Venezuela: Reading The Bolivar Devaluation
Risk Watchdog’s long-held view that the bolivar would sooner or later have to be devalued has finally materialised, with President Hugo Chávez on January 8 announcing the introduction of a dual exchange rate system.
Bolivars will now officially be exchanged for dollars at two rates, VEF2.6000/US$ and VEF4.3000/US$, as opposed to the VEF2.1500/US$ peg that had been held in place since 2005. The preferential rate will apply for imports of priority goods such as food and medicine, while the latter rate will be charged for ‘non-essential’ imports.
A central unknown is if the authorities will relax the supply of dollars at the ‘non-essential’ rate, which is far more attractive than the unofficial parallel rate (currently trading around VEF*6.2500/US$). I suspect that many businesses – those deemed of little ‘social’ value – will still find it difficult to obtain permission to buy greenbacks at the official rate, thus leaving them at the mercy of the black market. In effect, what Venezuela might now end up with is a three-tier system with the price of hard currency determined by potentially arbitrary categorisations. Nonetheless, the markets have given the devaluation move a resounding endorsement, with Venezuela’s bonds and Credit Default Swap (CDS) rallying briskly following the news. Notably the 5-Year CDS has now dropped below that of Argentina, putting paid to the latter’s outperformance over the past few months.
Political Calculus
Nonetheless, I feel that the timing of the move merits attention. With legislative elections due in September this year it has been clear all along that a devaluation would be a risky proposition, given the inevitable inflationary ramifications. Indeed, spooked Venezuelans stormed to supermarkets over the weekend to buy imported goods such as electronics and luxury clothing before a feared mark up.
Chávez has characteristically responded to this panic by ordering the National Guard to take care of retailers who bump up prices. The fractured opposition, for its part, has seized on the public’s nervousness to attack the government’s policies. The government is likely hoping that any immediate political backlash caused by the inflationary impact of the devaluation will be offset by the boost brought to the government’s coffers – as it will now get twice the amount of bolivars for each dollar collected. To be sure, the one-off surge in state revenues will enable Chávez to extend the numerous social programmes on which his political support crucially depends.
Economic Reverberations
As hinted at above, a key question is what the inflationary feed-through of the devaluation will be. Finance Minister Ali Rodriguez has suggested that it may add three to five percent to the country’s inflation rate, which averaged over 25% y-o-y in 2009.
I suspect that the effect will be more pronounced due to the Venezuelan economy’s dearth of domestic productive capacity. As for the impact on regional trade dynamics, it is clear that Colombia stands to lose the most, as the drop in the value of the bolivar adds further to the pain caused by Venezuela’s trade blockade against its western neighbour.
Chávez has made it very clear that a weaker bolivar is part of a strategy to discourage imports whilst trying to bolster exports and domestic productivity. How he will square the urgent need to accelerate entrepreneurial activity and lift local supply with his steamroller nationalisations remains to be seen. In short, although the devaluation is doubtless one key step towards reducing distortions in the economy, and reflects a modicum of pragmatism on part of Chávez, the messy nature of the new exchange rate set-up and probable inflationary impact could work against the government’s objectives.