The impending collapse of Venezuela

Fortune:

On Tuesday January 13th, the ratings agency Moody’s downgraded Venezuela to Caa3, one step above default. This comes as no surprise – markets have been pricing in the likelihood of default for some time now.

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The balance of payments problem is bad enough. The falling oil price is causing a widening foreign exchange gap. Venezuela needs an oil price of $100 per barrel to balance its external accounts, but oil is falling rapidly towards $40 per barrel and so far, Venezuela has failed to persuade other oil producers to reduce production in order to support the price. Venezuela’s foreign exchange outflows now substantially exceed its inflows, not least because it is supporting a complex and unhelpful exchange rate system: its US$ reserves are down to $22bn and falling fast. Venezuela will probably attempt to staunch the bleeding with tighter price and exchange controls, but all this will do is accelerate demonetization of the economy as more and more trading shifts to the black market.

But the real issue is Venezuela’s domestic economic problems. Venezuela has been in deep recession for most of the last year. Its budget deficit in October 2014 – before the most recent catastrophic oil price falls – was 17%. Inflation is officially at 65%, unofficially probably far more. Import controls, inflation and the overvalued bolivar are causing shortages of essential goods.

Shortages are nothing new in Venezuela. Indeed, a shortage of toilet paper has been the subject of global amusement for quite some time. But recently, the shortages have become much worse. Last week, a government official was jeered for saying that long lines indicated that “Venezuela has plenty of food”, when rows and rows of empty shelves in stores were telling a different story. Bloomberg reports that people are queueing overnight for necessities such as soap, milk and diapers. This is very dangerous. Venezuela is already one of the most violent societies on earth. And when shortages start to affect little children, people get angry.