Venezuela devaluation: the long and the short of it
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Emerging Markets

Venezuela devaluation: the long and the short of it

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Venezuela devalued its currency just ahead of a holiday. The move will benefit it in the short term but could bring more long-term pain

Venezuela’s fifth currency devaluation in about 10 years was announced last Friday, just before a long holiday weekend that ends on Tuesday evening.

The official bolivar exchange rate – at which importers and travelers can exchange money by applying through a state agency – was devalued by 32% to 6.3 for one dollar from 4.3, starting from Wednesday.

The measure had been expectedand, over the short term, could have positive results on public finances but over the long term it could fuel inflation, already among the highest in the world.

As underlying issues have still not been resolved, this is unlikely to be the last time Venezuela devalues its currency, various analysts said.

The central bank also announced that it would stop selling dollar bonds in the secondary market (Sitme) as a way to provide supplementary hard currency to companies. These transactions allowed companies in strategic sectors to get dollars with an implied exchange rate of 5.3.

The only supply of hard currency to the corporate sector will be dollars sold by the central bank at the official exchange rate through the Cadivi – the official government body which administers legal currency transactions.

“The good news is that the government’s beleaguered finances are set to receive a boost,” Michael Henderson, emerging markets economist at Capital Economics, said.

“Since a weaker bolivar will raise the local currency value of oil revenues, the government will now have more cash. In combination with public spending cuts, announced last week, this suggests a sizeable reduction in the fiscal deficit for 2013.”

Henderson estimates Venezuela’s budget deficit at 9% of gross domestic product for last year.

BOLIVAR STILL OVERVALUED

But the devaluation will not help over the longer term, as it is “unlikely to spark a strong revival in export-led growth” because crude oil – priced in dollars – makes up around 95% of total exports and the manufacturing sector is too small to drive a recovery, he said.

“The key point is that Venezuela’s economy badly needs dollars and the latest measures won’t do much to address the root of this problem,” Henderson said.


“The current malaise is the product of years of capital flight and underinvestment, which has hollowed out the country’s productive base.” Felipe Hernandez, a strategist with RBS, believes that even after the devaluation, the bolivar is still overvalued – by nearly 38% compared with 53% before the move.

No intention to increase the supply of dollars to the private sector at the new official exchange rate was announced by the government and the central bank, which means that companies will still have problems getting the dollars they need to pay for imports or transfer profits and dividends, he noted.

“Unless the government and the central bank increase the supply of dollars or come up with a new foreign currency mechanism to trade foreign currency, the exchange rate in the black market is likely to remain under pressure,” he said.

“Increasing constraints to access foreign currency are also likely to be a drag on economic activity and growth in 2013.”

The depreciation will also have a strong inflationary impact, because around one third of Venezuela’s domestic demand is covered directly with imported goods, which will become more expensive after the depreciation, and about half of domestic demand is covered by products that use imported parts and raw materials.

“In the short term the government is likely to use price controls to moderate the inflationary impact. Price controls are not effective and result in shortages of goods that in the past have forced the government to allow price adjustments,” Hernandez said.

According to various reports, the bolivar trades at around 18 to the dollar on the black market.

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