Revisiting the soaring parallel exchange rate

August 26, 2007

This week the swap (parallel) exchange rate shot up again, closing around Bs. 4,750, roughly 2.2 times the official exchange rate. About two weeks ago I wrote that the only way for it was up and indeed it has done that at a very fast clip since then.

People are constantly surprised that this can be so. They think that given the difference between the official and swap rate, it should not go up so fast and that given the Government’s resources, it will intervene in the market to make the rate drop.

This is all wishful thinking, there are both short term and long term conditions all pointing at the parallel rate continuing to shoot up and except for one or two measures, there is not much the Government can do at this time. This is the history of exchange controls in Venezuela: It all works at the beginning and slowly controls break down until they unravel.

Let’s look at the short term and long term reasons for the rise, looking first at what has made the swap rate move up from around Bs. 4,100 at the beginning of August to the current value:

The recent rise can be explained by some short term pressures on the swap market:

–Since June 1st monetary liquidity has jumped US$ 5 billion to US$ 59 billion , adding pressure to the parallel market

–The Government announced that it would sell some US$ 1 billion in structured notes to local financial institution in the next few weeks. As far as anyone has been able to determine only US$ 200 million was sold. many operators in the swap market were short (sold dollars they did not have expecting to buy them cheaper) awaiting for these sales to drive the rate lower.

–The Government announced the Bono del Sur III, which made many investors either wait for the bond before buying or go short. Since the bond had to be canceled or postponed this drove the swap rate higher. Until world markets stabilize this bond will not come to market.

–The final force driving the swap rate higher was the fact that part of the failure of the Bono del Sur III was that the bolivar part, the so called TICC’s, dollar denominated bonds which trade in local currency, was due to the fact that these bonds were part of the foreign currency quota banks may have. The Central Bank issued a resolution in the 16th. saying this is no longer the case. Since many banks had TICC’s as part of their foreign currency portfolios, after the resolution came out they went to the swap market to buy more foreign currency to replace their TICC’s in their quotas.

–The proposal for Constitutional Reform unnerved many investors because of the removal of the independence of the Central Bank, which will have a direct impact over the long term value of the exchange rate and the threat to private property rights.

Longer term, it is hard to believe the swap rate can have a significant drop and all signs point towards much higher rates before the end of the year. Among them:

–The Government’s ability to absorb monetary liquidity is now limited due to the high Government spending. Two years ago a US$ 3 billion issue would remove 10% of that liquidity, today it requires US$ 6 billion to have the same effect. Moreover, liquidity should keep going up the remainder of the year as the Government will certainly maintain its high spending (the only policy that can slow the growth in monetary liquidity) at least until the approval of the referendum for Constitutional reform.

–International reserves have not gone up much since March due to the high ever of imports as well as the fact that the more than 100% difference between the official and swap exchange rates creates many opportunities for arbitrage. The numbers are becoming staggering: Imports will be US$ 45 billion for the year and the US$ 3,000 per citizen for purchases via the Internet is becoming a huge source of corruption. People are paid to request these dollars which are then sold in the parallel market at a hefty profit. Just think if five million Venezuelans request this allocation, that alone represents a drain of US$ 15 billion in international reserves. In addition people get US$ 5,000 for travel per year and airline tickets are paid at Bs. 2,150 per dollar. After three years of a constant exchange rate and internal inflation near 20%, traveling at the official rate of exchange seems very cheap.

–The approval of the new Constitution and its consequences will keep the pressure on the rate till the end of the year, as the uncertainties mentioned above on the Central Bank and private property will make people and corporations seek refuge in foreign currency.

–Monetary reconversion, the new “Bolivar Fuerte” coming into effect on Jan. 1st., is also a source of concern. Since nobody believes that just removing three zeros from the currency will stabilize the currency, people suspect that there is an ulterior motive behind it, a devaluation of the currency being the most likely suspect. The Government denies any devaluation is in the cards at least until 2009.

–There are no incentives to save in local currency since interest rates are deeply negative. Inflation is running near 20% and a bolivar denominated Government bond offers at most 9%, while a PDVSA dollar denominated bond gives you a 10% yield.

–There are incentives to borrow in local currency and either buy durable goods imported at the official rate or to buy dollars and wait for the parallel rate to devalue further.

Of course, according to the President of the Finance Committee of the National Assembly, there is no problem. This is all part of the “new financial architecture” of the revolution. According to him, economics is an evolving subject where you can innovate and create new ways of doing things and the robolution is simply getting rid of the IMF paradigms such as the independence of Central Banks. I guess he thinks he can do away with other paradigms, such as inflation being a monetary phenomenon and exchange controls working with a parallel rate which is more than twice the official exchange rate.

He is in for a big surprise!


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