Archive for January 3rd, 2011

More on the Venezuelan devaluation

January 3, 2011

When the Government decided to unify the exchange rate last week, it did something that was necessary, but at the same time it is an isolated measure that in the end does little if nothing else is done to the economy. As I have said too many times, the problem is that the Government has established so many controls of the economy, that everything is distorted and when you touch one of these distortions it reverberates negatively throughout the economy. This devaluation from Bs. 2.6 to Bs. 4.3 is one more example of that.

The Venezuelan economy contracted 1.9% in 2010, after shrinking by 3.3% in 2009. Think about this, it is eight consecutive semesters of contraction, this is a long recession by any standards and there seems to be no end to it.

The problem is in part that there are no real economists running the show. Thus, the plans and decisions which are made are simply stop gap measures to what the Government perceives are the problems. And for the Government this means spending, that is all that it seems to be focused on all the time.

But think about it, oil prices are near $80 for the Venezuelan oil basket and the Chavez Government does not have enough money to live on. And with stagflation destroying productivity, the Government decides to increase the VAT, reestablish a financial transaction tax and devaluing the rate from Bs. 2.6 to Bs. 4.3, which applied basically to food and medicines.

Jeez, if that is loving the poor, they are getting too much loving from Hugo and Giordani, because all of those measures happen to hurt the poor the most.

-The VAT is a great tax to collect for the Government, but since the poor spend all their money, it is a tax that gets them the most.

-The Financial transaction tax is only applied to those that have bank accounts, which does not include the poor, but it is a cost that will be translated into inflation.

-The 65% increase in food and medicines impacts the poor the most, as they spend more of their income on food than anything else.

-The gasoline subsidy benefits the rich the most. By now gasoline is essentially free, for $1 you can fill your tank in Venezuela (and that includes a tip too)

The devaluation is estimated will give the Government about Bs. 13 billion in additional income, about US$ 3 billion, but it could have achieved more by adjusting gasoline prices at the same time. Doubling the price of gasoline from Bs. 0.1 to Bs. 0.2, i.e. from nothing to nothing, would have given PDVSA US$ 1 billion in additional income, but would have had much less inflationary impact on the poor.

Because in the end it is a strange devaluation. It moves the Bs. 2.6 to Bs. 4.3, but PDVSA changes more of its currency at the higher rate. Thus, it generates fewer new Bolivars for PDVSA, while making it more expensive for the Government to subsidize the imports. Why not do a little of everything? Why not slide the others? Or eliminate the Bs. 4.3 and have all go trough SITME at Bs. 5.3? I guess it’s too moo much to ask of the current financial authorities to show some coherence.

But in the end, the problem is that all of the announcements are fiscal measures that benefit the Government, but there are no announcements that help improve salaries, productivity, restore confidence, reduce gas consumption and/or attack the basic distortions in the economy. So, you have the worst of shock therapy to the economy, without doing anything constructive.

The only sector that benefits from these measures are local producers, who will be able to compete with imports that were being subsidized. This will be a good year for them. Their problem is that the Government is unlikely to increase prices instantly. It will likely drag its feet for two or three months trying to delay the spike in inflation or at least spread it around.

Exporters, despite claims to the contrary are indifferent to the devaluation. They have received the higher Bs. 4.3 rate since January 2010, despite which non traditional exports did not go up in 2010.

In part the problem is that the government does not even seem to remember why it imposed exchange controls. In its control mindset, it does not even consider eliminating it, which would in the end boost the economy after the initial impact. The current system of controls is costly, time consuming and creates arbitrage opportunities (which are reduced by the recent devaluation). Simply the changes in rules, delay investment and decisions. It is preferable to have a single exchange rate and find ways of subsidizing those that really need it.

The Government loses credibility when it says that this devaluation will have little impact on inflation. over 70% of imports were made in 2010 at the lower rate of Bs. 2.6 per US$. If the Government does not allow price increases, there will be shortages, but it should not delay the approvals, they will go against is goal to get the economy moving.

I still think that 2011 may yield another negative GDP year. The wild card as usual is oil, which may move to $100 per barrel and stay there. Even then growth will be anemic, inflation will top 30% and in the middle of another oil boom, the Venezuelan economy will continue to be one of the worst ones in the world.

And guess who is to blame for that?