Foreign exchange shortage is an indicator of economic imbalance

By El Universal:
Published: Monday, June 14, 2010

In the past five years, a parallel foreign exchange market coexisted with the official exchange rate controlled by the Foreign Exchange Administration Commission (CADIVI). In this unofficial swap market, companies and individuals bought US dollars without any restrictions because the government injected foreign currency into the unofficial market through the issuance of bonds. However, this system came to an end and has exposed Venezuela's economic imbalances.

Hugo Chavez' administration supplied foreign exchange to the swap market after placing $31.24 billion in bonds that companies and individuals bought in Venezuelan bolivars. However, in the process, Venezuela's debt increased from 28.14 billion to $61.62 billion. Therefore, the government was forced to "close the tap."

The Central Bank of Venezuela has taken control of the foreign exchange swap market by restricting the amount of foreign currency that companies and individuals can purchase. Further, authorities are forcing private and public financial institutions to sell bonds that only represent $2.7 billion, while in 2009 the Executive Branch of government and state-run oil company Petroleos de Venezuela provided $9.67 billion.

The Venezuelan economy faces a sharp rise in US dollar demand and restrictions on supply. Companies and individuals seek to protect themselves through the purchase of foreign exchange amid a political climate characterized by uncertainty and a high inflation rates that dilutes the purchasing power of the bolivar and is not offset by the interest rate that banks pay to investors.

At the same time, analysts and reports issued by investment banks such as Morgan Stanley and Goldman Sachs consider that the declining domestic industry encourages imports, while the exchange flow stalls due to the volatility of oil prices, production problems in PDVSA and the fall of non-traditional exports.

Overvaluation

Between 2005 and January 2010, the government's economic cabinet set a fixed exchange rate for the US dollar, even though Venezuela recorded an inflation rate considerably higher than its trading partners. As a result, the Venezuelan currency in highly overvalued, that is, the imported products are much cheaper than domestic products. The government, affected by such imbalance, devalued the Venezuelan currency on January 8, 2010, but the crisis persists.

In a report dated June 11, Barclays Capital said that the new system to sell currencies set by the Central Bank has a very fragile viability because the government of President Hugo Chavez has tried to maintain an exchange rate "significantly overvalued" amid an environment with a large demand of US dollars "due to the instability created by expropriations."

According to the calculation model of the international investment bank Barclays Capital, the Venezuelan bolivar is overvalued by 41.2% and the official exchange rate should be Bs.F 6.1 per US$ to reach a balance.