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Opinion and Analysis: Economy

Will Venezuela’s Latest Exchange Rate Reforms Help?

Once again, the annual tradition of reforming Venezuela’s currency exchange system is upon us. For anyone who’s managed to go through life until this point without knowing anything about Venezuela’s Byzantine foreign currency exchange system, then first let me congratulate you on your good fortunes. For well over a decade now, Venezuela’s currency, the bolivar (BsF), has been subject to a controlled exchange regime, meaning anyone wanting to buy or sell bolivars is supposed to go through the government. In reality, most trades take place on the country’s burgeoning currency black market, where exchange rates tend to be far lower than through official channels. Just how much lower, you ask? At the time of writing, the strongest official exchange rate was BsF10 to the dollar. On the black market, it’s closer to BsF5900 to the dollar. In other words, the government’s official rate is 600 times stronger than the street value. For years, the government has been promising to close this discrepancy between official and unofficial rates, mostly through these annual/bi-annual reforms to the official exchange system.

Roughly speaking in just four years we’ve seen around five major overhauls of currency exchange regime, each being plagued by a similar mix of problems. These have included complaints of a lack of foreign cash to satisfy demand, pricing systems that make next to zero sense, and opaque bureaucracy that just makes everything terrible.

Naturally then, my eyes lit up when the government announced a few weeks back that it would once again be undertaking yet another reform.

The latest reforms

Frivolities aside, let’s get down to the grim business of dissecting the latest round of reforms.

Unlike most previous rounds of forex reform of recent years, the new changes won’t add or remove any existing exchange tiers (thank God for small blessings). Instead, this year’s reforms are exclusively related to the Dicom exchange tier.

The story of Dicom itself begins just over a year ago, in March 2016. It was intended as a free floating rate for non-essential transactions, such as for Venezuelans going abroad, or businesses looking to import goods not covered under the Dipro rate. For anyone wondering, Dipro is an alternative, stronger exchange tier reserved for priority imports, such as medicine and the like. It’s currently trading at BsF10=US$1.

In short, Dipro is the currency exchange mechanism for important stuff, while Dicom is for all the other stuff. Seems simple, right?

Indeed, the idea behind the latest reforms seems to be simplicity – a breath of fresh air for a system that has gotten progressively more convoluted as the years have gone by. According to President Nicolas Maduro’s vice-president for economy, Ramon Lobo, Dicom transactions will now primarily be made through the website,

“We will optimise [Dicom]," Lobo said.

Like the previous incarnation of Dicom, the new system will work as a kind of currency auction house under the purview of the central bank (BCV). Through this system, individuals can purchase the equivalent of US$500 each quarter (for a maximum of US$2000 p.a.), while private businesses can obtain up to $400,000 per month.

All this can be done by simply logging on to the website, entering some basic details, and listo! In seconds, you’re ready to start trading BsF for USD.

This new, online system will undoubtedly be warmly welcomed by many Venezuelans, particularly private citizens who – until now – have had to invest long periods of time in line for their dollar allocations. Instead, users can now wait in the comfort of their own home for the page to load. It’s a minor gripe, but seriously; at the time of writing, the page was loading as if it were 1995.

It’s very likely this is just first day jitters though, and the site is probably buckling somewhat under unusual levels of traffic caused by curious netizens such as myself.

So, on the face of it, there’s nothing particularly offensive to the eye here, but what about under the hood?

State news agency AVN paraphrased Lobo as stating the new system will provide “greater transparency”, while also “dynamising the economy”.

Both these things are sorely needed, but will the new and improved Dicom deliver? The first step towards answering this question is to understand how the new system will determine exchange rates. According to AVN, the online platform will allow for a totally free floating exchange rate – a rate that will remain free, so long as it falls “within two limits, lower and higher”.

… Uh huh.

These two limits exist “in order to avoid speculative actions”, AVN reported.

In other words, this is pretty much just a band system. These bands will be determined “by the BCV … [and] will be adjusted periodically in response to the evolution of fundamental variables of the economy.”

So far, we don’t know what these bands will be. However, we do know that if the upper band isn’t somewhere near BsF5900 to the dollar (the current black market rate), then this new Dicom system probably won’t make much of a dint in the black market.

There is, however, slightly more to the story. AVN also stated that these bands will be altered between two rounds of auctions. My understanding of this system is therefore that during each auction cycle, there will be a first round with bands determined ahead of time by the BCV. Then, there will be some kind of follow-up round dubbed a “contingency auction”, during which the bands will be adjusted in the event of supply and demand not matching up. So, if demand outstrips supply, I’m assuming they’ll allow the dollar price to float a little higher, and visa versa. At first glance, this seems like a needlessly overcomplicated way of allowing the system to nudge closer to a float, but we’ll have to see how it ends up working in practice.

The verdict

Many details of the new Dicom remain unannounced. According to Lobo, the exchange rate will be automatically determined by some kind of algorithm, though we have no idea what the maths is behind it. He also said the bands will be adjusted based on various macro-economic data; again though, no further details have been made public.

