pattern of institutional bypassing andthus not subject to supervision or control by the central government. Theprograms attended to the basic needs of low-income individuals and families interms of nutrition, health and education and required extra-budgetaryresources to fund their expansion.

Daguerre (2011) points out that what really represented a break fromprevious administrations was the amount of money devoted to social spendingand the new programs. Social spending as a proportion of the GDP increasedfrom 8.8% in 1990/1991 to 11.7% in 2004/2005 (ECLAC, 2007). For Penfold(2007), total public spending for the Missions already represented 6% of theGDP in 2006. As Table 3 suggests most social spending was executed throughextra-budgetary mechanisms. Starting in 2004 extra-budgetary spending (as aproportion of GDP) went from 3.8% to 9.2% of total GDP in 2006. Whilehistorically the executive has always had a fair amount of leeway in determin-ing the use of oil rent, the sheer magnitude of resources that did not pass (andcurrently do not pass) through any budgetary process was unprecedented.This was achieved by (i) redirecting part of the oil taxes to the off budgetdevelopment fund, FONDEN, created in 2005 and directly controlled by thepresident, and (ii) bypassing the traditional budgetary mechanisms and usingPDVSA as an extra-budgetary fund to manage several of the government’ssocial programs and other expenses.

Table 3: The Great Recovery – Main Economic Indicators (2004–2008)

2004 2005 2006 2007 2008 Five-YearAverage

Average Oil Price (US$ /bl) 33.1 46.0 56.5 64.6 86.8 57.4GDP Growth (%) 18.3 10.3 9.9 8.8 5.8 10.6Per capita GDP Growth (%) 16.2 8.4 9.3 6.1 3.2 8.7Growth of Imports (%) 57.7 35.2 34.8 33.0 1.4 32.4Aggregate Demand Growth (%) 24.8 15.5 16.0 15.6 4.0 15.2Central Government Spending(% of GDP)

25.8 25.8 29.8 25.6 25.7 26.5

Extra-Budgetary Spending(percentage of GDP)

3.9 4.3 9.2 7.9 8.1 6.7

Total Government Spending(percentage of GDP)

29.7 30.2 39.0 33.5 33.8 33.2

Poverty Rate (%) 45.4 37.1 30.2 28.5 27.6 33.8CPI Inflation (%) 19.2 14.4 17.0 22.5 31.9 21.0Current Account Balance(Millions of US$)

15,519.0 25,447.0 26,462.0 18,063.0 37,392.0 24,576.6

Net Financial Transfers from abroad (17,037) (22,225) (22,603) (20,155) (24,408) −21,285.6Effective Real Exchange Rate(Index 2000= 100)

139.0 142.2 132.5 118.7 96.8

Source: Venezuelan Central Bank, National Institute of Statistics, Ministry of Finance and ECLAC


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The success of the redistributive programs and the recovery years of theChávez administration were very much supported by the spectacular rise in oilprices. Macroeconomic performance was thus influenced by the increase ingovernment oil revenues, which served to finance increased governmentspending. As also shown in Table 3, oil prices (and exports revenues) almosttriple in 5 years and from 2004 on the economy began to make steady progress.Venezuela real per capita GDP growth, that between 1999 and 2003 was farfrom satisfactory and volatile, jumped in the period 2004–2008 to an averagerate of about 8% a year, characterizing one of the best growth performances inthe world at the time and also in the country’s modern economic history. Asthe economy began to grow rapidly and social programs started to have a fullimpact, poverty was sharply reduced.

The commodity boom and the increasing State control of the oil rentbecame no doubt the cornerstone of the Chávez regime after his victory in therecall referendum. In January 2005, Chavez announced a new phase ofthe Bolivarian revolution, a call to build 21st century socialism.9 Further, hedecisively won a second 6-year term on 3 December 2006. Though the idea of21st century socialism remains undefined as yet, Venezuela has in recent yearsbeen applying a model that accentuates the role of the State in the economy.The model moves beyond market mechanisms for regulating production anddistribution of many goods and services, breaks away from the old institutionsof governance of Venezuela’s oil flows and replaces them with a wide range ofdiscretionary powers. In terms of the new role that the State was supposed toplay, a strategy for changing the ownership and control over the means ofproduction was rapidly developed. It was based on the expropriation of‘strategic industries’ (such as iron, steel, energy, transport, communications,agribusiness industries, insurance, banking, supermarkets, shopping malls,and even hotels) and also idle factories in the private sector.10

With Jorge Giordani back as a minister of planning, the oil boom and theprogressive restoration of the huge current account surpluses, well-knownincentives to peg the currency exchange above its fundamental valuereturned.11 Real exchange rate appreciation along with the substantial expan-sion of aggregated demand resulted in steep increase of imports. Thus, while

9 Chavez made this announcement at the January 2005 World Social Forum in Porto Alegre.10 The most prominent examples of expropriations include the 2007 takeover of telecom

company CANTV and electricity company EDC.11 Del Bufalo (2005) points out that in an oil-led development model since oil exports are not

sensitive to the variations in the exchange rate, a fixed parity covering a moderate real appreciationwas thought to be beneficial for the import of capital goods and an efficient way to protect personalreal income. Moreover, Garcia Larralde (2001) has advanced the thesis that currency overvaluation inVenezuela is very often sustained by oil booms.


