Venezuela's High Noon

CAMBRIDGE: On December 15th, Venezuela will vote in a referendum on a new Constitution. A landslide YES will demonstrate strong support for President Chavez, a resounding NO may bring chaos as it will restore the powers of Parliament recently stripped by President Chavez. A No-vote, indeed, may open the door to a coup.

Venezuela faces not only political problems but severe economic ones. Everybody has been holding their breath to see how the political story is resolved; everybody is holding their breath to see the kind of economics Chavez opts for. Will he surprise by opening up and running an efficient, stable and outward-oriented economy? Or will he be a repressive statist, papering over holes in a flimsy economy, not tackling big problems? Given Chavez’ strutting political style and military background, and his Jurassic Park team of advisors, people assume the worst.

Today Venezuela is not a basket case. It is only at the cliff’s edge, poised to go over. In fact, there are only two critical, unresolved issues facing its economy: a high domestic debt (including restrictions that keep the financial sector as a forced holder of domestic debt) and an overvalued currency. ( See Table). There is also the awful cyclical situation B a harsh recession following a year of no growth. This suggests the need for state spending, which is usually the beginning of a bad financial story. On the other side Venezuela produces oil, and if prices stay above $20 the current account situation looks cheerful even at today’s real exchange rate. The budget is not great, but certainly not atrocious.

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