Venezuela: going to the brink - Foreign Policy

In early December, Venezuelans went to the polls to elect mayors and local council members. After a disputed presidential election and months of economic hardship, many observers were predicting that the opposition would win the popular vote. Instead, the government's forces won, solidifying President Nicolás Maduro's hold on power.

Yet if Maduro's grip is solid, why is Moody's downgrading Venezuela's bonds? Why is Venezuela's bond spread the highest among emerging markets? The answer is simple: The Maduro regime, like glass, might appear strong, but it's also brittle, increasingly vulnerable to the sharp shocks that are likely to come from a complicated political situation and a rapidly weakening economy.

On election day on December 8, as I rode a motorcycle taxi through the winding and bullet-scarred streets of Petare, one of Caracas' poorest slums, I asked my driver, a local resident, what he thought of President Maduro. "Nobody likes him," he said. "They loved Chávez, but they think this guy is a fake."

Everywhere I asked during my tour, I got more or less the same answer. The comments from residents were an obviously biased sample of conventional wisdom from local opposition activists, but they also reflected reality: the opposition's incumbent mayor won re-election by eight points.

It would be a mistake to conclude -- as many analysts did in the days prior to the election -- that discontent is the overall sentiment in Venezuela. In a neighboring municipality, one with demographics markedly similar to Petare, the chavista candidate romped to a twenty-point victory.

The truth about Venezuela is that it remains a country deeply divided along many lines. It is a nation of stark contrasts, where urban, middle-class voters have apparently decided to abandon the Revolution for good, but where many poorer and rural voters hold steadfast loyalty to chavismo -- for now. The nation is divided roughly in half, but the chavista half appears to be slightly larger, ensuring a solid yet potentially vulnerable hold on all levers of power.

When Hugo Chávez died last March after fourteen years in power, the crowds that turned up at his funeral were like nothing Venezuela had ever seen. Hundreds of thousands of people paraded in front of his casket or joined the funeral parade. After such a massive, unscripted show of emotion, people naturally expected Maduro, Chávez's appointed heir, to coast to an overwhelming victory.

But in a few short weeks, something surprising happened. Maduro proved to be a hapless performer on the campaign trail -- awkward in tone, frequently off-message, and vacillating between grief for the fallen president and enthusiasm for his own candidacy. In spite of this, he managed to eke out a victory over his main opponent, opposition leader Henrique Capriles, but only by a measly 1.2 percentage points.

According to the official version of events, at least. Capriles, who had lost a national election to the ailing Chávez a year earlier, quickly demanded a recount. He has alleged numerous irregularities, accusing the Chávez camp of "stealing" the election, and has so far refused to recognize Maduro as president.

Things did not go better for Maduro in the months that followed. As the economy began slowing down and scarcity began to spread, opinion polls pointed to large numbers of Venezuelans saying the country was headed in the wrong direction.

In the meantime, businessmen with close ties to the government began buying up TV and radio stations. This meant the opposition had trouble getting their message out, something that opinion polls were also capturing: Maduro's popularity was hurting, but the opposition wasn't gaining from it. "In the last weeks of the campaign," an opposition political operator who spoke on condition of anonymity told me, "dozens of our ads were rejected by TV stations for no apparent reason."

Then, in the last few weeks before the election, came Daka. Daka is the Venezuelan version of Best Buy, a large chain of stores specializing in appliances and consumer electronics. With a month to go before the mayoral elections, Maduro, in a burst of populism that would have made the late Chávez proud, ordered significant cuts in the prices of all appliances, then invited Venezuelans to throng stores such as Daka and leave "nothing on the shelves."

The move seems to have been the game changer the government needed. The government won the popular vote, and while it lost most of the large cities, it retained control in many medium and smaller cities. As one local pollster put it, "populism ... is popular."

Maduro has outfoxed the opposition. No elections are scheduled for the next two years. Does this mean that his grip on power is firm? It depends very much  on what happens to the economy.