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the rate of growth of aggregate demand was substantially above real GDPgrowth, the rate of growth imports was systematically above the rate of growthaggregate demand, at least during the 2004–2007 period. This divergentpattern of growth between aggregate demand and imports could havecontinued as long as the price oil continued to increase. By the end of 2008,commodities, and particularly crude oil and derivatives, accounted for more than92% of Venezuela’s exports (Rodriguez et al., 2012).12 Unfortunately, oil pricessuffered a big slide during the second part of 2008 and all policy efforts turnedtoward dealing with the thread of an external and fiscal crisis.

The aftermath of the global crisis (2009–2010): The anti-Keynesian pro-cyclical adjustmentIn the second half of 2008 as the world oil market began to be seriously affectedby the aftermath of the global economic crisis, the price of crude oil began tofall. In just 6 months the price of crude oil fell 68%. In a period of risk aversion,international investors began to liquidate Venezuelan financial assets on amassive scale. In December, just when the price of oil reached its lowest level,spreads were at 7 year highs (as shown in Figure 1).

Oil prices gradually started to recover in 2009. However, the average priceof oil in 2009 was $56.93 which was well-below the average in 2008 ($86.81).With a drop in oil revenues of almost 40% in 2009, the surplus in the currentaccount disappeared. Unfortunately, the decline in oil exports proceeds could

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Figure 1: Oil Crude Prices and Country Risk, January 2014 to December 2014 (quarterly data).Source: Ministry of Energy and Bloomberg

12 Corrales and Penfold (2011) argue that a state that depends so heavily on one sector facesdiminished incentives to stimulate the growth of other sectors when the main sector is booming.


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not be offset by higher non-oil revenues. The value of non-oil exports fell as aresult of the marked currency overvaluation, Venezuela’s exit from the AndeanCommunity of Nations, and the fall in other mineral and commodity prices.

Venezuela had accumulated a comfortable level of reserves that reachedan historical peak of $ 42.299 billion at the end of 2008. Venezuela also had alow level of public debt (and, most importantly, low foreign public debt) whenoil prices began to fall, and could have borrowed and spent as much asnecessary in order to keep the economy growing. Moreover, the combinationof a high level of international reserves and exchange controls seemed to bedeterrent enough to prevent an orthodox adjustment.

However, instead of using exchange rate flexibility as a shock absorber,Venezuela’s authorities maintained the fixed parity and reduced the allocationof foreign exchange for imports and payments (see Figure 2). This clearlypromoted a further appreciation of the real exchange rate. In 2009, overallimports (including the public sector) were reduced about 22% from the levelrecorded in 2008. As nearly 77% of goods imports in Venezuela are inter-mediate inputs and capital goods, the discretionary reduction in the allocationof foreign exchange introduced a supply-side constraint that had a negativeimpact on production.

Beyond this initial reaction to the crisis, on 22 March 2009, almost9 months after starting the collapse of oil prices, the Executive announced aset of fiscal measures. The budget assumed that the price of oil for 2009 wouldbe $40 per barrel13 and the government also announced a 6.7% cut in nominal

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government expenditure for 2009 and an increase of 3 points in the rate of theValue Added Tax to bring it to 12%. To cover the fiscal gap the governmentauthorized an increase in domestic debt from Bs. 12 billion to Bs. 37 billion.

The measures looked like an effort focused on balancing the publicaccounts. This observation is important because it denotes the absence of aclear determination to act counter-cyclically. This could be because of eitherthe absence of fiscal space (a lack of financing or other resources to stabilizethe cycle) or to a lack of understanding. A well-known propensity to engage inpro-cyclical fiscal policy is explained in the case of Venezuela by its extremelyhigh dependence on oil (Baldani, 2005).

Even during the positive oil shock period the Venezuelan economy did notfully escape the external constraint since capital outflows were prominent inspite of the exchange controls. Moreover, when oil prices declined in 2009Venezuela lost 25% of its international reserves. The decision to make anexchange rate adjustment came late. Forced by the circumstances, in January2010 the government decided to adjust the exchange rate and established atwo-tier exchange rate system comprising a rate of Bs.F 2.6 (BsF) per dollar forselected items, chiefly food, medicine, educational materials, machinery, andequipment, and a rate of Bs.F 4.3 per dollar for other imports.

