Archive for October 19th, 2011

Why The Incoming Venezuela President Should Remove Exchange Controls Fast

October 19, 2011

Over in Caracas Chronicles, I have been having this discussion with Juan N. about exchange controls and their possible removal. Basically, one of the candidates, Henrique Capriles, said twice in one week, that he would not remove exchange controls. In particular, he told El Mundo something like: “En este momento, no estan dadas las condiciones para remover el control de cambios” (At this time, conditions are not given for the removal of exchange controls)

I did not like this statement for a number of reasons. First of all, there are so many specific proposals he could make, why choose this topic to be specific, in the absence of others. On top of that, thing could be better or worse i January 2012, the fact that his mind is set worries me.  Second, because keeping exchange controls is the easy way out, the typical trap of “I will remove them slowly”, “I will remove them later” and their many variations. But in the end it is a trap. There are so many political consequences to removing exchange controls, that they become impossible to remove after a while. But I think they should be like the proverbial band-aid removal: Do it all at once, fast and speedy.

There is never an ideal moment to remove exchange controls.

Rather than continue the discussion with Juan over there, then let me outline my thoughts here for all to argue and destroy what I say. I am, after all, not an economist.

My first argument for the removal of exchange controls is very simple: Exchange controls represent today the biggest source of corruption and graft there is in the country. A whole system of approvals has been set up and we have no idea why some requests in CADIVI are approved and others are not. To say nothing of bond offerings with huge profit margins, CADIVI cupos, “remesas” to family members and the like all of which generate an industry of people benefiting at the expense of the remainder of Venezuelans. Arbitrage has become a way of life in Venezuela, if you can get at it.

Doing away with controls will wipe all of this insanity. Instantly.

But there is more. When you go to a store and buy a computer, for example, that company probably obtained dollars at Bs. 4.3 per dollar, but you have no clue if they did. In your mind, you are thinking about prices in the context of that now non-existing exchange rate which was forbidden a year and a half ago. Or think about what happens when you get a bottle of wine: How do you differentiate between the wine imported by that large company, which is given no CADIVI dollars or that imported by the small company which needs less than US$ 300,000 a year and can thus bring things in via the Central Bank’s SITME system at Bs.5.3.

The fact that you can’t tell at what price the dollar was purchased at from the Government,  turns into obscene profits for someone, whether the wine seller, the laptop seller, the camera seller or the whatever seller. By keeping exchange controls, you keep these so called arbitrage opportunities all over the economy.

There is a vast sector of the economy that lives off this arbitrage. You think you are getting a great deal buying something and the seller is making a mint, because the dollars were bought at Bs. 4.3 (CADIVI), Bs. 5.3 (SITME) or they were obtained at around Bs. 6 from one of the Bs./US$ local bond issues. Some food even importers bring in the food, over bill and don’t even bother to sell the food, with the over billing they already made a lot of money.

All of that has to go.

Think for a moment, you are assuming the Presidency of a State that has been destroyed. There are no checks and balances. No controls. If you keep the current system in place: Who are you going to trust to control the myriad requirements, steps, approvals and the like that are built into the system? It is simply impossible, you are trying to play a game you can’t possibly win.

Then there is the problem of competition. It is very difficult for local industry to compete with 30% inflation year after year, with imported products at the official rate of exchange. Thus, by allowing for the differential, you favor foreign producers. Think chicken producers, for example, in 2002 with the dollar at Bs. 1.6, a Venezuela chicken producer competed with that dollar. Since then, assume 25% inflation per year, if he could compete then, his costs are now, if we adjust them for inflation, at Bs. 11.9 per US$, while imported chickens are being brought in at Bs. 4.3 per US$. This guy can’t possibly compete with this. This happens everywhere, this is why local production has been destroyed over the last few years.

The problem in removing controls is three fold: Where will the exchange rate go, where will the inflation rate go and will international reserves be depleted. Let’s take them one at a time:

The Exchange Rate

The number of Bolivars available in the Venezuelan Economy is well known. Go to the BCV’s Indicadores page, go to Agregados Monetarios and download the Liquidez Monetaria spreadsheet, the latest number says M2 is Bs. 364 billion. Since International Reserves are at US$ 30.4 billion, then if the first day ALL Bolivars were exchanged for dollars, you would have to set the rate at Bs. 11.98 (Funny how close that comes to the chicken rate above, no?)

