Venezuela taking thorny path in fixing forex rates

www.forbes.com Reuters, 01.29.03, 12:53 PM ET By Susan Schneider

NEW YORK, Jan 29 (Reuters) - Venezuela, in preparing to fix its exchange rate, is boldly going where most of its Latin American neighbors have gone before. But the path is strewn with pitfalls. As a two-month-old general strike gouges oil revenues and ravages markets with uncertainty, the government of Venezuelan President Hugo Chavez has grappled with a plunging currency, an exodus of capital and dwindling international reserves. The shutdown, waged by Chavez's foes to provoke his resignation or new elections, has already forced the embattled leader to import food and gasoline and shutter the currency market. Now, his government is studying the drastic step of fixing the bolivar currency under broader capital controls. "The first impact of this is that it deters foreign investment," said Fernando Losada, senior Latin American economist at ABN-Amro. For local companies "there are going to be controls, there is going to be paperwork, there is going to be bureaucracy. Everything will be much more difficult." Finance Minister Tobias Nobrega said Monday the government was considering a single fixed rate. Government and banking sources said discussions are focused on a single rate lasting four months, adjustable monthly, followed by a dual rate. The move will let Venezuela achieve key short-term goals, said analysts. A mix of capital controls and the fixed currency would help the cash-strapped nation guard its reserves of $11 billion and prevent more cash from bleeding across the borders, until oil output can be converted from a trickle to a torrent. Such steps are probably necessary in the short-term to help keep the government solvent, said analysts. But whatever the final recipe it is likely to take Venezuela on a chaotic and damaging ride, one already blazed and abandoned by much of the region, they added. "The imposition of capital controls for even a day undermines confidence and credibility significantly because it reminds you that at any time, if you've invested in Venezuela, there may be a day when you can't get the investment out if you need to," said Christian Stracke, head of emerging markets strategy at research firm CreditSights. Beyond the battering of confidence, a fixed rate will almost certainly give rise to a black market, opening the door to corruption and inefficiency, analysts said. "Most every country in the region has experimented with these controls and I can hardly think of a case in which it was very successful, ABN-Amro's Losada said. PLUNGING BOLIVAR Venezuela's bolivar, which closed at 1,853 to the dollar before the market was shuttered last week, has slid 28 percent since the strike started. The government and private banks are discussing a fixed rate of between 1,500 and 1,850 bolivars. Although the fixed rate prescription would help halt this slide, the non-oil side of the economy may endure heavy side effects. Oil holds immense sway in Venezuela, providing a weighty one-half of government income before the strike, but other industries count for a key chunk of taxes . Under a fixed rate, exporters would probably underinvoice shipments in order to take advantage of the better black market rate, while importers would likely overinvoice their products to take advantage of a lesser, official rate, analysts said. "It creates a lot of distortions, corruption and confusion, especially at the customs level," said Siobhan Manning, Latin American debt strategist at Italian investment bank Caboto. The system would also hit consumers, said analysts. The government would likely use the dollars it has to import essential goods like food or medicine while prices of non-essential imports would likely soar. "The non-oil sector has already suffered through high political risk, which has curbed investment and created so much uncertainty that consumers aren't spending," Caboto's Manning added. "Then you add in add the market controls and distortions -- it's going to wreak havoc on an already distressed non-oil economy." Economists say Venezuela's gross domestic product, which contracted in 2002 even before the strike took root in December, may post a fierce double-digit contraction in 2003. GOOD FOR BONDHOLDERS, SHORT-TERM Ironically, controls are welcome to Venezuelan bondholders. Capital controls and a fixed rate stand guard over currency reserves, meaning cash to pay foreign debts will not run dry. But the long-term price tag is high, as Venezuela has learned with similar moves in 1994-96 and before. "Venezuelans were already aware that capital controls were a risk and now those fears have been reinforced," Stracke said. "The next time the capital controls are lifted they'll go back to doing what they've always been doing -- whenever possible move money offshore and avoid investing in Venezuela."