Venezuela's currency controls including its fixed exchange rate are among the most controversial of Chavez-era policies. Under former president Hugo Chavez, Venezuela's currency was fixed, and exchange controls were imposed. The initial objective of Chavez's currency policies was to stem capital flight amid the 2002-03 oil strikes, but they are now a well established part of the government's economic policy; particularly aimed at controlling inflation and sheltering domestic industries, among other goals.
It's important to note that this isn't the first time Venezuela has seen a fixed exchange rate. After coming off the gold standard in 1930, Venezuela's currency was fixed. Until 1983, Venezuela's currency was widely perceived as among the most stable in the region. From 1983-89, the country had a multiple exchange rate regime, with room for a parallel exchange market. However, by the time controls were lifted in 1989 there was around a 132% difference between the official and parallel rates.
Yet further liberalisation had questionable results. Even into the 90s high inflation continued, averaging between 50-60% during the middle years of the decade. In 1994 the country underwent a severe banking crisis, in the wake of which inflation surged thanks to the government's “massive injections of liquidity” into failing banks.
Controls aren't unique to Venezuela either. For example, Brazil imposed new capital controls in 2010 to stabilise the real, and there are plenty of countries with fixed-exchange rates. Fellow OPEC member Saudi Arabia's riyal is pegged to the dollar, and generally fares relatively well.
In Venezuela, current price controls have produced mixed results – both wins and losses. To start with, let's look at some of the positives aspects of Venezuela's currency policies over the last decade, then move on to the cons.
The pros of currency controls
The first incarnation of today's controls were imposed in response to the second major challenge to the Chavez government – the 2002-03 oil strike. The strike came as a serious blow to the government. Given that this was the second attempted overthrow of the government within just a few months, it's not hard to imagine why Chavez suspected there would be further attempts to sabotage the economy. Since then, Venezuela has largely “achieved high rates of economic growth”, according to the World Bank, which cites 5.6% GDP growth in 2012. However, as the WB rightly points out, last year growth slowed, and they now predict “modest” short-term future growth. However, if Chavez was hoping for economic stability in the wake of the oil strike, then there's a compelling case to be made that his wish came true. As the Center for Economic and Policy Research's Mark Weisbrot argues,
“[Once the] the government got control of the national oil company in 2003... the whole decade's economic performance turned out quite well, with average annual growth of real income per person of 2.7% and poverty reduced by over half, and large gains for the majority in employment, access to health care, pensions and education.”
The political stage has also been relatively stable, with no subsequent attempts by the opposition to violently overthrow the government on the same scale as the 2002 coup.
For most of his presidency, inflation was lower under Chavez than preceding administrations. Even after a Bolivarian era record inflationary spike in 2013, we're still yet to see anything like the sustained, chronic inflation of the 1990s, let alone its peak of 99% inflation in 1996 (compare the new century to the 1990s here).
Fostering domestic industry
Another key objective behind the currency controls is to be to aid domestic industries. Since the early 20th Century the Venezuelan economy has been dominated by the oil sector. Hugo Chavez sought to shake off Dutch disease by instituting a range of policies aimed at diversifying the economy and rebuilding sectors like agriculture. Funding for domestic development projects continues to grow. There have been many successes on the road to “endogenous development”, though oil revenue still makes up more than 90% of Venezuela's export earnings. Moreover, results in agriculture – one of the main targets of the endogenous development project – have been mixed. Figures from the United Nations Food and Agriculture Organisation indicate that domestic agricultural output started to pick up in 2004, after slumping in the first years of the Chavez administration. It's important to note that prior to 2004 the government's ability to manage the economy was severely curtailed by stiff opposition from the right-wing, including the 2002 coup and the oil lockout that followed. By 2005, however, the production of food crops had surpassed the 2001 peak, and continued to rise until 2007. However, after that, output fell yet again, and the latest figures show that from 2010-2011, production improved marginally. According to the government, agricultural output again rose in 2012, and between 70-80% of basic foods are now produced domestically.