For two consecutive years (2009 and 2010) output fell precipitously andVenezuela said good-by to the golden year of high growth.

Riding the economic roller coaster (once again)Venezuela’s economy plagued with severe ups and downs, with GDP fluctuat-ing wildly between periods of impressive growth and dismal slumps, recoveredsome ammunition in 2011 and 2012 as oil prices returned in the first quarter of2011 to their pre-crisis level. The recovery in the value of oil exports, coupledwith government measures to increase its share of oil revenue, supported publicspending. But, despite oil averaging $ 100 per barrel in 2011, growth did notreturn to pre‐crisis levels. For 2011 and 2012 the economy grew 3.9% and 5.7%respectively. The economy was boosted above all by the construction, com-merce and financial sectors. Other key sectors such as oil and manufacturingrecorded low growth in 2012 (1.4% and 2.1%, respectively).

An examination of this recovery phase reveals the key role played by thepolitical cycle. Hugo Chavez was running for an unprecedented third term inoffice and his political success depended on his ability to maintain the supportof his core base at all costs, a consideration that pointed to generous and heavypublic spending.

With an eye in the presidential elections, very early in 2011 the govern-ment began to develop a strategy aimed at accumulating funds. In January2011, as it tried to boost revenue and narrowed the budget deficit, the


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government harmonized the exchange rate at BsF 4.3 per dollar, abolishing theBsF 2.6 per dollar rate. For operations not eligible for the BsF 4.3 per dollar rateauthorized by Foreign Exchange Administration Board (CADIVI), there was analternative swap market mechanism (the so-called SITME) created in 2010.14

The move attempted to ease the fiscal gap by giving the government moremoney in local currency terms for every dollar it earns in oil exports. Exchangerate policy remained however tied to an adjustable peg system that could notavoid a continuous overvaluation of the real exchange rate. Moreover, inOctober 2011, the 2012 budget was prepared based on a very conservativeassumption regarding oil prices (US$ 50 per barrel). The idea was, once again,to allow the executive the use of extraordinary resources for discretionaryspending.

To increase the State’s share of the rent generated by increasingoil exports, in April 2011 the government established a special levy on windfallprices in the international hydrocarbons market, specifically on exports of oiland derivatives. Under the decree-law, when oil prices exceeded the price setin the Budget Act a tax would be levied on the difference between the twoprices. The revenue from this tax would be then channeled into FONDEN. Inessence, the implication was that a spending flow subject to political oversightwithin the framework of the budgetary system was changed to one that wassubject to the discretionary power of the executive.

In addition to these policy measures, the Central Bank transferred US$ 3.5billion in international reserves to FONDEN in 2011; and US$ 10.4 billion more

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in 2012. By the end of the third quarter of 2012, just days before thepresidential election, international reserves reached their lowest in many yearsand stood at US$ 25.8 billion.

Thus, the growth needed to consolidate Chavez’s revolutionary projectand his election to a third term in office was founded on a massive fiscalexpansion which emphasized housing infrastructure and the social develop-ment programs.15 A look at Figure 3 indicates that there was a large shift intotal public spending (budgetary and extra budgetary) during 2011 and 2012.Monetary policy basically accommodated the fiscal stance.

After the government ramped up spending in 2012 ahead of October’spresidential election, the economy was left with worrisome imbalances and asevere external constraint. Official data reporting current account surplusesappeared inconsistent with independent estimates of the value of oil exports,the dramatic decline in international reserves and the sudden and drasticrationing of foreign exchange allocations to the private sector that started inthe second part of 2012. The dollar shortage became the dominant feature ofVenezuela’s economy which would generate a contraction in output andhigher inflation.16

President Chávez passed away in March 2013 and several weeks later,after a brief but nasty presidential campaign, the new elected President,Nicolas Maduro, had to face the crisis in the country’s main external accounts.The most debilitating problem for the non-oil sector of the economy was aninadequate supply of foreign exchange. The country’s which was last inrecession from 2009–2010, reported a new output contraction in the firstquarter of 2014 even before the most recent and catastrophic decline in oilprices. The lack of foreign exchange resulted also in chronic domesticshortages that, along with monetary disorder and expectations of exchangerate realignments, have been a major contributor to the country’s current highand accelerating inflation rate. The Venezuelan economy, which showed ayear-on-year inflation of 21% in December 2012, has seen uninterruptedincreases in the inflation rate, reaching 68.5% in December 2014.

