Fred Aarons of Aarons & Asociados in Caracas considers the current landscape in Venezuela from an energy and infrastructure perspective
A grim outlook
Venezuela is known for being the country with the largest proven oil reserves in the world, but also for being a country that has been unable to manage its large oil wealth in order to achieve sustainable development and better living for all its inhabitants.
The current foreign currency exchange control regime in Venezuela, in place since 2003, has proven to be more harmful than previous foreign currency control regimes adopted in Venezuela in the twentieth century, while it has shown the same structural faults as the Venezuelan economy.
The foreign currency exchange regime legal framework in force since 2003 has profoundly altered the socio-economic system established by the constitution of 1999, has set aside international treaties signed by the republic, has limited commercial and contractual capacity and promoted a lack of institutionality, which adversely affects the levels of legal uncertainty in the country.
The foreign currency control regime in place since 2003 is a cornerstone of the economic policies that need to be adjusted promptly to give a jolt to the economy, to revamp private sector investment and to restore much needed order in a country desperate to get its act together in accordance to the potential suggested by its oil wealth.
Since the establishment of a sound foreign currency exchange regime is of the essence to achieve a sustainable economic framework, both the public and private sector need to work in partnership to bring forward social and economic stability.
Infrastructure investment is much needed in Venezuela nowadays. Indeed, infrastructure is an essential variable in the development of a country that is driven by business activity. Such business activity is propelled by communication, transportation, distribution, finance and energy supply. These assets are certainly fundamental to society and economic growth. As reported by those institutions that follow investment in infrastructure, it involves a commitment in the long term, the policies aimed at promoting economic growth, institutional respect to the underlying investment and the ease of doing business in the location.
During the tenure of the Chavez administration, nationalisation was perceived by government authorities as a presumed panacea for the evils of the private sector. The central government re-centralised many public services, taking them out of the hands of the states. Such moves included roads, airports, ports, all of which have sustained accelerated deterioration ever since. Even the Caracas, which used to be regarded as a model of efficiency, has had over the last decade a poor service and maintenance record. The government decision to move the running of all public transport infrastructure from local to federal control has likely led to inefficiencies in the operation of assets. The collapse of bridges throughout the country has been the evidence of the lack of proper maintenance of the road network over the years.
If the general belief that “a country’s development cannot be promoted without investment in infrastructure” holds true, then Venezuela’s economic and social outlook is of substantial concern, to say the least. In fact, more than $90 billion is needed to maintain existing infrastructure and to double investment in new projects. Venezuela is currently devoting less than 4% of gross domestic product to infrastructure, as compared to higher rates in other countries in the region, such as Colombia, Chile and Panama. Venezuela relies on oil revenues for the vast majority of government revenue, hence, government investment is largely dependent on oil prices.
Most of the country’s highways are paved, but their maintenance is poor. Most of these highways are located in the northern part of the country, where population density is greatest. The southern part of the country is more dependent on aircraft or river travel for transport. The bulk of goods transportation takes place via trucks. The country has a very small railway system, which is mostly used to transport freight.
Venezuela has 11 international and 36 domestic airports, with the major one in Caracas processing most of international flights. The airport facilities are not high quality. It has 13 ports and harbours, but most bulk cargo is handled by 3 ports on the Caribbean sea, located in Maracaibo, La Guairá, and Puerto Cabello.
The country has one of the highest electricity consumption levels in South America. Three-fourths of its power originates from hydroelectric plants on its rivers. Venezuela is believed to have the fifth largest reserves of natural gas in the world, of which approximately less than 15% is consumed daily to generate power. Power generation, transmission and distribution systems have been enduring significant hurdles lately to maintain uninterrupted service, mostly due to lack of proper maintenance over the years. The nationalisation movements that has taken place in the electricity sector has prompted a poorly run system and an ageing infrastructure, which has led to power cuts.
The telecommunications industry was once the fastest growing industry in the country, but lack of access to foreign currency due to the exchange control regime currently in place has thrown the industry into a downward spiral where the network maintenance required to preserve competiveness and a reliable service is practically non-existent.
The general consensus is that Venezuela is one of the riskiest places to do business in Latin America. The government’s populist agenda has led to anti-market decisions and poor economic policies. High inflation is rampant, low growth and low productivity has all contributed to make Venezuela an inconvenient place to do business. In fact, foreign capital has been at its lowest levels and is not a real option for Venezuelan infrastructure. Besides the uncertainty of political and economy, corruption is a key factor that produces a weak investment climate in Venezuela. Since no one wants to invest in a country that cannot foresee profit return, investors will tend to avoid investing in Venezuela.
The few projects that have been recently developed are the result of scattered bilateral state agreements for shipyard development, hydropower projects, subways and petrochemical plants, which have been supported by funding from the Brazilian development bank (BNDES). A number of rail projects in the country’s provinces are driving infrastructure construction, but at an inconsistent pace.
What is needed to revamp Venezuela’s economy and infrastructure investment level?
Regardless of the proposals, it is necessary to have a comprehensive vision for achieving exchange rate stability within an executable, efficient, and rational context, based on morality and justice in line with the terms of institutional and socio-economic development of Venezuela.
The current foreign currency exchange regime has affected extensively different areas of the Venezuelan economy, which in turn have prompted (i) higher level of imports; (ii) lower level of international reserves; (iii) less economic productivity; (iv) increased indebtedness; (v) increased administrative discretion; (vi) less legal certainty; (vii) less access to foreign currency by citizens; (viii) increased economic dependence; (ix) increased economic and social dislocation; (ix) an unprecedented disregard for the socio-economic regime established in the country’s constitution; (x) increased financial uncertainty; and last but not least… (xi) increased economic isolation.
