Caracas Chronicles

[Note: For critical context on the —ahem— hidden agenda behind this post, be sure to read this.]

Venezuela is in desperate need of economic stability. The brutal costs of economic chaos are all around us. As we weather the storm, it’s not too early to start asking what we can do to ensure no such calamity can ever befall us again.

In the short term, Venezuela needs stabilization: emergency measures to reactivate the economy and address the humanitarian crisis. But the conversation cannot stop there. Once the economy comes out of its current, acute crisis, Venezuela will need to get serious about the fundamental institutional reforms needed to make sure economic chaos can never destroy millions of Venezuelans’ livelihoods again.

All of the economic dislocations Venezuela faces today have their roots in the way the state handles money.

The comprehensive reform proposal here will do just that, ensuring economic stability for this generation and generations to come.

Our starting point is a simple but powerful observation: all of the economic dislocations Venezuela faces today have their roots in the way the State handles money. The path to prosperity passes through stability, and the road to stability passes through an ambitious, comprehensive reform of the public sector’s financial management framework.

The impact of mismanaging the State’s finances is all around us. You see it in the queue outside the bakery shop, you see it in the bare cupboards in stores and the stagnant productivity of farms and factories. It’s not just a problem. It’s the problem.

Over the past several months, Caracas Chronicles has conducted a far-reaching analysis of the major problems with Venezuela’s current public sector financial management framework.

Here, we set out the seven most important solutions in language anyone can understand.

Some of our recommendations will strike readers as ambitious. Utopian, even. But this is not the time to think small. If the evidence of the last few years doesn’t convince us that we need a complete rethink of the way the state handles its money, nothing ever will.

Reform 1: Balance the budget over the medium-term

Let’s start at the very beginning. Venezuela’s macroeconomic chaos is a direct outcome of persistent deficits. In the last 17 years, the government has run deficits in good times and bad. It has run deficits with the oil market was in triple digits, deficits that run against any imaginable type of economic rationality.

It’s the need to finance such deficits that has led, first, to the ballooning of the public sector debt, and later on to the collapse in the value of the bolivar, as a cash-strapped government has ordered the Central Bank to create money to finance deficits no lender would cover willingly.

There are good reasons to run countercyclical deficits even in the best run economies.

Ending this destructive pattern of persistent deficits does not mean that the budget needs to be balanced every single year. There are good reasons to run countercyclical deficits even in the best run economies. Over the span of the economic cycle, though, primary balance is essential: running a deficit is fine when things are tough, but only if your commitment to balance it with a surplus during the fat years is credible.

But that means that budgeting on a one-year horizon just isn’t good enough to make sure the nation’s goals are aligned with its budgetary practice.

To fight short-termism and ensure a rough balance, budget planning must be inscribed in a multi-year framework, one long enough to take in the whole of the business cycle. It’s over the medium term that balancing the budget is essential, if not overall — some investment plans take years to bear fruit — then certainly in terms of ordinary income and ordinary spending.

The multi-year framework should play another role too: it should be the moment when we stand back, once every few years, and ensure that we really are devoting natural resource rents to investment rather than ordinary spending. That’s the responsible approach to Natural Resource management. Our oil reserves, the biggest in the world, should lead to the accomplishment of medium to long-term State goals and not just the goals of the current government.

Reform 2: Bring rationality and oversight to public sector debt

A second major driver of the current crisis is debt, or rather, the irrational over-reliance on debt at the peak of the oil cycle. Hunger and disease this year has been driven by a parallel collapse in food and medicines production and food and medicines imports, and the import collapse has been driven by the need to set aside dollars that might have been used to import food and medicines to service debt contracted during the high-oil years.

The State cannot be allowed to take on financial debt without legislative oversight.

This dynamic needs to be short-circuited by ensuring public indebtedness cannot rise beyond what the size of the economy, investment needs and revenue generation capacity can justify. The key here is effective oversight: the State cannot be allowed to take on financial debt without legislative oversight. Secret bilateral debt deals not subject to effective oversight must be explicitly ruled out.

In fact, at the risk of being accused of radicalism, we recommend going further and stating explicitly that the State shall not recognize any debt obligation not previously subjected to a vote in the National Assembly.

Reform 3: Getting serious about the National Budget

The drift away from legality has been so intense these last few years, fundamental reforms will be needed to establish some simple, basic ground rules with regard to the budget. Ground rules like “yes, there has to be a National Budget” and “yes, the president must present it to the National Assembly by a given date,” and “yes, that budget must explicitly set out the longer term goals of fiscal policy and actually explain how the government expects to meet them within a framework of fiscal responsibility and budgetary balance.”

Getting serious about the National Budget means accepting that there is only one budget.

Getting serious about the National Budget means accepting that there is only one budget. It means taking seriously the idea that the State can only spend money if that expenditure has been authorized in a budget law.

It’s a simple principle — too simple, you might think, to need stating. But after 17 years when we’ve seen an explosion of workarounds to this principle — from PDVSA’s social budget to the off-budget funds like Fonden and the Fondo Chino — it apparently does need stating.

Of course, there can be extraordinary circumstances that were genuinely unforeseen at the time the budget was drafted, and any public sector financial management framework must include safeguards to ensure those genuinely unforeseen spending needs can be met.

