What the strong devaluation of the Venezuelan currency says about the economic situation in the country

  • Angel Bermúdez – @angelbermudez
  • BBC News World

6 hours ago

Credit, Getty Images

photo caption,

In just three days, the Venezuelan currency lost almost 25% of its value against the dollar.

Dominated by swings in oil prices for decades, the Venezuelan economy feels like a roller coaster ride, with constant upheavals and countless bumps.

This roller coaster suffered a dizzying downward movement in 2013, which caused the country’s Gross Domestic Product (GDP) to shrink by about 80%.

Venezuelans then began to live with prolonged hyperinflation. Its currency, the bolivar, became worth more as paper for crafts than as a means of payment.

The bolivar that Venezuelans have always known – which had been devalued during the government of former President Hugo Chávez (1954-2013) and renamed the bolivar forte – has been transformed into the sovereign bolivar (in 2018) and digital bolivar (in 2021). In all, 14 zeros were cut along the way.

Despite everything, good news has started to emerge about the Venezuelan economy in recent times. The country emerged from hyperinflation in December 2021 and began to increase its oil production (which had returned to mid-century levels). Experts and international institutions even predicted GDP growth in 2022, in different percentages.

But a fundamental change was one of the factors behind these improvements: the informal dollarization of the economy.

Since Chávez established the exchange control system in 2003, the use of foreign currency in Venezuela has been repressed by the government and has even been considered a crime.

But, forced by circumstances, the government of President Nicolás Maduro revoked in 2018 the Law on Illicit Exchanges, to allow the use of the dollar in Venezuela.

The move meant an important change. Businesses, merchants and people with access to foreign currency could now start working and plan their operations based on a more stable currency, which was virtually impossible with the bolivar facing inflation levels that in 2018 reached 130,060.2% , according to official figures from the Central Bank of Venezuela (BCV).

That is why, in recent times, the Venezuelan economy has started to recover, albeit in an incipient way. There were people – some ironic; others didn’t – who summed up the situation in an exaggerated phrase: “Venezuela got ready.”

Until, in the midst of this apparent tranquility, the roller coaster of the Venezuelan economy surprised again by registering an abrupt devaluation of the currency, of almost 25%. The official dollar was quoted at 6.28 bolivars on August 23 (Tuesday) and changed to 7.83 bolivars per dollar just two days later, on Thursday, August 25.

In the parallel market, the devaluation was even stronger. In the same period, the dollar went from 7.04 to 9.33 bolivars – a variation of almost 33%.

This huge swing alarmed Venezuelans. Maduro even posted a message on Twitter urging his followers to fight for economic stability.

But what is behind this strong devaluation of the Venezuelan currency?

No foreign exchange reserves

Financial analyst Orlando Zamora, who was head of the currency risk analysis division at the Central Bank of Venezuela, believes the sharp devaluation was caused by several factors – among them, the depletion of Venezuela’s foreign currency reserves.

Credit, Getty Images

photo caption,

The Venezuelan currency has changed its name and denomination, but it continues to lose value

Zamora says that, shortly after the devaluation, the BCV was flexible and reacted to the law of supply and demand. Therefore, he assures that many people believed that the official dollar would have its true market value and that the parallel market would cease to exist.

But the BCV later began to apply an anchoring policy to try to contain the bolivar’s devaluation. This attempt meant that the Central Bank had to constantly intervene in the market, selling dollars from its reserves to satisfy the growing demand for the US currency. Until your resources were reduced.

“The Central Bank’s reserves are more than US$ 5.1 billion, but about US$ 4.8 billion of that amount is in gold. Therefore, only 16% is left in cash – and it would have to be seen if all this amount is negotiable, as it certainly includes hard-to-negotiate bonuses”, explains Zamora.

“The BCV had to ‘burn’ its reserves to be able to offset and maintain this policy of supplying foreign exchange to the market. [meta para a taxa de câmbio] it’s almost impossible.”

“This policy did not work because the Central Bank overestimated its ability to control the market, despite the serious problem of not having reserves with liquidity”, he says.

Company adjustments and claims

Professor Leonardo Vera, head of the Faculty of Economics at the Central University of Venezuela and a member of the country’s National Academy of Economic Sciences, believes that the August “currency crisis” is a reaction to the depletion of foreign currency reserves and the increase in the of bolivars put into circulation by the authorities in response to workers’ demands.

Vera explains that the Maduro government had been applying a kind of undeclared anti-inflationary policy, which consisted of three measures:

  • The increase in compulsory deposits (amount of money from savers that banks cannot lend, which currently stands at 73%, restricting the credit market);
  • The dollar anchor;
  • The freezing of the minimum wage.