Capital flight mitigation
One of the key benefits currency controls can offer governments is increased oversight of the movement of capital in and out of the country. Indeed, one of the main justifications for currency exchange restrictions was to stem capital flight in response to the 2002-03 oil strikes. However, just how successfully capital flight has been mitigated is questionable. For example, Venezuelan economic think tank Ecoanalítica is highly critical of the ability of controls to stop flight. Last year, Barclays estimated that capital flight did indeed decrease in the first year of currency controls, but has since rebounded and peaked in 2009. Between 2008 and 2013, the country lost over US$15 billion in capital flight; equal to 27% of export revenues, Barclays claims. Despite this sizable figure, the real question is just how much potential capital flight has been mitigated – or, how much worse would it have been without currency controls? Even assuming it would have been worse, this is a partial success at best.
Cons of currency controls
Distribution of foreign currency
Perhaps the most common criticisms levelled against Venezuela's currency policies relate to the capacity for state institutions to efficiently and fairly distribute currency. In recent years it has become common for companies to accuse the government of failing to provide foreign currency in a timely manner. Last year, the backlog of applicants was reportedly over a year long. At the time of writing, the most recent corporate voices to air this grievance have been a number of international airline carriers complaining of having funds trapped in Venezuela due to delays in the currency exchange system. US car manufacturer Ford has a similar story. Explaining a reduction in production in Venezuela, one representative described access to foreign currency as “uneven and unpredictable”, according to Bloomberg.
Another serious drawback to a fixed exchange rate is the tendency towards a parallel, unofficial foreign currency market. Unlike under the fixed exchange regime that existed in the 1980s, today the parallel market is illegal, and the government has taken numerous steps to try and stamp it out. Among the most recent initiatives are efforts to ease access to foreign currency and tackling websites that show the unofficial exchange rate. Yet the black market continues to thrive, and it's not hard to find hawkers willing to trade currencies illegally on the streets of Venezuela's larger cities.
In early 2008, CEPR estimated that the bolivar was at least 32.4% overvalued compared to the US dollar, though probably more. As CEPR's Mark Weisbrot and Luis Sandoval argued at the time,
“The overvalued fixed exchange rate, combined with present levels of inflation, also presents a significant intermediate-term problem. Even if inflation is stabilized and begins to be reduced, so long as it remains at or near current levels and the nominal exchange rate remains fixed, Venezuela's currency will become increasingly overvalued. This will increasingly squeeze domestic production outside of oil and non-tradables, and would eventually become unsustainable.”
Although the CEPR report points out that this is a serious long term problem that could impact the government's stated aim of diversifying the economy away from oil, at the time they argued that it wasn't an imminent danger.
Since then the bolivar fuerte currency denomination has been instituted, and devalued from its original value of 2.15 to the dollar to its current official rate of 6.3. When the first devaluation of the new currency took place in 2010, Venezuela faced annual inflation of around 25%. Last year's inflation was 56.2%. This should mean that imported products are artificially cheap, but that's not what ordinary Venezuelan consumers see. Instead, retailers generally appear to adjust prices of imported (and some domestically produced goods also) according to the black market rate. Furthermore, the retail prices of many common imported consumer products aren't much less than first world prices, if we calculate the prices based on the black market exchange rate (which seems to be what retailers are doing). Weird price comparisons abound; for example a small imported can of tuna costs a similar amount to a cheap set menu lunch, while a generic pair of jeans will cost almost as much as a minimum wage earner's weekly income. If imports are artificially cheap, then the benefits don't always appear to trickle down to street level.
