The Global Financial Crisis Batters Chávez

The Venezuelan President may be forced to moderate his revolutionary policies and ease regulations on foreign investment

By Stephen Baker and Peter Wilson

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Propaganda in Caracas reflects sour relations with Washington Jorge Silva/Reuters

Little of the oil wealth has gone to shore up crumbling infrastructure Meredith Davenport/Polaris

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Chávez has put oil wealth to work to bolster his popularity Ivan Gonzalez/EPA/Corbis

Caracas - Petrodólares. As oil prices soared in recent years, Venezuela's fiery President, Hugo Chávez, doled them out to win friends and influence people both at home and abroad. For Venezuela's poor he built health clinics and schools and funded farming co-ops. He distributed cheap oil to Cuba and other Caribbean neighbors while bankrolling his debt-ridden allies in Argentina. Three years ago he even ventured onto the turf of his archenemy, the U.S., and offered cut-rate heating oil in poor neighborhoods. The day the first deliveries arrived in the South Bronx, the front-page photo on New York's Spanish-language El Diario showed a smiling Chávez wearing a Santa Claus hat.

But while Chávez built his "Socialism for the 21st Century" on a foundation of crowd-pleasing gestures, he scrimped on traditional investments—the ones that pay economic returns. So traffic crawls on Caracas' crumbling highways. An overtaxed power grid has led to three nationwide blackouts this year. Businesses, fearful of revolutionary taxes and confiscation, have trimmed investments to the bare essentials. And while the government says oil production tops 3 million barrels per day, industry sources think it's fallen to a mere 2.4 million barrels, down by a quarter from 1999.

As long as the price of oil rose, none of this bad news held back Chávez or his revolutionary ambitions. He was flush. As it turns out, it took the Wall Street collapse and the specter of the worst global recession in decades to drag down the oil market and hit Venezuela where it hurt.

The question now is how Chávez will respond to the economic constraints. Will he trim back his revolution and warm up to private investors—perhaps using the arrival of the Obama Administration to seek détente with the U.S.? Or will he bull ahead, seizing on economic unrest to nationalize more industries and establish authoritarian rule?

On a stormy afternoon, as thunderclouds empty onto the valley of Caracas and turn the snarled highways into rivers, economist Ignacio de Leon hurries in from a patio restaurant at the swank Hotel Tamanaco InterContinental. Finding a dry table, he sits down and draws a Y with his finger on the white tablecloth. "We're at a fork in the road," says De Leon, a managing director of economic consultancy Econlex. "Chávez has to choose—to moderate or radicalize."

Whatever his choice, it's clear that Chávez must adjust to more frugal times. He counts on energy sales for 95% of export revenue and half of his government budget. Prices for Venezuela's crude have fallen by nearly 60% since July, to as low as $52.92 per barrel. That leaves him dangerously short. Deutsche Bank (DB) estimates that Chávez needs $95 per barrel to finance operations and pay for imports, including much of the nation's food. Less than a year ago, Chávez chopped three zeros off the bolivar and vowed to defend the new currency. But on the black market this "strong bolivar" fetches half what it did in June. Venezuelan government debt, meanwhile, now yields nearly 20% annually, double its level of six months ago.

The full impact of the downturn hasn't yet reached Caracas. Oil revenues, based on contracts made three months ago, are still coming in at August's higher prices. But the prospects are darkening just as Venezuela heads into state and municipal elections on Nov. 23. True, the voting might not mean much, since Chávez in July issued a decree empowering him to appoint regional leaders. But a decisive loss would signal that Venezuelans may be weary of his revolution—and reluctant to rewrite the constitution so that the 54-year-old leader can stay on beyond the end of his term in 2012.

Naturally, both foreign and Venezuelan businesses are hoping that Chávez's growing needs will force him to moderate. But there's little sign of softening as he storms through the country campaigning.