The vulnerability of Venezuela's economy is not an accident. Instead, it is an essential characteristic of Hugo Chávez's petro-state economic model. Distilled to its essence, this model took a dramatic surge in commodity prices and created a system of subsidies, price controls, and other distortions that is simply too expensive to maintain. In the process, oil production has suffered, and the government has run out of money. It is even consideringmortgaging its last remaining gold reserves.

The Venezuelan government gives away gasoline for practically nothing. It has set an artificially cheap price for foreign currency which, combined with a ruthless attack on private property, has meant the death knell forscores of private companies. The government has also decided it wants to control the prices of everything that is produced by, sold in, or imported into the country -- everything from labor to industrial parts, from toilet paper to women's underwear. The end result is ever-spreading scarcity, combined with a plethora of black markets.

This web of subsidies and price distortions can be sustained as long as you have the money for it; the USSR, after all, kept it going for several decades. With deep enough pockets, you can subsidize pretty much everything you want, and you can take over many industries by simply importing your way out of trouble. The problem for the Venezuelan government is that, despite high oil prices, it has run out of money.

Venezuela ran a budget deficit of 11 percent of GDP in 2012, according to Moody's. (Official government statistics are unreliable). It's quite possible that the 2013 budget deficit could hit17 percent of GDP. China, long a bankroller of the Venezuelan Revolution, is beginning to cut back on its funding, insisting any future loans be managed by their own bureaucrats.

The government's cash crunch explains why there are lines to buy basic staples: there are fewer cheap dollars to give out, and the government is also being forced to start selling them at a higher price. The crunch has forcedthe government to print bolívares, the local currency, at an unprecedented pace. GDP growth has stalled, and the UN's Economic Commission for Latin America and the Caribbean is forecasting a paltry 1 percent growth for next year. Inflation has risen sharply and is set to end this year at more than 50 percent. The government has even delayed publishing inflation numbers after Maduro complained about how they are calculated.

The paradox of chavismo is that it preaches communism and consumption at the same time. The problem with such an approach, of course, is that it requires a lot of funding. If oil prices were to surge, Venezuela could continue on this path. But if oil prices stay put or fall, tough decisions will be unavoidable -- leaving the system's constituents extremely unhappy.

Will people revolt if subsidies are cut? The likely answer is that no, they won't ... yet. The government controls almost all of the media, and voters are not yet linking their economic situation with the government's own policies. When TV and radio are constantly sending the message that the economic crisis is caused by others ("the Empire," "oligarchs," "the right wing," "the bourgeoisie," "the opposition"), you can buy some time before folks come at you with pitchforks. Then again, Venezuelans have taken to the streets before when faced with cuts in their subsidies. In 1989, in an event known as the "Caracazo," Venezuelans responded to fuel subsidy cuts with rioting and violence, essentially issuing a death sentence to the system that preceded Chávez. While it's impossible to predict when such a surge in discontent might repeat itself, there's certainly no reason to rule it out.

Then there's the role of the armed forces. Simón Bolívar once allegedly quipped that "Quito is a convent, Bogotá is a university, and Caracas ... is a military barrack." The quote highlights the importance of the military in Venezuelan society. The institution has played a pivotal role in Venezuelan history, and its influence on the outcome of any major political upheaval will be crucial.

Venezuela experienced military coup attempts in the 1960s, in the 1980s, twice in the 1990s, and in 2002. The common thread linking these is that they occurred in periods of relative crisis, be it political (the guerrilla wars of the 1960s or the instability of 2002) or economic (the dismantling of the welfare state of the late 1980s). Ever since 2002, things have been quiet in the armed forces, thanks in large part to Chávez's masterful military intuition. But if Venezuela goes into a full-mode economic crisis, how will the military act?

In order to assess this question, one has to ask who the military are, and what they are currently doing. In spite of Chávez's insistencethat the military was "socialist and chavista," military sources in Caracas who spoke on condition of anonymity insist there are three groups within the military.