Vera points out that Venezuela had been raising the minimum wage every three months due to inflation, but the increases were suspended between May 2021 and March 2022.

“The government decided to give a big increase because there was a lot of inflation accumulated since May of last year”, according to him. “That is, the system has been broken.”

The professor explains that, when Maduro decided to raise, the minimum wage had dropped to less than US$ 2 (about R$ 10.40) per month. The increase was 1,705%, but the minimum wage is now only about US$ 28 (about R$ 146) per month.

In parallel with the increase in the minimum wage, the government tried to contain payments to civil servants. To this end, the National Budget Office (Onapre, for its Spanish acronym) issued an instruction reducing the payment of bonuses to civil servants in addition to salaries. These bonuses typically represent an important part of employee income.

Sale of hot dogs in Venezuela, with prices in bolivars and dollars

Credit, Reuters

photo caption,

Dollarization in the Venezuelan economy is widespread

Vera points out that this determination reduces many of the benefits obtained by workers through collective agreements.

The policy has led to an increase in labor protests, which have recently reached their peak. That’s when the government tried to split the payment of bonuses, traditionally paid to civil servants in July of each year. According to Vera, they represent about three months of salary.

This measure generated a large wave of protests, which led the Maduro government to honor its financial commitments. Bonuses were paid to civil servants in the week before the recent currency devaluation.

“Many of these people went to the banks to buy dollars, but there were no dollars [à venda] because the BCV was not offering it”, explains Vera.

“With that, they went to the parallel market, which could not withstand the pressure and began to rise significantly – which makes the BCV also react, increasing the official exchange rate because, if it allows the difference to become too large, the stampede will be bigger and bigger.”

The expert explains that this episode is a “clear and faithful” demonstration of the distrust that Venezuelan citizens have for the country’s currency. According to him, this is the main problem exposed by the devaluation of the bolivar in August.

Orlando Zamora points out that social pressures led the government to relax the fiscal discipline that had been applied. In financial terms, these measures generated an increase in the amount of bolivars in the economy – which, in turn, pressured the dollar exchange rate.

“The enlarged monetary base [dinheiro emitido pelo BCV + dinheiro secundário criado pelos bancos na concessão de crédito + todo o dinheiro disponível entre os cidadãos] was 4.814 billion bolivars (about US$ 626 million or about R$ 3.255 billion) in March 2022 and by the end of August it had reached 11.091 billion (about US$ 1.442 billion or about R$ 7, 5 billion). It grew 2.3 times in just five months,” he says.

The limits of recovery

The recent devaluation of the Venezuelan currency will have as a consequence the increase in inflation that the country has been registering in recent months – and which already placed Venezuela among the five countries with the highest inflation on the planet.

Leonardo Vera warns that this will have an impact on the population, as not all social groups have the same ability to protect themselves from inflation, which can reduce citizens’ purchasing power.

For him, “this is bad news for companies and, of course, for an economy that is now starting to recover from a great depression”.

Workers' protest in Venezuela

Credit, EPA

photo caption,

Government restrictions on wages generated a wave of protests in July and August of this year.

In addition to these more concrete and immediate effects, Vera believes that this episode shows the importance of quickly reducing inflation to single digits when applying an anti-inflation program like the one in Venezuela, since restrictions on the legal reserve, exchange rate anchoring and payment of wages have consequences for the economy and need to be temporary.

For him, the underlying problem is the lack of confidence in the Venezuelan currency and in financial and foreign exchange institutions. The Maduro government has not yet put in place a strategy to deal with this issue.

Orlando Zamora believes that the process of devaluation of the Venezuelan currency will continue.

“It’s a situation that, for me, is irreversible,” he said.

“I believe they will have to let the bolivar fall against the dollar. It is possible that the exchange rate will stabilize, but all the causes and factors that led to this collapse situation remain.”

Zamora says that, at the height of the pandemic, the economy was more paralyzed and the BCV was able to regulate this smaller market more efficiently. But with the incipient resumption of economic growth, the strategy collapsed.

For him, “the adjustment plan that was being carried out broke down and [com ele] the expectation that there was about the recovery, the control of inflation, because, for everything that happened, there was a very relative success, between many quotes”.

Zamora adds: “Are we going to guarantee the success of this plan, will inflation be kept low? Certainly not, because the usual problems, such as the growth of inorganic money, low production capacity, dependence on imports, all these factors persist and will continue to generate this pressure on what is vital for the economy, the dollar, because it is a clearly importing economy”.

“If this situation persists, the roller coaster of the Venezuelan economy could take new unexpected turns.”

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The article is in Portuguese

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