ECONOMICS: LATIN AMERICA PERSPECTIVES—JANUARY 7, 2011
Senior Economist—Latin America Research, (212) 823 3420
financed by buying dollar-payable bonds
When the Chávez administration recently abandoned its with bolivars at a deep discount and selling
the bonds abroad. Anyone not entitled to
awkward multiple exchange-rate system, it reduced economic
one of these exchange rates was forced to
distortions, while modestly devaluing the bolivar. Our biggest scramble to obtain even less favorable
rates as weak as 10 bolivars per dollar.
concerns remain the country’s overall political direction and the
impact of heavy foreign borrowing. Systems like the one just discarded by
Venezuela distort underlying economic
Near the end of last year, the Venezuelan exchange-rate system—once a common forces—political motivations direct
government quietly announced a widely approach for single-export economies economic decisions. At the same time,
anticipated effective devaluation of its seeking to distribute foreign exchange in they require a massive enforcement effort,
currency. The Chávez administration ways that further the government’s because unfavored buyers are much more
scrapped a two-tiered exchange rate that preferred policy path. These systems assert inclined to resort to illegal means to gain
applied a more favorable rate of 2.6 that the currency has a high value— access to a more favorable rate...behind
bolivars per US dollar to certain sanctioned Venezuela’s “bolivar fuerte,” for the government’s back. These motives and
activities, replacing it with a single rate of instance—but policymakers only grant a actions create enormous social pressure on
4.3 bolivars to one US dollar. more favorable exchange rate to activities any bureaucracy, and Venezuela’s was no
that meet the government’s objectives. It’s different.
We see two main effects from this action. essentially a tax scheme in which
First, it simplifies the previous non-favored buyers subsidize favored Temporary Relief...Fewer Economic
multiple-exchange-rate system by setting buyers by receiving a weaker currency rate. Distortions
one value for the bolivar. Second, the In unifying its exchange system, Venezuela
overall result is a small devaluation for the Almost extinct today, these types of eliminated the stronger exchange rate for
bolivar, on average, because many currency regimes were pervasive several favored activities, with the net effect of a
activities were already subject to the less decades ago among emerging nations, modest devaluation for the currency.
favorable exchange rate. On balance, this leaving deep economic distortions and Devaluation acts as a broad tax on the
devaluation doesn’t seem to increase damage in their wake. In Venezuela’s case, public, since government revenues are
Venezuela’s capacity to service its foreign the favorable rate of 2.6 bolivars was largely in dollars, while its costs are in
debt obligations. reserved for preferred imports, while the bolivars. In the interlude before local prices
main rate of 4.3 bolivars was applied to catch up to the higher cost of foreign
Discarding the Multiple-Exchange- other worthy, but non-priority, uses. exchange, government finances are
Rate System actually strengthened: revenues in dollar
Since the beginning of 2009, Venezuela There was also a peculiar debt-linked rate terms rise compared to local costs—mostly
had been enforcing a multiple- of 5.3 bolivars per dollar made available wages. Eventually, though, higher inflation
for certain private-sector needs that were
bids up wage costs. and a lot of time with which to carry out rationale that it would aid Venezuela’s
these policies. recovery from a heavy rainfall and
Venezuela’s history is marked by bouts of subsequent flooding late last year. In 2011,
currency fixing followed by But full-scale socialist policies would exact Chávez faces a much less supportive
devaluation—brought on largely by the a huge economic toll, in our view, hurting assembly.
pursuit of easy oil revenues. Venezuela’s ability to produce food,
construction, material and even oil. Oil Heavy Borrowing Raises Concerns
The elimination of the 2.6 bolivar rate and exports amount to about US$70 billion In addition to using oil to support an
its replacement with the 4.3 rate creates a compared with US$200 billion for the rest otherwise falling standard of living,
65% increase in the cost of dollars for the of gross domestic product (GDP). So, we Venezuela is also borrowing heavily—a
20% to 30% of import transactions see the current course as a race against tool often used by governments to buy
affected. However, as high-priority time to produce enough oil to fund additional time when they can’t enforce
imports, they’re still likely to receive public imports that can supplement declines in their will through other means.
subsidies, which will erode any fiscal other areas of domestic GDP.
benefits from the unified rate. How has Venezuela fared so far with its
Political Considerations oil-for-socialism experiment? One simple
The net result from changing the currency In the end, much will depend on President way to assess its progress is to compare
regime is likely to be a reduction of the Chávez’s determination to adhere to net dollar-denominated debt with net
distortions and corruption stemming from democratic principles in a bid to stay in dollar oil revenues. Between Venezuela’s
multiple rates, and an increase in the power through the 2012 presidential heavy borrowing and a decline in its usable
average cost of foreign exchange of about elections. He must demonstrate at least a foreign-exchange reserves, it appears that
20%—roughly in line with Venezuelan minimum standard of living to the need for dollars exceeds the country’s
inflation rates. Venezuelans as he accelerates his oil revenues used to support an otherwise
nationalization efforts and seizes more falling standard of living.
A Race Against Time powers to address what he frames as
In our view, the Chávez administration structural problems within the country. As a result, Venezuela is forced to borrow
seems determined to use oil revenues to additional foreign funds in order to calm
reshape Venezuela along utopian and Until early this year, he had the support of the political waters. This is clearly evident
populist principles. Many political analysts an overwhelmingly pro-Chávez national in the high pace of Venezuelan borrowing,
have misgivings about this approach, assembly, resulting in a series of unsettling both by the national government and its
regardless of the path of oil prices. fundamental changes to the country’s state-owned oil company, Petróleos de
Aggressive socialist approaches have constitution that eventually met resistance. Venezuela. In our view, nothing in the
historically caused significant economic Last December, the assembly also granted administration’s recent devaluation will do
damage, but oil revenues and rising oil Chávez the right to govern by decree for a much to fend off trouble on this front. n
prices give Venezuela a big margin of error period of time, on the questionable
JANUARY 7, 2011 ECONOMIC PERSPECTIVES
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JANUARY 7, 2011 ECONOMIC PERSPECTIVES