Venezuela On The Brink
The decision taken by President Hugo Chávez’s administration to suspend trading in Venezuela’s black market ‘parallel’ rate marks a step closer to Zimbabwe-style hyperinflation and domestic economic ruin. To-date the government has avoided paying the cost of its rampant spending spree and erosion of productive capacity thanks to robust global oil prices, but even without the recent retracement in oil markets, the downward spiral of the parallel rate over the last 12 months has been a very visible sign of the destruction of Venezuelan’s purchasing power. While there are still several policy options available to the government if it is to avoid the types of economic, social and ultimately political turmoil experienced by Zimbabwe in the early-2000s, Risk Watchdog is concerned that Chávez’s determination to push on with the Bolivarian revolution at all costs makes any easing up in distortive economic policies highly unlikely.
The official reason for trying to control trading in the black market rate was to stem inflationary pressures after April’s price spike, which saw official consumer prices in Caracas rising to 36.6% on a 3mma annualised measure (from 28.2% in March). However, I find it hard to believe that the government genuinely believes ‘speculators’ were responsible for the parallel rate’s downward spiral since the beginning of the year, as it was the private brokerages trading in dollar-denominated securities which had provided a relatively efficient method of avoiding currency controls, in turn meeting the huge domestic demand for foreign currency.
With several weeks until the new exchange regime comes into play, importers barred from accessing dollars through official channels will now be forced to use illegal means to continue trading (possibly resorting to offshore exchanges in Panama, Colombia of the Netherlands Antilles), or perhaps even be forced cease trading altogether. This will translate into a further shortage of consumer goods, a factor which will be significantly compounded by government-imposed price caps (in one example of the ludicrous price regulations, Chávez’s government arrested around 40 butchers in early May who had sold meat above regulated prices). Even once the technicalities of the new exchange rate regime are ironed out and implemented, this will do nothing to address the underlying structural issues afflicting Venezuela’s economy. On the contrary, it is highly likely to make the situation much worse.
Addressing Symptoms Not Causes
At the heart of the problem with Venezuela’s currency (and economy in general) is the collapse in domestic productive capacity under Chávez’s regime, where a policy of asset appropriation has placed ineffective bureaucrats in control of the few remaining sources of forex earnings. The result has been to increase the economy’s dependence on oil exports, which reached 95% of total exports as of December last year, compared to just 77% at the start of 2003. At the same time the authorities have pursued a policy of monetary expansion to keep pace with the government’s fiscal profligacy, making it increasingly expensive (and complicated) to maintain the bolivar’s official peg against the dollar. The devaluation and introduction of two official rates (at VEF2.5000/US$ for essential goods and VEF4.3000/US$ for non-essentials) at the start of the year was insufficient to remove these pressures, as the ratio of M2 money supply to US$ reserves implied the market rate was closer to VEF6.0000/US$.
Yet not only is the money supply no longer backed by foreign currency reserves, but even the country’s massive oil exports are insufficient to bolster confidence in the national currency. The accompanying chart shows annual oil exports as a proportion of M2 money supply. With the bolivar value of exports almost halving between 2008 and 2009, M2 supply was over double the value of oil exports in 2009, an indication of how rapidly the printing of money had exceeded the value of the country’s most valuable asset. Clearly, this picture could be reversed by another spike in global oil prices, or the ability of state-owned oil company PDVSA to ramp up production levels, but with the former looking unlikely given the weak outlook for global demand and the latter almost impossible without greater private-sector participation, I’m not hopeful.
The Next Zimbabwe?
On many levels there are clear parallels with Venezuela today and the early stages of Zimbabwe’s hyperinflationary cycle and resultant social and political upheaval; ranging from government appropriation of private (productive assets), an armed militia which depends on political patronage for power, and a massive supply and demand mismatch of foreign exchange. However, Venezuela is not yet at the stage of exponential inflationary rates and civil war. Despite Chávez’s attempts to crackdown on all forms of open dialogue – most recently highlighted by the forced closure of all internet sites that reported the parallel currency rate – there is still a chance that September’s legislative elections will see an opposition victory, which could dampen the government’s ability to continue with its distortive economic policies.
Unfortunately, I remain far from convinced that electoral race will be free and fair, hence cannot rule out significant political turmoil in the run up to September’s ballot. What is clear, in my view, is that Venezuela is set to experience a second consecutive contraction in real GDP growth this year, and that this recent move to control the parallel rate will simply make the necessary economic readjustment that much more painful when it does come.