Via The Dipomat, a report on China’s engagement with Venezuela:

The visit of Venezuelan President Nicolás Maduro to China last month was, on the face of it, a cause for quite a bit of relief for Beijing. After all, strong Beijing ally Hugo Chavez had only passed away in March, and there was some concern about how stable Venezuela would be following the death of such a personality-oriented, individual leader. Whilst the visit was marked by the usual fanfare about deals, cooperation and even conspiracy theories (as usual centered on the U.S.) the cheer actually masked what is rapidly becoming a dire economic situation in the Latin-American country as decades of populism come home to roost. Even the conspiracy theories represent political strains in Caracas. China should be wary.

Chinese investment and support for Venezuela continued unabated both before and during Maduro’s visit in late September. Indeed, $28 billion of Chinese investment in Venezuelan oil production was announced before Maduro even set foot in Beijing. These numbers are large, but cumulative Chinese exposure to Venezuela is much higher, with China Development bank alone having a third of its overseas lending as of late 2012 in the country according to the book China’s Superbank. Much of China’s investment in Venezuela, like the recent $28 billion, is focused on the oil industry. Other lending to Venezuela from China, like another $5 billion loan agreed during the visit, is often contracted to be at least partially repaid in oil. The same applies for a separate $20 billion credit line from China that is soon due to be renewed.

Venezuela is going to need such Chinese help as much as ever over the coming months and years, as the troubled Latin-American country faces up to years of populist economic mismanagement, which may have made Chavez a hero to his people, but threaten to be much less kind to the current and any future government as they are handed the bill. Problems include a looming currency crisis, stagnating production at the vital yet mismanaged government petroleum company PDVSA (which has been used to back populist social spending), massive inflation and mounting corruption problems that are complicating efforts to clean things up.

The mismanagement at PDVSA is a root cause of many of the problems, even if it results directly from nationalization policies (which drove away much foreign investment and more importantly technology in the oil industry), and the failure to allow the company to retain enough of its income to invest in future production, or for that matter in an ability to refine petroleum products for the home market. The result: Venezuela only exported roughly 1.7 million barrels per day of oil in 2012, down from 3.1 million barrels per day in 1997. Meanwhile, imports of refined products (from the U.S.) have jumped from an annual total of $568.9 million in 2011 up to $3.3 billion in 2012.

The country’s central bank reserves are rapidly depleting, and are currently less than half the level held at the start of 2008. The chronic lack of foreign currency is being compounded by the highly corrupt exchange rate mechanism – in which dollars are sold (to those with connections) close to the official exchange rate of 6.3 bolivars to the dollar, while black market rates are currently around 45 bolivars to the dollar or more. It doesn’t take a genius to work out what many people do if they have access to the government-provided cheap dollars.

Meanwhile the currency crisis affects more and more aspects of life; the most comical so far is a chronic lack of toilet paper, which led to yet another government seizure of a private company. Yet this is no laughing matter, shortages of cooking oil, powdered milk and other vital goods are continuing. Inflation is at a whopping crisis level of 49.37 percent, and may hit 60 percent by the end of the year.

There seems little hope for the government to reverse its destructive policies, addicted as it is to the popularity (votes) which they have generated. Attempts to reform the moribund currency system were put on hold when Maduro moved against Finance Minister Nelson Merentes earlier this month. The troubles look set to continue, even if it is almost certain that some sort of devaluation must occur, despite government claims to the contrary.

Meanwhile, in true Chavista style, Maduro is increasingly blaming the nation’s economic problems on everyone but the government’s dreadful long-term mismanagement of the economy. Municipal elections in December should show whether or not voters are convinced. Unfortunately long term problems will require even longer term solutions; there is no quick fix to Venezuela’s woes. The necessary devaluation will only exacerbate inflationary pressure, given Venezuela’s reliance on imported products.

China would thus be advised to think carefully before lending more money into the Venezuelan economy, however much Caracas is desperately in need of it. Devaluations and inflation can be very troublesome for foreign creditors (depending on how debts are denominated) and investors. The kind of political stress which is likely to result from the current economic crisis will not necessarily result in foreign creditors being prioritized over domestic issues either.

The one positive for China is that much (though not all) of its investment into Venezuela is in the oil industry – which is set to continue being not only the sole real source of economic product in the country but also a key part of the government’s ability to remain in power. Still, China should perhaps prepare for requests to “renegotiate” certain deals over the coming years, even if the Chavistas manage to hold on to power.