On the domestic side of the spectrum, Maduro’s policies drove theeconomy with one foot on the gas, and the other on the brakes since the

15 In the run-up to the presidential election, President Chavez made low-income and socialhousing a priority, launching a plan to build three million homes by 2018. During the first quarter of2012, the construction sector expanded by a whopping 29.9% compared with the same three monthsof 2011. Chavez stepped up house-building in the run-up to the election.

16 On the question of why government authorities have systematically preferred a quantitativeadjustment of imports to exchange rate devaluation, it would be convenient to point out thatdevaluation is perceived as a policy that penalizes everybody, while the rationing system of importsestablished certain priorities and preferences.


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government launched all kinds of initiatives to stimulate demandwhile braking hard on supply. Moreover, the government’s unorthodox anti-inflation policies, such as price controls and the Law on Fair Costs and Priceswould only compound the problem, by encouraging domestic firms andforeign investors to cut production and investment and promoting furtherincreases of prices in many sectors of the economy. 17

During 2013 and 2014 as inflation accelerated the overvaluation of thecurrency got worse. Expectations of a sizeable devaluation started to developand further pressures on the parallel exchange rate market signaled more acuteshortages of hard currency and of intermediate and final goods. Thus, theexternal constraint set in motion a cumulative process of price inflation andfurther foreign exchange shortages.

It does not take much of a leap of faith to infer that the poor state of theeconomy was the most pressing of the problems facing President NicolasMaduro. The Maduro government’s inability to fight price and exchange ratedistortions and to halt the ongoing increase in corruption, smuggling andspeculation as well as the rapid increase the open-market parallel exchangerate has generated severe criticism from all sides of the political spectrum.More worrisome, and indicative of growing difficulties is the fact that a nearly50% drop in the price of crude since mid-June 2014 has made the foreignexchange constraint worse and has left Venezuela’s finances in shambles.

THE CHALLENGES FOR THE CENTRAL BANK: MONETARY AND EXCHANGERATE POLICY

The involvement of the Central Bank in the managing the macroeconomicand institutional challenges facing Venezuela calls for serious assessment.Venezuela’s Central Bank is a relatively young institution. It was established inthe 1930s as were most central banks in Latin America. Like other centralbanks in the region its legislation was extensively amended in the 1990s tomake it more independent from the executive branch. This reform providedstrengthened the institution in several ways: a clear mandate was definedplacing priority on maintaining the value of the legal currency; the institutionwas given certain political independence to design monetary policy; themembers of the Board of Directors were appointed and confirmed by the

17 The Decree with status of Law on Fair Costs and Prices was published in July 2011 and wentinto effect 90 business days later. Though wide prices controls had existed since 2003, the objective ofthis Law was to establish a National Superintendence that would establish the standards for theNational Registry of Prices of Goods and Services, and would have overall responsibility to regulate,supervise, control, and monitor prices.


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executive branch but also by the legislative branch; and the institution wasgranted operational autonomy to execute monetary policy. But provisionscontained in the central bank legislation and the relevant parts of nationalconstitution have never measured the central banks’ effective independence inVenezuela. One thing is to grant de jure independence and another differentthing is to perform de facto independence. The difference between de jure andde facto independence is relevant, particularly in countries where institutionsare weak and changing, as the recent case of Venezuela seems to suggest.

Between 1999 and the early 2003 when full currency convertibility wasstill in place, one of the most important pressures that monetary authoritieshad to face was capital flight. While the management of foreign exchangereserves was at that time still under the full responsibility and control of theCentral Bank of Venezuela, the responsibility of managing the foreignexchange market resided both at the Central Bank and the executive thorougha so-called ‘exchange agreement.’ Therefore, while the executive imposed andkept a fierce attachment to nominal exchange rate stability, the Central Bankhad to deal with pressures on the external accounts by drawing on interna-tional reserves and using interest rates. Since 2003 when the exchange controlmeasures were imposed along with interest rate controls and a currency peg,the Central bank has responded to balance of payments pressures with similarquantitative adjustments through import compression and monetary targeting.

So long as inflation was persistent (at a double digit level) and the nominalexchange rate remained fixed, Venezuela’s currency became increasinglyovervalued no matter whether the system was of free or restricted convert-ibility. Figure 4 shows the real effective exchange rate appreciation between1996 and 2001 which was followed in early 2002 with the decision todevaluate. Evidence collected by Campos et al. (2006), using the rate-of-returnband test developed by Svensson (1991), shows that estimated expectations ofdevaluation started to increase and became significantly different from zerojust at the end of 2001. This seems to suggest, in line with previous empiricalresults reported by Cuddington (1986), that the increasing probability ofdevaluation may have been a major determinant of capital flight.