A move should be directed at establishing the required consensus to promote rational goals and an appropriate legal and institutional framework. It is not an easy task for developing countries – ask the most developed countries and we could ascertain that there is no single answer whether in a socialist framework or in a fierce capitalistic one – but all the parties must ponder about the proposed long-term goals and determine from there the different alternatives to attain them. Irrespective of the political, economic and social models that are pretended to be applied, a sound partnership between the public and private sector is needed in Venezuela to achieve sustainable economic and social development. Time is of the essence to attain critical results in favour of the population based on new investments, an invigorated labour force, preservation of human capital, sound monetary policy, and promotion of savings to allow all social classes’ to access not only to basic goods and services, but also a better standard of living resulting from sustainable policies over time.
There is an urgent need to establish an adequate general framework in place, where populism could be put aside to promote sound, viable and enduring public policies aimed at promoting rational social and economic growth in Venezuela. The existence of adequate incentives addressing both developmental and commercial concerns is key to the creation of consistent and reliable partnerships between private and public entities. We would like to highlight different policy issues raised and results to be considered when government is putting together a bidding proposal and a concession to develop projects in partnership with the private sector.
The Venezuelan government needs to transfer back activities to the private sector in order to execute major investments, to improve “value for money” in government procurement, counter limited tax revenues due to reduce private sector activity, and to circumvent the progressive deterioration of services throughout the country.
The Venezuelan government should consider the most efficient and rational approach to achieve the twofold goal of attracting private sector investment while ensuring the fulfillment of straightforward policy goals. Where risk is transferred from the public to the private sector, principles should vary depending on the government’s goals and the tools used to achieve them. An adequate balance in the incentives to the different parties is needed throughout the process of transferring assets back to the private sector.
The Venezuelan government must take the necessary steps to understand what is needed to win the private sector’s confidence and attract investment. By so doing, three fundamental principles ought to be considered: (i) continuity of the service; (ii) non-discrimination between the users of the service; and (iii) adaptability of the service to the needs of the public.
The government of Venezuela must demonstrate long-term commitment, if any, and willingness to provide reliable conditions that satisfactorily share the risks and obligations.
The government of Venezuela should consider reinstating a strong concession program, in as many industries as possible, to promote infrastructure investments.
The government of Venezuela must consider that in long-term service relationships a well-staffed regulatory authority is essential to ensure appropriate balance between the interests and incentives of the parties involved and, more importantly, to facilitate the smooth performance of the concession.
An independent regulatory authority with appropriate technical capabilities would contribute to a long-term and balanced partnership with the private sector, and would help address unanticipated developments. In addition, the presence of a well-structured regulatory authority may promote equitable mechanisms as a way to solve controversies throughout the life of the concession. Without a balance in power, it is unlikely that the partnership process will be equitable and sustainable.
The government of Venezuela must bear in mid that contracts should be awarded through competitive bidding rather than negotiated with a single entity. Negotiation may jeopardise the inherent benefits of the project due to the government's relative inexperience in provided services on a commercial basis. A competitive process offers transparency, ensures maximum efficiency and builds much needed public confidence.
The government of Venezuela may even consider private entities operating infrastructure services as "contracting authorities" so that they would be obliged to follow public procurement procedures in awarding their own contracts.
Furthermore, the government of Venezuela should avoid rushing bids and the bid evaluation processes. Doing this often produces inaccurate use measurements and revenue forecasts, which are key to the success of these types of ventures.
The government of Venezuela must avoid burdening a project with profit restrictions or unrelated social development goals that would undermine commitment to project implementation. Indeed, the principal aim should be to ensure an inexpensive and efficient service. On the other hand, concessionaires should be responsible for making cost and traffic estimates and, therefore, be held responsible for cost overruns. Depending on the underlying project, governments may consider pro-viding credit to support the revenue stream and ensure stable cash flows (which are quite sensitive to traffic), and as a mechanism to facilitate any potential bond issue backed by the project.
Overall, the process by which these concessions are granted and carried out must not only focus on getting investment costs off government's books, but also on getting efficient, competitive projects and making the public accept the payment of real and fair prices for services. Such an approach would ensure a balanced private-public partnership. The foregoing review illustrates issues, among other relevant aspects, that the government of Venezuela must consider well before a much needed change of economic model takes effect to embrace genuine and sound private sector participation. Lack of consideration to these balancing incentives, may jeopardise any well-intentioned effort to initiate and maintain a long-term partnership with the private sector. Ex-post facto efforts to amend such pitfalls are indeed a limited alternative and a highly inefficient approach to properly balanced incentives.
Fred Aarons
Partner
Aarons & Asociados Abogados
Caracas
About the author
Founder and partner of the firm Aarons & Asociados Abogados, recognised by the IFLR1000 edited by Euromoney publications, as one of the best law firms specialised in banking and financial matters in Venezuela.
Graduated in law from the Universidad Católica Andrés Bello (UCAB) in 1988, he obtained a master’s degree in applied economics for development banking, majoring in finance, and a master’s degree in international legal studies, both granted by The American University, Washington, DC, United States.
He participated in the International Tax Program, at Robert Kennedy College, Zurich, Switzerland, and in the Business Management Program at Yale University. He is currently preparing his thesis for the PhD in law at the Universidad Central de Venezuela.
Specialist in banking, financial and corporate issues, he has developed his career in corporate affairs consultancy, specialising in the banking and finance areas, including project development, regulatory matters, and contractual issues.