Venezuela’s Decision Not to Devalue Its Currency Raises Questions

Cory Fischer Hoffman looks at the pressures facing the Venezuelan economy and the questions raised by the decision of President Nicolas Maduro’s government not to adjust (devalue) the country’s exchange rate in the near future.

By Cory Fischer-Hoffman - Venezuelanalysis.com

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José Khan, Director of the Central Bank of Venezuela (BCV) stated that Venezuela will not devalue the bolivar currency (El Universal)
José Khan, Director of the Central Bank of Venezuela (BCV) stated that Venezuela will not devalue the bolivar currency (El Universal)
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Cory Fischer Hoffman looks at the pressures facing the Venezuelan economy and the questions raised by the decision of President Nicolas Maduro’s government not to adjust (devalue) the country’s exchange rate in the near future.

José Khan, Director of the Central Bank of Venezuela (BCV) stated this week that the government will not devalue Venezuela’s bolivar currency. 

A devaluation would mean reducing the large disparity between the official exchange rate and the “black market” rate to the dollar, however government officials claim that devaluation could lead to increasing inflation in a country where the annual inflation rate is already at 64%.  Investors and bond-traders continue to fear a default despite a recent Moody's report that states that Venezuela's fiscal problems “do not constitute a critical vulnerability for the sovereign's creditworthiness.”

While meeting with the Finance Committee of the National Assembly, Khan noted that inflation was a complex problem that could not be fixed easily.  He ruled out devaluing the currency, noting that “it is necessary to look for solutions.  It is necessary to generate other policies that aren’t devaluation,” El Universal newspaper reported.

Many analysts note that the economic problems in Venezuela, which include high inflation, scarcity of basic goods, and difficulties in accessing foreign currency under exchange controls, may only worsen with the falling price of oil on the world market.  Roughly 95% of the country’s foreign exchange earnings come from exporting oil. 

Despite Venezuela's attempt to encourage the Organization of Petroleum Exporting Countries (OPEC) to make a move to stabilize prices, the current cost of a barrel has fallen from a previously stable US $105 in July down to $81 currently. A  Reuters blog cited that for every $1 drop in the price of oil Venezuela would lose roughly $770 million in revenue.

The recent fall in oil prices has lead to increased debate about Venezuela's financial situation and potential policy solutions.  There seems to be a shared consensus that there are serious problems in the Venezuelan economy, but there is much disagreement as to what the root causes are and therefore what policies could be implemented to address the problems.

In an article published in September by economists Ricardo Hausmann and Miguel Angel Santos called “Should Venezuela Default?”, the authors claim that due to Venezuela's inability to meet its foreign currency obligations, the country should default, and bond holders should bear some burden of the responsibility. 

The article led to a flurry in the financial press, and bond holders and traders speculated about possible implications of the oil giant's potential default.  In response to the questions posed by the economists, Francisco Rodríguez of Bank of America Merrill Lynch argued that Venezuela should not default, because defaulting on debt is related to solvency (an ability to pay debt) not the availability of goods or the scarcity within Venezuela.  In his article, published on the business oriented Beyondbrics blog, Rodriguez noted that “it is very hard to make the case that Venezuela is insolvent” and that “the economy is not over consuming.”  Rodríguez noted that the problem is not “the lack of dollars” in Venezuela, “it is that the government is giving dollars away.”

Rodríguez is referring to the multi-faceted exchange rate system in Venezuela in which the primary official exchange rate for the Venezuelan bolivar is 6.3 to the dollar.  The over-valued bolivar, combined with currency controls that limit Venezuelans’ access to dollars through legal means, has spurred a parallel exchange rate and an informal and illicit trade in dollars.  While the rate is unregulated and constantly in flux, the parallel rate has risen to over 100 bolivars to the dollar, over 15 times higher than the official rate, generating a series of economic distortions.

Mark Weisbrot, co-director of the Center for Policy and Economic Research based in Washington DC argued in an op-ed, published in Venezuela's daily Ultimas Noticias, that the economic problems in the country stem from the “dysfunctional exchange system” in the country.  