Misappropriation of preferential rate currency
The difference between the black market and official exchange rates has been exploited by a myriad of different fly-by-night schemes. These involve obtaining foreign currency at the official exchange rate cheap and selling the cash on the black market at a premium. The latest such currency scheme literally involves flying (presumably sometimes by night). Raspacupos (scrapers) take advantage of an initiative under which Venezuelans travelling abroad can apply for an allowance of foreign currency valued at the official exchange rate. The scheme is simple: a Venezuelan resident buys an international plane ticket, applies for a credit card loaded with the foreign currency, then has the credit card “scraped” of its credit the minute they arrive at their destination. The scraper then flips the currency on the black market for a profit. At the height of the scheme, there were reports of scrapers not even leaving Venezuela, but instead just posting their credit cards to international contacts. Recently appointed economy minister Rodolfo Marco has claimed that other scrapers made the most of each trip by carrying as many as 20 credit cards at a time. Along with the self evident misuse of the exchange system at the expense of the state, there are other more unusual consequences of the scrape. By late last year there was a shortage of airline tickets out of Venezuela, yet planes were reportedly flying out of the country half empty. The government has since pushed to eradicate the practice. However, the scrape is just one of many possible schemes. A few other exchange exploits that have been used in the past are listed here; given the recent shake-ups of the exchange regime it's difficult to say how many of these schemes are still being pulled off, but the list serves to illustrate how problematic the parallel currency market is. One of the most incredulous schemes listed is the “carousel” – which involves applying for official rate currency to freight goods from a neighbouring country. The kicker is that the profiteer never unloads the truck, instead just driving backwards and forwards over the border and apply for cash to import the exact same products over and over. The truck is never unloaded, but the profiteer is sold currency at the official rate for each 'delivery'.
Trade with US
Trade between two countries can be benefited when one fixes its currency to the value of the other. The US remains Venezuela's largest trade partner. Last year Venezuela imported US$12.2 billion from the US – these would have mostly been “machinery, organic chemicals, agricultural products, optical and medical instruments, autos and auto parts” according to the State Department. Comparatively, Venezuela exported US$29.4 billion to its northern neighbour in 2013. These figures are down from 2012, though US exports are more than double the value they were in 2004 (around US$4.7 billion). Comparatively, in 2004 Venezuelan exports to the US were US$24.9 billion (though they did spike to US$51.4 billion in 2008). It makes economic sense for a country to peg its currency to the value of that of its primary trade partner – if it wants to make bilateral trade easier. Yet one of the main objectives of the Venezuelan government over the last decade has been to develop domestic industries. However, imports of US goods continue to rise, so whether or not this is actually a benefit is questionable. Moreover, like his predecessor, Nicolas Maduro has pledged to deepen trade with Venezuela's second largest trade partner, China.
During the Chavez administration, trade between the two nations increased dramatically; from under US$500 million before 1999, to US$7.5 billion in 2009. The Venezuelan government also hopes to increase oil exports from the current level of 600,000 barrels everyday to China, to over a million in 2015. Hence, pursuing a currency policy that may favour the US isn't exactly coherent with Venezuela's stated geopolitical interests.
Brittle by nature?
Fixed-exchange rate regimes have a reputation for being brittle. “By definition, they can break if the external and internal economic and financial forces arrayed against them are strong,” Edwin Truman from the Institute of International Economics summarised in 2002 when discussing Argentina's experience. Between 1991 and 2002 the Argentine peso was pegged at parity to the US dollar, mostly as an attempt to deal with hyperinflation. Although Argentina's inflation was slashed during the time the regime was in place, the system was abandoned during the depression that began to set in during the late 90s. Of course, fixed exchange regimes don't have to end like this. Truman himself suggested Argentina could have considered pegging the peso to a basket of other currencies, with a band of around 15%. There are other examples of flexible fixed-exchange rate regimes. For example, Iceland's fixed-exchange rate regime worked fairly well given the country's economic circumstances in the 1970s and 80s. The regime was particularly flexible, and from 1972 to 1989 the value of the Icelandic krona was adjusted 24 times. Comparatively, Venezuela's currency has been devalued five times (six if you include this recent controversial overhaul of the exchange system) since being fixed in 2003. The bolivar was originally set at 1,596 to the US dollar for sales and 1,600 for purchases in February 2003. Since then the bolivar fuerte has replaced the bolivar at a rate of B1000 to BsF1. Could the bolivar afford to be a little more flexible?
Currency policy isn't just a question of fix or float. In Venezuela's case, it's also a question of how effectively currency controls can be enforced, and how the benefits of the system can be best distributed.