The world is addicted to oil, as everyone knows. But there are few places with an addiction as deep, and as potentially destabilizing, as in Venezuela.
Consider that Venezuela pumps an estimated 2.5 million barrels of oil per day, around three per cent of global supply. At US$60 per barrel, that's close to $150 million per day in income generation.
The high oil prices of the past two years have been a major windfall for the country, pushing economic growth above 10 per cent in 2005 and 2006. Oil accounted for nearly 90 per cent of export earnings last year.
Since nearly half of government revenues come from oil, government spending has skyrocketed as well, reinforcing the surge in economic growth. The government is nevertheless accumulating assets, and is believed to be a net external creditor today.
Rating agencies have conferred a series of ratings upgrades on Venezuela in recognition of these improved fundamentals.
Consumers are benefiting, to be sure. Consumer spending rose by 19 per cent in 2006, car sales by 50 per cent and sales of Scotch whisky by more than 50 per cent.
Bank lending is up over 60 per cent, leveraging the improvement in economic fundamentals even further. This is quite a party, by any measure.
No such party can go on forever, least of all this one. The most important driver of growth has been government spending, which now makes up around 40 per cent of GDP.
The economy is running too hot, as indicated by the inflation rate, which is around 20 per cent.
The government is already carefully rationing foreign currency - importers must have their foreign purchases approved by the government, which has issued a list of so-called "priority imports" intended to forestall shortages of basic necessities.
In the background, the true value of the domestic currency is depreciating steadily - the parallel exchange rate is some 50 per cent below the official one.
The government plans to introduce a new currency in 2008, but this will do nothing to alter the economic fundamentals, which are eroding steadily.
Venezuela's boom will fade as oil prices continue to ease down toward the $50 range. Were oil prices to fall below $50 for any length of time, the tenuousness of the country's situation would become obvious.
Reinforcing this is the fact that oil production rates are falling due to declining investment in the sector's infrastructure.
Political uncertainty gets the blame for this weak investment. President Hugo Chavez has taken an increasingly populist approach to governing since he took office in 1999. Government spending has doubled as a share of GDP in that time.
His expropriatory actions and violation of business contracts have sparked fear among foreign investors, especially in the oil and gas sector.
Coming reforms of the country's mining and banking laws may have similar implications for these sectors.
The bottom line? The combination of a lethal dependence on oil and an anti-business political agenda do not bode well for Venezuela's economy.
Absent either a renewed surge in oil prices or a major shift in policies, the ingredients are all present for a bout of capital flight, a forced devaluation of the currency peg and an abrupt slowing of economic growth.
(Stephen Poloz is a senior vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)
