An overwhelming amount of local currency resulting from foreign exchange is used to cover astounding government expenditure. In order to curb inflation, the Venezuelan Central Bank has resorted to a wide variety of instruments, including the renowned Monetary Stabilization Funds
Venezuela is a peculiar nation. Half of the income comes from the oil business. Therefore, the Government receives foreign currency, exchanges it for local currency and injects it into the economy every time it has to pay for social welfare programs, wages and anything else listed in the budget.
As a result, a large amount of Venezuelan bolivars comes in the economy from public expenditure. If they are used to buy an equivalent amount of goods and services, prices escalate. Therefore, in order to prevent soaring inflation, the Venezuelan Central Bank (BCV) should take out money of the system.
And this has been the case. BCV has offered financial institutions 10-percent interest rates for 28-day placements. Ending the first half of 2006, BCV had contained USD 17 billion, a historical record.
A case study prepared by the economic research management at Banco Mercantil found that previously, when BCV had to withdraw money from the economy, liabilities incurred had been far away from the current level.
BCV used zero coupon bonds to absorb a maximum of USD 2.664 billion in April 1991. And Monetary Stabilization Notes (TEM) accounted only for USD 5.39 billion in November 1994.
The result is technically the same. Zero coupon bonds managed to contain about 18 percent of the monetary liquidity, TEM hit a maximum of 35 percent, and current deposit certificates have gone beyond the barrier of 40 percent.
Payment of interest accrued on deposit certificates resulted in losses for BCV the first half of 2006. But the Executive repaid an old debt and exchanged for US dollars a portion of idle local currency. This made BCV show a credit balance at the end of the first half.
The Government, under the law, must offset any potential losses suffered by BCV. But this is not a big issue.
Financial analysts fear that if BCV continues increasing the amount of contained money at such a rate, it is possible that in the medium term it will be unable to pay interests accrued. As a result, it will have to relinquish the absorption policy and let prices to rebound.
Translated by Conchita Delgado