As the bolivar came under pressure during the whole year 2001, theviability of the band began to look fragile. The Central Bank then had to defendthe exchange rate by drawing on international reserves and raising interestrates as a reaction to the capital flight. As shown in Figure 5, the interest rate inthe market for loans increased about 100% during the last three quartersbefore the first currency crisis of the Chávez administration and the introduc-tion of the free float. Unfortunately this kind of monetary restriction proved tobe mostly inappropriate for the problem at hand. Concerns about currency anddefault risks played a major role in the portfolio decisions of foreign investors


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and domestic residents, and in that sense the policies that had the largestchance of stemming capital flight were those that decrease the risks associatedwith holding domestic assets.

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Neither the exchange rate peg nor the monetary tightening (through anincrease in interest rates) was an effective intermediate operating targets torestrict inflation and stop capital flight. In a broad sense these policies wereunsuccessful. The late implementation of a floating system in 2002 did notwork either since the very low level of international reserves, heavy capitaloutflows and the work stoppage in the oil sector resulted in a shortage offoreign exchange, which in turn led the Central Bank, in conjunction with thegovernment authorities, to trigger a new sharp devaluation and to introducestrict exchange control measures in the early 2003.

The attempt by the central bank to ensure nominal exchange rate stabilityand free convertibility, also conditioned the stance of monetary policy. Facingupswings of oil surplus flows and subsequent net capital outflows, monetaryaggregates, from the point of view of the balance of payments, were prettyclearly set as a residual. The central bank mandate was to monetize positiveinflows in the current account and, in turn, to sterilize huge amounts of netcapital outflows. As a consequence, monetary authority was unable to manageits own balance sheet and influence monetary aggregates with sufficientprecision. Between 1999 and 2001, following the destabilizing impulse of oilprices, the little exchange rate flexibility built into the system exacerbated thedomestic variation of monetary aggregates. With the upswing in oil prices thecentral bank tried to maintain the exchange rate. As a result, it has poor controlover monetary aggregates and inflation persistence; monetary policy usedcapital flight as the alternative to depreciation. Somehow and ironically, capitalflights became then the mechanism to sterilize ‘excess money’ and to maintaininflation under control.

Since January 2003, an exchange control regime has restricted the sale andpurchase of foreign currency; it has remained in place for more than a decadewith several modifications. Though the central bank participates in the design ofthe currency exchange, the administration of currency control has always beenunder an exchange control authority (CADIVI or CENCOEX). Thus, in order tohonor payments in foreign currency, every entity in Venezuela must gain theprevious approval of this government authority. The exchange rate for alloperations is at an official pegged nominal rate, but eventually the governmentmakes a modest concession to economic reality and devalues the currency whenthe real appreciation induced by chronic inflation is no longer sustainable. Theresulting pattern of prolonged exchange rate appreciations and sudden realign-ments can be observed in Figure 4. Noteworthy, the oil boom encouragedmacroeconomic policy and specifically an adjustable peg system that made thecountry more vulnerable to a turn in the international oil market.

As very often happens with currency exchange controls, the system co-exists with an illegal or quasi-illegal parallel market and there are times when


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this parallel market becomes very significant and dominant. This is preciselywhat happens in the extreme and more recent case of Mr Maduro’s adminis-tration, when stronger rationing of currency exchange and the expansivemonetary policy followed by an already captured Central Bank resulted in anincreased in the black market premium.

The Venezuelan experience with prolonged currency exchange controlssuggests that the imposition of these restrictions along with a pegged nominalrate did not succeed in putting an end to capital outflows, nor did they succeedin halting the deteriorating situation in the country’s degree of internationalcompetitiveness.

As a complement to the regime of currency controls, since 2003 a system ofcontrolled prices for basic consumption goods and financial services hasbeen in place since 2003. With regard to the financial industry, thegovernment explicitly stated its preference for the Central Bank to setmaximum rates for lending and minimum rates for deposits. Policies andregulations also included directed lending to specific sector of the economy,explicit or implicit caps and floors on interest rates, regulation of cross-border capital movements, tighter connection between government andbanks either explicitly through public ownership or through heavy ‘moralsuasion,’ high reserve requirements, financial transaction taxes, and theplacement of significant amounts of government debt.18 Zarra-Nezhad et al.(2012) measure financial repression in a selected group of oil exportingcountries for the period from 1990 to 2009 and find that financial repressionin Venezuela was the highest among the selected countries.

To understand the complication to monetary policy in Venezuela as theintroduction of this regime of heavy regulation and control, it is cruciallyimportant to understand how monetary policy operates under conditions offinancial repression, and, specifically, in an environment of domestic interestrate controls and growing ‘insulation’ from international financial markets.

