US imposes economic sanctions on Venezuela

By Prashansa Srivastava

The Trump administration, in an effort to cut off the country’s credit lines to the United States, has hit Venezuela with its first round of economic sanctions. The new sanctions take aim at the ability of Venezuela and its state-owned oil company, Petróleos de Venezuela SA (PDVSA), to sell stocks and bonds in the US, and cuts off the ability of banks to lend Venezuela money.

Reasons for the imposition of sanctions

The Treasury Department has banned debt trades for bonds issued by the Venezuelan government and Petróleos de Venezuela, S.A. (PDVSA)—a Venezuelan state-owned oil company which is the economy’s main financial driver.

The US is doing this in response to Venezuelan President Nicolás Maduro’s stubborn march towards an undemocratic and unconstitutional government. The goal is to starve the troubled government of much-needed cash. The prohibition affects bonds held exclusively in Venezuela, mostly by high-level government, military, and business leaders. Those bondholders will now find it more difficult to sell those securities in international markets.

This move, however, will not harm US investors. For example, in May, Goldman Sachs bought $2.8 billion of deeply discounted Venezuelan debt from a broker, giving the cash-strapped Venezuelan government an important lifeline. Goldman will still be able to sell the bonds it already owns, but any similar purchases in the future will be prohibited.

Venezuela’s economic crisis

Venezuela—once the richest country in Latin America—now has its economy and democratic institutions lying in shambles. Over the last 4 years, GDP has fallen by 35%, which is a sharper drop than the one seen by the US during the Great Depression. The country is facing an unprecedented economic collapse caused by plunging oil prices and rampant mismanagement that has led to hyperinflation, violent crime and widespread food and medicine scarcity.

The oil-rich nation is very dependent on the energy market. Oil accounts for more than 90% of the Venezuelan exports. It funds the government budget and provides the foreign exchange that the country needs to import consumer goods. When oil prices soared in the 2000s, Venezuela earned a large amount of cash. However, the boom ended in 2014, following which the volume of dollars to Venezuela declined. The fall in global oil prices meant that the country was no longer able to support the vast number of social programs. The government of Nicolás Maduro, who had recently taken over after Hugo Chávez’s death was faced with the option of allowing the Venezuelan currency (the bolívar) to devalue. However, this would have led to a rise in prices of imports and more importantly made the new government unpopular. Thus, Maduro kept the overvalued currency and tightened the flow of imports.

This had the unintended effect of rising prices. Policies of price controls then led to the proliferation of a black market. Fear of unpopularity meant that the government rejected options of widening the tax base and cutting spending, and instead printed money to finance its deficit. This led to a staggering hyperinflation spreading mass discontent, which is clearly visible in protests and clashes of citizens with the government.

Effect of these sanctions

Venezuela’s dismal economic situation combined with political woes of an authoritarian government and a large number of human rights violations signals a grave danger. The country’s negative credit rating and its increasing international isolation have fast eroded its financial stability. This has effectively shut out debt markets, with investors seeing it as too big a risk.

The economic sanctions will further cripple the ability of Venezuela to pay off interest on its growing national debt. Though the new sanctions are mild and allow the financing of most commercial trade, including the export of American light crude oil to Venezuela for mixing with its heavy crude, they will have a severe impact and will push Venezuela closer to a financial default. A key test will come in the fourth quarter of this year when $3.8 billion in bonds become due.

A debt default would spark a cascading effort by foreign investors to seize Venezuela’s global assets, potentially slamming its all-important oil industry. As the economic crisis gripping the country deepens, it could also create conditions so harsh that Maduro’s grasp on power could be challenged by the country’s military, some analysts say.

With the US intervening, the idea seems to weaken the government to such an extent so as to force a political transition. However, the long term wellibeing of Venezuela can only be resolved in concert with world leaders.

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