What must be ruled out, we believe, is the routine use of “créditos adicionales” to cover entirely predictable expenses. Explicitly ruling out this old and destructive practice would constitute nothing short of a revolution in the way the Venezuelan State manages its finances, as would establishing the principle that such “additional credits” must, like the budget law they amend, always be subject to parliamentary approval.

Reform 4: Building accountability into the fabric of budgeting

If accountability is to be more than theoretical, every single line item in the spending side of the National Budget explicitly sets out, in numeric terms, the objective of that expenditure and names — actually names — the flesh-and-bones officials responsible for delivering that result. And within six months after a budget has closed, a mechanism must be established to check which officials followed through and which did not.

Every single official entrusted with the sacred duty of spending on behalf of the collectivity who must be held accountable.

Why? Because budget accountability needs to go beyond the macro-level of allowing people to vote governments in and out. That is far too coarse an oversight device. Accountability must be granular: it’s not just the President who is accountable to the nation in some abstract sense, it’s every single official entrusted with the sacred duty of spending on behalf of the collectivity who must be held accountable. We envision a website to centralize this information, allowing anyone to search out the actual identity of the officials in charge of delivering projects that affect them. Radical? Yes it is. But an idea whose time has come. Some call it “transparency”.

Reform 5: Empowering an Autonomous Central Bank to Target Inflation

Terminology can be confusing, so let’s start with the basics: a Central Bank is not a bank. Not in the usual sense of the word. Its role isn’t to take in deposits and make credit available. A central bank is a regulatory institution that looks after the value of the nation’s currency.

The Central Bank must be formally empowered to focus narrowly on price and monetary stability.

The Central Bank’s autonomy needs to be legally protected so we never again face ‘innocent’ requests for a millardito that becomes six and then becomes a never-ending place source for covering public sector deficits no investor in her right mind would cover by choice. A truly autonomous Central Bank can never become the place the rest of the public sector turns to when it’s running short of cash.

Our call is for the Central Bank to be recognized as Venezuela’s autonomous monetary authority, nothing more, nothing less. The Central Bank must be formally empowered to focus narrowly on price and monetary stability by formulating and executing monetary policies; by participating in the design and execution of foreign exchange policies; by regulating credits portfolios and interest rates, and by managing international reserves.

Autonomy cannot be used as cover for a free-spirited, como va viniendo vamos viendo approach to Central Banking. Autonomy is about having the space to take your formal mandate seriously and guarding it against encroachment zealously.

With great autonomy comes great responsibility. An autonomous Central Bank must be held accountable for its successes and its failures, given that it must focus on price and monetary stability. Let’s not forget that the Central Bank manages the money-printing machines.

It might sound like a lot of work, but Venezuela’s Central Bank should report on the actions, goals and results of its policies, preferably to the National Assembly. It should also issue periodic reports on the behavior of Venezuela’s macroeconomic variables and respective technical analysis.

Reform 6: Coordinating policy in the service of stability

The last few years have established the paramount need for economic stability. What the nation needs now is a clear mandate for the institutions charged with managing the public sector’s finances to coordinate effectively to deliver on that objective.

A call for effective policy coordination must never be allowed to become a pretext to pressure the Central Bank to support irresponsibly policies.

Coordination between the Finance Ministry and the Central Bank is both necessary and potentially problematic. The temptation for Executive overreach will always be there, which is why a call for effective policy coordination must never be allowed to become a pretext to pressure the Central Bank to support irresponsibly policies.

For that reason, we propose to marry the mandate to coordinate with an explicit ban on Central Bank being subject to directives from the Executive Power or of financing of public sector deficits: these goals are compatible, so long as the overall objective — stability — is clearly established.

Reform 7: Ending the Oil Boom and Bust Cycle

We’re endlessly told that the economic cataclysm of the last three years has its roots in the oil cycle. That’s not quite true: it has its roots in the fiscal mismanagement of the oil cycle. Rather than making provisions for the inevitable eventual bust, Venezuela spent all of the proceeds from the 2002-2014 oil boom of close to US$ 800 billion — and then some. Failing to save some of the excedent when the takings were good was the original sin that led to the current disaster. When the oil market soured, Venezuela was left badly unprepared.

The mechanism we propose will include guaranteed payments to state and local governments during oil downturns.

It doesn’t have to be this way. That’s why we propose a radical new mechanism to save excess oil revenues in high oil years and hold them in reserve, to be tapped during low oil years. The system could even out the inevitable booms and busts of the oil market, making the fiscal income from oil more predictable and the impact of oil downturns easier to absorb.

A mechanism to smooth out the oil cycle will need broad buy in, not just from central government but from regional governments too, which is why the mechanism we propose will include guaranteed payments to state and local governments during oil downturns. The operating rules for this fund shall observe the basic principles of efficiency, equity and non-discrimination between public entities. Judiciously applied, this mechanism could end the cycle of oil boom and bust forever.

A Reform Agenda Whose Time Has Come

These seven reforms must be at the heart of any incoming government’s economic agenda. Venezuelans are yearning for economic stability, but economic stability can only be achieved through far-reaching institutional reforms to create a framework for managing the nation’s money responsibly for the future.

These are the seven pillars on which a new, stable, prosperous economy can be built.

Balancing the budget over the medium term, bringing rationality and oversight to public sector debt, getting serious about the National Budget, building accountability into budgeting, empowering an autonomous central bank to target inflation, coordinating policy in the service of stability and ending the oil boom-and-bust cycle are the seven pillars on which a new, stable, prosperous economy can be built.