In theory, restrictions on currency convertibility allow governments notonly to peg the nominal exchange rate (as Venezuela effectively did for a time)but also to use monetary policy for meeting domestic objectives. Thus, incontrast with the period of free convertibility, monetary aggregates targetingmay become the focus for day-to-day policy operations.

During the oil boom that started in 2004, with so much money pouring intothe country, the Central Bank of Venezuela was forced to monetize amountsequal to a substantial share of its existing money base. To avoid massive marketpressures and other domestic distortions normally central banks try to sterilize

18 For many years, the government has used foreign exchange restrictions for the purpose ofincreasing bank liquidity and closing the financing gap of the public sector.


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such money creation, and the Central Bank of Venezuela did try to mop it up.But most measures of money nonetheless continued to increase rapidly, andthere was a real question about the effectiveness of sterilization with highlyliquid instruments that were already a close substitute for money.19 Moreover,money supply targeting that relies on two essential requirements, a stabledemand for the monetary aggregate, and a supply process readily controllable bythe authorities, did not work well and was called into question (see Vera, 2009).

With respect to the predictability of money demand, the problem was thatexchange rate expectations and institutional uncertainty have chronicallygenerated significant amounts of both speculative inflows and capital flightwhich undermine the ability of the central bank to predict money demand.This significant activity in the capital account in Venezuela during a period ofexchange controls is partly explained, as widely believed, by the evasion ofcapital controls, by the over- and under-invoicing of exports and imports, andby a great deal of local corruption. What is more, although much of the trade-related capital inflow and outflow is still controlled by the central bank, anincreasing share of capital flows occurs outside the central bank.

On the controllability of the money supply, it is important to note thedecisive influence that fiscal policy has on the behavior of the monetary baseas well as the degree of endogeneity of monetary base to the erratic behaviorof external oil shocks and capital outflows.20 As the discussion in theprevious section suggests during the last 5 years (including the presidency ofMr Maduro) the behavior of the monetary base has been subordinated to fiscalfinancing requirements.

To uncover the influence of the fiscal stance on monetary policy it may beconvenient to explore the details. In an environment of chronic and accelerat-ing inflation as in Venezuela, the Central Government and, in general, publicagencies used to protect themselves against inflation through inflationadjusted nominal spending. However, an important portion of ordinary fiscalrevenues in domestic currency are tied to oil revenues in foreign currency. Aslong as international oil prices (and revenues) have remained stable and thenominal exchange rate has been pegged, this component of fiscal revenues indomestic currency has not grown.21 Hence, in the fiscal realm a situation has

19 The tools used to sterilize inflows, mainly short term bills issued by the central bank andtransaction in the repo market, are themselves forms of money, and the more extensively they areemployed, the more liquid they become and hence more ‘money-like.

20 The first case corresponds to what is known as a fiscal dominant regime. The endogeneity ofmonetary aggregates to the behavior of external shocks fits with what Ocampo (2013) calls a situationof ‘balance of payments dominance’.

21 Of course some form of indexation will appear in other government revenues, but it turns outto be impossible to make the entire tax collection fully inflation proof.


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developed in which government spending increases with inflation whilegovernment revenues stagnate. This inconsistency between Venezuela’s fiscaland exchange rate policies during Maduro’s administration has weakenedmonetary policy.

Now, while the central government fills this gap with higher non-oil taxesand/or higher government debt, in the case of PDVSA these options are notavailable. However, PDVSA was benefited by a new amendment to the lawgoverning the Central Bank passed by the National Assembly in 2009 thatallowed the Central Bank to purchase bonds issued by PDVSA, thus bridgingPDVSA’s deficit in domestic currency.

The continuous financing of PDVSA has been one of the main causes ofthe expansion in the monetary base in recent years and has led to aconsiderable increase in the amount of money in circulation (liquidity) in theeconomy. Moreover, this accumulated stock of liquid resources (whosecounterpart comes as short term debt instruments) is highly correlated withthe ratio of M2 to international reserves. Figure 6 shows, using monthly data,the recent pattern followed by both the accumulated stock of PDVSA’s moneyfinancing from the Central Bank and the index of broad money to internationalreserves. Since 2010, both variables have followed a rapid increase and nearlyparallel courses, which might indicate that PDVSA’s money financing has beeninfluencing the capabilities of the Central Bank to back the liabilities of thebanking system. Of course, more liquidity chasing the same restricted volume

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Figure 6: PDVSA’s Money Financing and Broad Money to Foreign Reserves Ratio (January 2010–March2014).Source: Data from the Central Bank


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of output, and chasing the same amount of dollars, has an impact on bothinflation and exchange rate depreciation dynamics.

