Venezuela Currency Devaluation Sends Shock Waves Through Economy

From Financial Times

The sharp devaluation of the Venezuelan bolivar decreed last week by the government of President Carlos Andres Perez is sending shock waves through the economy, which relies heavily on imports.

Prices for many goods and services are rising steeply, and the economy will most likely suffer a substantial contraction this year, after registering a 4.2% increase in gross domestic product in 1988.

Most car assembly plants have closed down temporarily and many other companies have curtailed operations until they work out plans for coping with the new situation, especially in terms of financing imports and servicing foreign debt under the new foreign exchange system.

Many companies will be forced into severe financial straits, or even bankruptcy, by the new exchange policy, which has almost doubled the local-currency cost of imports.


The government, concerned at the dismissal of an estimated 10,000 private sector workers in recent weeks, with the prospect of more to come, ordered a 120-day freeze on dismissals only 1 day after the devaluation took effect. This and other recent social welfare moves may mean the government is not willing to permit a socially and politically painful restructuring of the Venezuelan economy.

The recent devaluation is part of a general economic program announced by the government on Feb. 16 that includes removing most controls on prices and domestic interest rates, reducing tariffs attempting to lower the government’s fiscal deficit.

The new exchange policy eliminates a dual-rate structure under which Venezuela had an official exchange rate of 14.5 bolivars per U.S. dollar and a free market rate. It establishes a system whereby a single, floating rate is set during daily free-market trading at commercial banks and exchange houses.

Although the government has not made the situation entirely clear, it appears that the floating rate will apply to all but a handful of international financial transactions. This means that it will cover all imports, public- and private-sector foreign debt of $33 billion and a big share of $6 billion in outstanding letters of credit owed by Venezuelan importers.

Contrary to the expectations of many, the bolivar has strengthened since the devaluation was decreed last week, moving from just over 40 per dollar to 36.3 at close of trading on Tuesday.

The old official rate was used for most of the country’s international transactions, including imports (around $11 billion last year) and foreign debt repayments. The impact of eliminating this rate is great, since the country must import most of the raw materials and components used by industry, as well as around half of its foodstuffs.

In addition, a devaluation penalizes importers financially while it rewards exporters, and in Venezuela the government is by far the top exporter. In 1987, for example, private-sector exports were only 5.4% of the country’s total exports of $10.6 billion, while private companies accounted for 77% of total imports of $8.8 billion. The situation was not much different last year.

The new exchange rate system should spur investment in non-petroleum exports, but the process of converting Venezuelan industries into exporters on a substantial scale could take 3 years.


Before most private companies even consider the possibility of making new investments for export business, they must grapple with a variety of serious problems directly related to the devaluation, such as outstanding foreign debt, letters of credit and a domestic market reacting to sharply higher prices.

Repayment of over $6 billion in letters of credit, for example, presents a dilemma above and beyond other existing obligations to foreign banks.

Until the March 14 devaluation, the government had guaranteed foreign exchange to private companies at the official exchange rate of 14.5 bolivars per dollar to settle letters of credit. Now, however, under a new government scheme, only a portion of outstanding letters will receive foreign currency at the old rate.

The president of a big vehicle assembly plant said privately that the industry had about $700 million in outstanding letters and that the government plan meant they would get around 40 cents on the dollar. Losses for this sector alone, a major employer, will be huge, and some foreign companies may be forced to leave the country.


As the effects of this devaluation begin to be felt, business analysts in Caracas are concerned about two other key factors.

Last week’s devaluation is part of an economic adjustment plan, worked out by the government and the International Monetary Fund, meant to let Venezuela develop a more competitive economy with reduced government intervention.

But the government, traumatized by riots 3 weeks ago and worried that higher prices and joblessness could provoke another social explosion, is maintaining some of its paternalistic tendencies. It is trying to cushion the effects of the program for workers by establishing obligatory private-sector wage increases and by offering a range of costly new social welfare benefits. In addition to several socially minded measures already announced, the administration is rumored to be contemplating a job-creation program to keep unemployment down in a country where it has been traditionally low.

But the economy will hardly become more competitive if widespread bankruptcies occur over the next 2 to 3 years, and the only private companies rich enough to pick up the pieces are the existing oligopolies that already control big sectors of Venezuelan industry and commerce.