That’s the upper limit, the maximum rate which it could possibly go to if all Bs. fleed the country day one.

But the Government has many mechanisms to control this. First, 14% of all the deposits in the banking system are in the BCV, say the banks can’t get them for three months. Second, 35% of all deposits or so (Haven’t seen the numbers recently) are “official deposits”, prohibit all Government institution without Cabinet approval from buying dollars. See that rate coming down fast already?

In fact, if 50% of the goods are imported at Bs. 5 and 50% at whatever the forbidden rate is, the average is not Bs. 11.9, but something like Bs. 6.5 or Bs. 7.

Given that the Chavez Government just went from Bs. 2.6 to Bs. 4.6, is that jump so huge in order to eliminate, corruption, arbitrages and distortions? Or to help create a healthier economy?

I think not. The benefits outweigh the initial negative impact of the measure.


Yes, that is where the problem is. You devalue, you create inflation. In fact, Giordani has been trapped in this labyrinth for a few years. He devalues, but he does not allow prices to rise and inflation just stays at an unacceptable level. Because he is simply delaying the adjustment. He (and Chavez) would be better off allowing a big jump in inflation and then prices would come down. Inflation only stays at 25-30% because increases are repressed.

In fact, this is what happened under Caldera, when he devalued from Bs. 290 per dollar to Bs. 530 per dollar in April 1996 (and the rate went quickly down to Bs. 460). Inflation in January 1996 was running at 8.11% per month with exchange controls in place. Controls were removed in April, inflation jumped to 12% in May, was 7.1% in June, but then dropped and none of the second six months of the year were above the first six. Inflation went down!

And it was not that different in 1989 when Carlos Andres Perez devalued from Bs. 14.5 to Bs. 45. Inflation was running at 6.8% in December before CAP even suggested he would devalue. Yes, it jumped to 21% in March and 13.5% in April, but after that it began dropping like a stone and closed the year at 1.33% for November and 1.74% in December 1989.

The problem is, of course, how to mitigate the impact of that devaluation on the people and the jump in inflation. There are two ways. One is to allow the currency to float for everything, but subsidize individual food items. The second is to take a big chunk of the money saved from direct aid to Cuba and give it to people directly. Say you take US$ 3 billion and give every Venezuelan with a cedula US$ 100 to compensate the peak in inflation in February and March 2012.

What happens to International reserves

There will be a drop. There is a lot of money repressed currently in the economy. Companies have not been able to repatriate dividends for years. There is pent up demand from individuals. But there will be savings also. The number of people traveling will go down*, it will no longer be the bargain it is at Bs. 4.3 per US$. The same with “remesas” and the large number of people who are studying abroad because it is cheap. But maybe you can create tax incentives so that companies don’t repatriate it all.

But parallel funds like Fonden will be gone, that should add to reserves about US$6-7 billion per year, so will savings from aid programs that never collect payments, to say nothing of Chavez’ largesse giving money away. Venezuela can also go to multilaterals and ask for money for specific projects. With the infrastructure decimated, there should be plenty of projects to get financing for. CAF pledged Peru’s elected President US$ 7 billion in loans, how much should Venezuela under a new Government get?

Just remember, in 1989, Venezuela pledged part of the gold to have cash in an emergency when exchange controls were removed. The loan was for all of US$ 100 million and was actually never needed. At the time liquid reserves were practically zero and the devaluation was from Bs. 14.5 to Bs. 45. Going from Bs. 4.3 to Bs. 9 initially should not be as painful this time around. And the rate will drop to below Bs. 8 fast, just watch.

And may be we can start building a healthy economy without distortions from there.

* Want to go to Europe cheap? If you have a friend in Caracas, have them buy a Miami/Madrid/Miami flight at Bs. 4.3 to the US$ with American/Iberia…