THE SEEDS OF BAD OIL RESOURCES GOVERNANCE

Together with the expanded network of State-run companies, controls,and regulations, the oil windfall facilitated and precipitated several long-lastingand critical reforms in oil governance structures, particularly around the rulesand institutions that shape the exercise of power and interactions betweenintra-government institutions and between citizens and decision makers. Mostof these changes were not an ideal for good oil governance, were sown in goodtimes, and would promote several devastating effects later on, eliminating anyhope of immediate stabilization that could push the economy on to a morebalanced growth path.

PDVSA’s new administrative governance and changes in the governmentbudget making processAfter the recovery of PDVSA’s full control in 2003 President Chavez adopted acentralized model of administrative governance in order to better control themanagement of hydrocarbon activities. In this model there was no divisionbetween Chavez’s political representation, the regulatory state bureaucracy,and the operational business activity of PDVSA. Chavez’s primary focus wason achieving the rent from the offshore sector to maintain and strengthen hispolitical project and the extent of the social development programs.

But much of the enthusiasm generated around the recovery of PDVSA’scontrol gradually declined as the government/state-owned company allianceestablished itself as an impenetrable monolithic power. PDVSA was soon togenerate so much income and accumulate so much power that it could act as aMinistry of Finance for the whole country. PDVSA became a developmentagency and the company was used to finance social development programs,food imports, infrastructural programs and presumably electoral campaigns,including two presidential campaigns. Between 2006 and 2013 contributions toFONDEN from PDVSA averaged $7.5 billion per year which represented about10% of the total oil bill.22

The budget making process was not exempted from this overall institu-tional deterioration. The National Assembly, controlled by a government

22 The company was also used to underwrite the government’s foreign policy initiatives andunder the aegis of its Petrocaribe program, Venezuela sells or barters oil to Caribbean, Central andSouth American countries offering subsidized finance.


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alliance, for years has passed the executive’s proposed budget without anymajor changes to the flagrantly biased assumptions regarding oil prices,production, and expected income. Thus, during the oil boom, systematicunderestimation of the crude oil price has allowed the executive to retainand use extraordinary resources for discretionary and extrabudgetaryspending, leaving only a small share of the oil rents subject to politicaloversight within the framework of the budgetary system. This centralized andauthoritarian order of control has facilitated the direction of neo-patrimonialpractices toward pro-poor outcomes, but it has come at a price. Obscurenetworks based on clientelism developed along with a system that devoursresources and wants to extend its jurisdiction without minimum public financecontrols.

The new structures of oil governance knock on the door of the central bankThe period between 2003 and 2008 saw also a number of significant reforms thatinvolved the Central Bank. In July 2005 Venezuela’s National Assembly passed areform of the country’s Central Bank charter. Basic questions concerning theexplicit contract between the Central Bank and PDVSA on the surrender offoreign exchange proceeds, and concerning the adequate amount of internationalreserves were particularly pressing.

The reform changed the balance of power between these two publicinstitutions (the Central Bank and PDVSA). Indeed, the old rule or obligationimposed on PDVSA and the oil industry to surrender and sell their foreignexchange proceeds to the Central Bank was lifted. Of course, this gave PDVSAmore flexibility in meeting legitimate external payments and in transferringforeign exchange resources to government funds and other public require-ments. But this regulatory change severely affected and undermined thecapabilities of the central bank to response to exchange market pressures andto effectively manage its holdings of international reserves. It seems conve-nient to remark that a major drawback for central banks in oil dependenteconomies is that their main source of foreign exchange comes from thesurrender requirement on oil exports. As illustrated in Figure 7, the foreignexchange inflows reported by the Central Bank as a percentage of the oil bill (inquarterly terms) fell to 49.9% for the period after the charter reform (it wasclose 70% before the reform).

The Reform Act of the country’s Central Bank passed by the NationalAssembly in 2005 also introduced the concept of ‘optimal level of reserves’ andserved to create FONDEN. Thus, under a specific provision the Central Bankwasobliged to divert excess reserves into this new investment fund. In 2005, theCentral Bank delivered $6 billion to this special fund ahead of elections inDecember when Hugo Chávez was expected to be re-elected. Between 2005 and


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2013, the Central Bank handed over part of its international reserves beyond apre-determined ‘optimum level’ and transferred $53.5 billion to FONDEN.

Figure 8 displays the Central Bank’s and PDVSA transfers to the fund overa period of 9 year between 2005 and 2013. The transfers amounted $115billion. This money funneled through FONDEN has been ultimately spent bygovernment agencies, but it doesn’t require congressional approval. Instead,FONDEN outlays often begin with the President’s approval and are viewed bya board of directors made up of his closest allies. In practice, the political

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process introduced short-run pressures on FONDEN to financially support awide array of bad structured and inefficient projects and even engaged inactivities that violate its own internal rules about which investments it doesand doesn’t make.

