Expropriation threat: employees of the Exito hypermarket in Caracas and supporters of Hugo Chávez express support for the presidents decision to take over the chain
"The devaluation provides a short-term fiscal windfall but it does not solve the underlying economic models propensity to throw up distortions," says Stuart Culverhouse, head of research at investment banking boutique Exotix. "If serious changes arent made to the fiscal spending regime and monetary policy isnt tightened then a devaluation will be necessary again in a few years to keep the country going." This was the third devaluation since 2003, when Venezuelas president, Hugo Chávez, introduced controls to prevent capital flight.
Last month Chávez announced a move to establish a dual currency and effectively devalue the bolivar. This announcement was followed with threats that any business that tried to increase prices in response would be at the mercy of government troops. "I want the national guard on the streets with the people to fight against speculation," said Chávez during his weekly radio show on January 8. "Go ahead and speculate if you want, but we will take your business away and give it the workers, to the people."
The president hopes the move will contain new inflationary risks. Morgan Stanley expects inflation to reach 40% in the coming months, up from 25.1%, a shift that will hit Chávezs key support group the poor.
But as Steven Zausner, an analyst at CreditSights, says: "Dual subjective exchange rates, this is pure crazed genius."
Although announcing a second peg that is 50% below the existing rate seems odd, it eases the governments need to raise debt in the short term.
The exchange rate for key imports such as food, medicine and heavy machinery will be Bs2.60 to the dollar. Capital controls will remain in place.
the black market exchange rate
"Effectively the government is imposing a tax on imports and consumption," says Zausner. "The low exchange rate on basic goods acts like a subsidy, which in theory is paid for by the high rate on non-essential goods. The same result could have been achieved with the more traditional but probably less politically palatable alternative of just raising taxes."
Some believe the move was also inspired by the situation at state-owned oil company PDVSA. For the first half of 2009 its net income dropped 67% year on year to $3.17 billion on the back of lower oil prices and output. But now PDVSA will book its petrodollar gains at the 4.30 rate, thereby doubling its profits. The companys revenues, which stood at $32.5 billion as at June 30, fund about half of the national governments budget.
"In an election year we dont expect a lot of fiscal discipline but some of that money could be actually used to pay down the countrys growing budget deficit and allow PDVSA to pay off debts with foreign contractors," says Zausner.
Whether the money will go to anything beyond Chávezs social spending remains unknown but Venezuelan stocks and bonds rallied on the news.
The news is not so good for the US and European companies that do business in Venezuela. The shares of cosmetics company Avon plunged 2% since its Venezuelan operation had up to $135 million in local currency. Other consumer names, such as Colgate-Palmolive, Procter & Gamble and Heinz, are reassessing the situation before taking action.
But in the long run it looks as if there will be no winners from this devaluation.
"I want the national guard on the streets with the people to fight against speculation. Go ahead and speculate if you want, but we will take your business away and give it the workers, to the people"
But in Venezuela the chance of Chávez reversing this measure in the foreseeable future seems slim and so rising inflation is unavoidable. "Social spending is essentially a tool to shore up political support, so reversing this dual-exchange-rate measure, which has provided a windfall of much-needed cash, is very unlikely," says Culverhouse. "This is a government that has built its credibility on the Bolivarian revolution so they arent about to change their fiscal spending ambitions."
In the days following the dual-currency move, the energy minister announced plans for rolling blackouts as the energy grid continued to fall short of supply demands. After uproar, Chávez reversed this decision. However, it seems to be only a matter of time before the power grid fails completely. Walter Molano, head of research at BCP Securities, thinks this could be the end of the line for Chávez. "Like a cat, it always seemed as if he had nine lives," he says. "But Chávez is running out of lives, and the countrys situation looks bleak."