First are the "nationalists," those who are doing business in various government schemes and lining their pockets in the meantime. These are the officers that handle the ports, the import of food, much of the black market, and are even the main smugglers of gasoline across the border. The nationalists are corrupt, but they resent the Cuban influence inside the military -- reports say that Cuban intelligence have infiltrated the armed forces, with permission from the presidency. The main leader in this group is, allegedly, the president of the National Assembly and second in command in the Revolution, Lt. Col. Diosdado Cabello.

The second is the group of officers with links tothe drug trade, some of whom have beentargeted by the US government. How involved in drug smuggling are the Venezuelan armed forces? It is almost impossible to say, but the United Nations has stated that Venezuela has emerged as a major trafficking point in the last few years. Recently, The New York Timespublished a story on increased flight activitythrough Venezuelan territory, presumably linked to the drug trade.

Just last month an Air France flight from Caracas to Paris was discovered to be carrying1.3 metric tons of cocaine in its luggage compartment, the largest single drug seizure in French history. It is hard to view these events as happening independently, particularly since the military handles all aspects of security in and around the airport where the Air France flight originated.

The third group within the military is the so-called "institutional" wing, professional officers who view the other two groups with contempt and who would like to see the armed forces restricted to a non-partisan, institutional role. It is impossible to judge how large this group is, since it (obviously) operates in the shadows. But the military analysts I consulted with insist it exists, and its size is not negligible.

It is difficult to overstate the involvement of the armed forces in all aspects of Venezuela's life. The Maduro administration continues to stack the top echelons of government with military figures. The president has also made it a point to regularly visit military garrisons, offering members of the armed forces all sorts of goodies, from a special Armed Forces Bank to a military TV channel. As his public acts in garrisons increase in frequency, it is not far-fetched to conclude that Maduro is nervously watching his military flank.

A severe economic downturn would hurt the military's pockets. A budget crunch could force the government to cut back on the lucrativearms deals enabled by the oil boom. An end to subsidies may put an end to the burgeoning black market. And there is now talk in Caracas about ending the nation's unaffordable gasoline subsidy, which the military thrives on.

How the military will respond to all this remains a mystery. Maduro may be able to navigate an economic downturn as long as the generals remain well-disposed, leaving him with some room to maneuver. Perhaps the loyalty of the armed forces to the chavista project is deeper than most suspect.

Or perhaps the economic crisis is the trigger that a segment of the armed forces could use as justification to act. When the armed forces have been so politicized and allowed to become corrupt, there is little institutional restraint to prevent a coup attempt. Judging by historical precedent, however, it seems as though an economic crisis would not, on its own, trigger them to act. An additional ingredient -- perhaps a deeper political crisis, or even an act of political violence -- would be necessary.

Regardless, it would be a tragedy were the Venezuelan story to take such a turn.

What, then, should we expect from Venezuela in 2014? With a relatively secure government, and with absolute control of the media and the institutions, it would seem as though Maduro's position is solid. As I have argued, this hides deep risks.

The key variable to watch is the price of oil. With oil selling at $100 a barrel, the Venezuelan government is barely making ends meet, yet it can continue to muddle along at this rate. Yes, inflation and the subsequent loss of purchasing power will continue unabated, but it could be years before Venezuelans begin blaming the government for it. If the price of oil surges, the government will find its economic model is affordable once again.

However, if the price of oil were to dip below, say, $80 a barrel for a prolonged period, Venezuelans will find their purchasing power severely diminished, forcing the government to change its model. Whether it can do so and avoid corresponding political turmoil remains to be seen. While other authoritarian governments (such as Zimbabwe and Cuba) have navigated deep economic crises, the Venezuelan opposition seems better positioned to reap the benefits of public discontent than its counterparts in those two countries.

As mentioned before, the bond markets now consider Venezuela to be the riskiest of all emerging markets, with premiums that surpass Greece or Argentina. A revolution where the key players hold all the cards but is still in desperate need of foreign financing, where the economy and the viability of the political system depend on the volatile price of a single commodity, is not a safe bet. The markets know this, and that is why, in spite of Maduro's grip on power, they don't solid. They know that, if oil prices take a prolonged dip, all bets are off on Venezuela's stability. In short, Venezuela's glass revolution is more vulnerable than it appears.