In shifting the flow of foreign exchange oil proceeds from the Central Bankto a development fund and slicing the stock of international reserves, thecountry was signaling a severe weakening of reserve management practicesincluding the capacity to intervene in support of the domestic currency. Thesystematic and direct transfers of international reserves to FONDEN severelyaffected Venezuela’s external exposure. Though over time the Central Banktried to partly cover these losses with gold revaluations, by the end of thethird quarter of 2012 Venezuela had only $2.4 billion in liquid reserves (seeFigure 9). The risk of a severe external crisis partly generated by these reformswas not perceived or in any case was dismissed.

As we already pointed out, well-before oil prices started to plunge in mid-2014, worrisome trends in external flows and the extremely low level ofinternational reserves led the government to a sudden and drastic rationing offoreign exchange allocations. External factors can’t be blamed for this suddenweakening in the country’s external position and the dollar shortage. Policymismanagement and institutional weakening are of critical importance. Anappreciating real effective exchange rate (that kept non-oil exports at theirlowest levels and promoted cheap imports in a massive scale) played a part.External debt servicing over the period 2011–2013 exerted additional pressure

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on available foreign currency. A rapid growth of government’s foreignpurchases (to limit shortages of basic goods) also put further pressures in theforeign exchange market. But the new rules and institutional design are criticalto explain the disastrous management of Venezuela’s oil cash flows andinternational reserves.

CONCLUSIONS

The descriptive account and analysis of Venezuela’s macroeconomic perfor-mance and policy experience during the administration of President Chavez(1999–2012) provide a number of interesting lessons. It seems to be clear that apolitical project that seeks consolidate long-lasting, non-neutral and radicalreforms cannot fully reconcile a system of free convertibility and a fixedexchange rate with external balance. Beyond the thwarted coup d’état and theseries of strikes that occurred in Venezuela during Chavez’s first years ingovernment, these political and economic inconsistencies, in essence, explainthe first collapse of the Venezuela’s economy between 2002 and 2003. Thefollowing phase that runs with the commodity boom (between 2004 and 2008),faced a different exchange rate arrangement (because of the implementation ofthe exchange controls system) and in this period there was successful introduc-tion of a brand new system of social development programs. However, thepolicy initiatives were plagued by perverse incentives the led the economy to avery fragile situation. On the hand, the progressive restoration of huge currentaccount surpluses, generated incentives to peg the currency and to promote asubstantial appreciation of the effective real exchange rate. On the other hand,the need to buy political legitimacy and the scenario of higher oil revenues werea catalyst for the expansion of the State, centralized decision making and a newstructure of governance that led to an overall institutional deterioration.Monetary policy and the Central Bank basic commitments to society were notimmune to these changes. The pro-cyclical nature of fiscal and monetary policy,though always present in the macro-policy design of the revolutionary govern-ment, was very prominent during the global crisis in 2009 and 2010. Moreover,currency exchange rationing instead of exchange rate adjustment, was key tounderstanding the adjustment to the fall in oil prices. Thus, governmentauthorities, by cutting fiscal spending and tightening exchange controls induceda profound and prolonged recession. The country had a short-lived recoveryduring the biennium 2011–2012 that unraveled very quickly since it was built onfragile foundations. The foregone oil revenues caused by the severe institutionalweakening and policy mismanagement of oil production and exports had theequivalent impact of an adverse oil price shock. An impressive currency


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overvaluation and a massive increase in government spending and importscombined with a rapid suppression of foreign assets led to a severe shortage offoreign exchange and to several interlinked perverse macroeconomic circles.

The Venezuelan economy is obviously under considerable strain at thistime (February 2015). With inflation bordering 70%, the monetary basegrowing above 70%, the scarcity of goods, as well as the economy almostsurely slipping into recession this year, it is not difficult to understand that thismess is nothing more than the result of the accumulation of poor governance,misguided policies, and induced distortions that have, over the years, led to theerosion of macroeconomic stability.

Nicolás Maduro, strongman Hugo Chavez’s handpicked successor, aftermore than 2 years into his term, is facing this very complex and challengingsituation and so far has sent few indications that his government is ready totake the meaningful actions needed to recover Venezuela’s macroeconomicstability and improve its long-term outlook.

AcknowledgementsThe author would like to thank Ricardo Ffrench-Davis, Roberto Frenkel, MarioDamill, José Antonio Ocampo, and participants in the workshop on CentralBanking at CEDES in Buenos Aires for comments on an earlier draft. EduardoOrtiz Felipe, Marcos Morales and two anonymous referees provided helpfulcomments.

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