Despite a decade of currency controls, USD 150 billion has seeped through

Anchoring the exchange rate has failed in keeping inflation from drifting

Saturday January 26, 2013  12:00 AM
Feeling the strains of a deep political crisis leading to an oil-sector strike, plundering financial deposits, massively increasing purchases of US dollars and deficits in public accounts, Hugo Chávez slammed the door on those wanting to purchase foreign currency and, on January 22, 2003, established stringent currency controls that have remained in place for 10 years.

This move, granting the government the power to decide who can acquire dollars and how much that party would be entitled to, eventually turned into a permanent policy -even though crude-oil production rebounded and oil prices have defied the laws of gravity and soared into the longest-lasting oil boom to date.

Currency controls are aimed at putting an end to currency flight and at holding back inflation to secure exchange-rate stability for imports, yet actual results have been quite different from what was originally expected.

Barclays Capital's latest report shows that, over the decade of currency controls, capital flight has reached USD 150 billion and, from 2007 to 2012 alone, these figures averaged 20 billion per year, that is, three times the average for the five years prior to those restrictions.

Analysts pointed out that capital flight, in spite of government restrictions, takes place through bonds issued in Pdvsa dollars and by the Ministry of Finance, acquired in bolivars by corporations and individuals and later resold abroad to obtain foreign currency.

This practice, which sheds light on the meteoric rise in the country's foreign debt, has also extended since 2010 to the Transaction System for Foreign Currency Denominated Securities (Sitme), used by companies to acquire bonds in dollars from the Central Bank of Venezuela.

Another loophole has been the parallel currency market, powered by sophisticated swap transactions, but this practice has been shut down by the government through intervention of nearly all brokerage firms. 

Further, it would be no surprise that, just like the days when former President Jaime Lusinchi implemented currency controls, overcharged imports may be taking place, that is, it may so happen that certain companies apply before the Foreign Exchange Administration Board (Cadivi) for more dollars than they would actually use for their import activities.

Rising inflation rates

Government believes that, by regulating the purchase of foreign currency, it would be able to stabilize the official exchange rate for a prolonged period of time to ensure that import costs lag while inflation remains low. Nevertheless, prices relentlessly continue to rise.

Barclays notes that, throughout a decade of currency controls, inflation has averaged 20% per year, which is practically the same as when no controls were even in place. Over the past five years, inflation has averaged 26.3% per year, making it the highest in Latin America.

None of this comes as a surprise. While authorities maintain the same exchange rate, they also pour a huge amount of bolivars into the economy through public expenditures, thus creating imbalances between supply and demand, ultimately boosting inflation because companies can ultimately manage to make their products pricier without suffering from significantly lower sales volumes.

In addition, a large portion of the economy uses the black-market exchange rate, which has a life of its own and is detached from the official rate, thus leading to higher inflation.

During the first three years of currency controls, authorities raised dollar prices in line with product prices, but things have changed since 2005. Therefore, dollars may very well be the cheapest item in the economy, following petrol.

Therefore, it is easier to import commodities than to produce them in Venezuela, and purchases from foreign suppliers have skyrocketed while dependence on oil prices deepens to the extent that a barrel stands for USD 96 of every USD 100 coming into the country, as opposed to USD 80 on the year prior to controls being implemented.

Since the government sells dollars more cheaply, state finances feel the effects of placing currency out in the market at a cost much lower than its actual value.

Barclays estimates that, since the beginning of currency controls, sales of dollars at such low rates has represented for the government an average cost of 6.8% of the GDP and, in 2012, this figure rose to 10% of the country's GDP.

But there is more. This cost is greater than the average deficit in public accounts of 5.6% of the GDP and has forced a spike in the nation's debt from 2008 to 2012, going from 23% to 51% of the country's GDP.

Under this scenario, Barclays believes that an adjustment to the exchange rate, which since 2010 stands at VEB 4.30 per USD 1, is inevitable though the timing for that adjustment remains unclear as a result of current political uncertainty.

Translated by Félix Rojas Alva
The end of a cycle

Hundreds of thousands of demonstrators took to the streets of Brazil on March 13 to demand the ouster of embattled President Dilma Rousseff, carrying banners expressing anger at bribery scandals and economic woes. A banner read "We don't want a new Venezuela in Brazil."

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