This makes it very difficult to say how effective this revamped Dicom will be. Realistically though, there are only two factors that matter. First, the government needs to be able to sell bolivars at a rate that’s at least comparable to the black market. That’s a tall order, given that back in March, reported the Dicom rate was still at BsF700 to the dollar. Even now, the original Dicom rate is still at around BsF720 to the dollar. For now, we have no idea if Dicom can match the black market, though it’s inarguable there’s a lot of ground to catch up on.

Second, this new system actually needs to guarantee enough supply of foreign cash to satisfy demand. If it can’t do this, then the black market will continue to thrive. Previous rounds of reforms have repeatedly failed to deliver in this regard, and the government is yet to provide any compelling reason to assume things will be different this time.

Whatever the case, this new system is looks like a major step backwards for the idea of Dicom, which was originally touted as a fully free floating rate (with no bands). Of course, the same could be said of the likes of Simadi, Sitme and Sicad II: all of which were supposed to be steps towards an open currency market. At best, this new system is a compromise between a fixed rate and a peg, but even that might be optimistic. If the government fails to set the upper band at anything close to the unofficial rate, then we’ll just end up with all the currency exchanges sitting right on the band. In this sense, the upper band will function just like a de facto peg, and we’d be back to square one.

The other supposed benefit of this new system is that it’ll be more transparent. At this early point, there’s no reason to believe this claim at all. After all, the new online auctions are under the auspices of the BCV, which famously only reports critical economic data when the moons of Jupiter line up perfectly with Venus.

Overall, if the new Dicom system follows the pattern established by previous rounds of reform, then we should see a familiar story unfold: things will hold together for the first few months, with perhaps a few successful rounds of auctions. The government will declare victory. Then, a few months in, the new system will be quietly shuffled out of the limelight, as the exchange rate once again detaches from reality and the cash dries up. Then, we’ll see a new round of reforms next year.

Perhaps this time will be different, but there’s not much reason for optimism right now. At this moment, there’s simply no good evidence to suggest the new Dicom is a step towards a free currency market.

Why Venezuela needs to float the BsF

At this point, I need to make something clear: it doesn’t matter where on the political spectrum you stand, you must agree that Venezuela basically needs to float its currency. There is nothing “neoliberal” or “imperialist” about this conclusion. Take Mark Weisbrot, an economist who comfortably sits far to the left of the typical free market centrist. He has long provided a compelling argument that Venezuela is trapped in a kind of “inflation-depreciation spiral”.

“The fastest and best way to break this cycle is to allow the currency to float,” he argued last year.

Clearly, the government has at least heard Weisbrot’s argument. After all, he was a member of a UNASUR team mandated with presenting a set of proposals on how Venezuela can fix its economy. He has gone as far as arguing Venezuela’s current economic crisis was partly sparked after “the government sharply reduced the availability of foreign exchange” in 2012 and early 2013.

Nowadays, the government’s artificially favourable exchange rates for BsF holders continues to spur the exact speculation it’s supposedly intended to stop. Unscrupulous traders are still free to buy dollars on the cheap through official channels, then sell them on Venezuela’s thriving currency black market for windfall profits. For example, if you can buy a dollar through Dipro for just BsF10, why wouldn’t you immediately walk outside and sell that same dollar for BsF5900 on the black market? It’s easy money, and it’s driving speculative demand for foreign currency while killing the bolivar.

Worst of all, the government itself is effectively subsidising this speculative economy, simply because it keeps the official value of the BsF artificially high. After all, in that hypothetical currency exchange mentioned above, who do you think is footing the bill for that BsF5890 that somehow appeared out of thin air? In the initial purchase, the government itself basically provided a subsidy on the purchase of foreign currency. For every BsF10 the currency trader spends, the government is basically pitching in BsF5890 to keep the official rate so favourable.

This is a huge drain on the government, with few clear benefits.

In short, Venezuela’s exchange system is a breeding ground for corruption and speculation, and it’s sucking the blood of the government’s dwindling coffers, not to mention the economy in general. As I’ve argued in the past, by continuing to effectively subsidise dollar purchases, the government is digging its own financial grave.

The only argument against a float is the fear that it could prompt more inflation. This is mostly unfounded. Venezuela’s economy is already dollarised by default, and almost all transactions take place based on the exchange rates posted on Miami-based black market currency website Dolar Today. To put it bluntly, the government lost this battle years ago. Everyone knows this, except, I suppose, Maduro himself. Indeed, even if the Maduro administration outlives the current oil price collapse, it will still need forex reform before the economy can truly turn around. Frustratingly though, after so many years of half measures and steps in the wrong direction, it seems the government simply isn’t prepared to undertake serious reform. We take one step forwards, and two back towards economic disaster. So unless Lobo has some big surprises for us in the pipeline, we’re about to take two more steps backwards.