“Inflation, scarcity, economic deescalation: they all come from the scarcity of dollars.  But, in turn, the scarcity of dollars is a product of the fact that the government gets rid of almost all of the dollars that it obtains through oil revenue at a fraction of their real value,” Weisbrot explained.

Weisbrot, like Rodriquez, claims that Venezuela's financial problems are not “an authentic crisis in their balance of payments” in which “a shortfall in export earnings would make it impossible to cover imports and external debt.” 

Matt Ryan, portfolio manager at MFS Investment Management also sees default as unlikely. “The government has been pretty adamant about its intention to service its debt since they appear to believe very strongly that to do otherwise, to default, would really compromise their ability not just to export oil but to also import goods. I think they see the downsides to a default as quite significant,” Ryan stated, according to Reuters

As analysts and economists come to a rough consensus that Venezuela does not face a balance of payments crisis and therefore default is an unlikely outcome in the near future, however, this week’s announcement by Finance Minister Rodolfo Marco Torres that there is “no devaluation planned” is raising eyebrows.

A devaluation of the bolivar would mean raising the official exchange rate of the bolivar to the dollar.  While some analysts have suggested raising the rate to 30, Weisbrot suggests that “overshooting” and setting the rate at 40 might serve to stabilize the economy, before the rate could be lowered again.

So, why not devalue the currency?  Many Venezuelans fear that devaluation of the bolivar could increase the already extremely high rates of inflation and it would certainly mean an immediate price-hike on all imported goods. Furthermore, Venezuelans who have access to dollars at the official (CADAVI) exchange rate or, even at the slightly higher SICAD I rate of 10.6 bolivars to the dollar, are able to spend cheap dollars on travel and essentially subsidized consumer goods.

Large multinational corporations are also the recipients of these “preferential dollars.” According to a report authored by Luís Enrique Gavazut with collaboration of researchers from Socialist Tide, General Motors, Ford, Toyota, and TELCEL, were among the five companies that received the most foreign currency, along with the state owned steel company, SIDOR.  The power point presentation, which is published in its entirety on Aporrea.org, states that 1 of every 10 dollars of the preferential dollars that the government distributed between 2004 - 2012 went to 5 companies (4 of which are multinational corporations), and over 20% of the total preferential dollars given out by the government went to 15 companies. 

Despite an uproar from sectors within chavista ranks following the release of the Gavazut report, a series of opinion polls show that the majority of Venezuelans are still against devaluation. Weisbrot, citing a poll that notes 80% of Venezuelans are opposed to devaluation, concludes that “it seems that this electoral pressure, not special interests, are what is impeding the necessary changes to recuperate a healthy economy.”

Despite a recent increase in the minimum wage by 15% which will go into effect December 1st, the 55% increase in the minimum wage over the last year and a half and the increased food assistance subsidies have still not kept pace with the 63% inflation rate.  In other words, wages have fallen in real terms because the increase in wages has been less than the increase in the costs of consumer goods over the last year. 

This month, the Center for Documentation and Social Analysis (Cendas) concluded in a report that the cost of the basic monthly basket of goods for a family is at 15,000 BsF, over 3 times higher than the newly raised minimum wage of 4,889 bolivars per month (US$776 at the official exchange rate of 6.3 and roughly $48.89 at an informal rate of 100).  For upper and middle class individuals who can access preferential dollars through requests to travel or through using their credit card (if they have them), these inexpensive and subsidized dollars create some padding from otherwise climbing prices of consumer goods.

The Venezuelan government has declared that devaluation is not in the cards in the near future, sparking concern from bond-holders and progressive economists alike and increasing yields on the issuing of new national debt.  Rodríguez of Bank of America Merrill Lynch argued against what he called the “inexplicable decision to continue to tax the working and middle classes through inflation while giving away cheap dollars to importers and rent-seekers.”  Despite critiques coming from many directions, the government seems to be going for a policy that appeals to many voters; no devaluation, and no change to the exchange rate system, por ahora (for now).

Other possible adjustments have been mentioned in government policy discussions, such as reducing subsidies on the country’s practically free domestic gasoline. However beyond the on-going crackdown on smuggling, hoarding, fraud and price speculation, it remains to be seen what further measures will be taken to address current economic problems and distortions.