The twists and turns of Venezuela's economic "policy"

<a href=www.vheadline.com>Venezuela's Electronic News Posted: Tuesday, April 15, 2003 By: VenAmCham

VenAmCham's Jose Gregorio Pineda (chief economist) and Jose Gabriel Angarita (economist) write: Venezuela's economic policy seems to be turning in circles as far as foreign exchange management is concerned. That conclusion springs from statements by Planning Minister Felipe Perez, who announced that the government will return to a band system in the third quarter of the year and will combine that measure with as tax on foreign exchange transactions.

The band system would be very similar to the one applied by the Central Bank (BCV) up to February 2002. A central parity rate would be set, around which the bolivar could fluctuate freely according to supply and demand, subject to daily review and adjustment based on the average market rate in the 45 previous days; the fluctuation limit would be 7.5% above and below the central parity rate. There would be no quantitative restriction on foreign exchange purchases, but there would be a 5% (Tobin) tax on such purchases.

Unfortunately, this return to the band system occurs only after the failure of the floating exchange rate and exchange control arrangements, following a year of high macroeconomic volatility that has yielded Venezuela the worst macroeconomic performance in its contemporary history, in economic growth terms.

The question is whether the authorities can lift the exchange and price controls (and the interest rate controls to be imposed in the near future), since the economy's fragile state would only stimulate the economic agents to seek refuge for their assets in a hard currency like the US dollar.

There is already so much pressure on the economy that this announcement seems extremely difficult to bring to fruition. Though foreign reserves have grown quite substantially during the period of exchange controls, the country's fiscal problems and economic deterioration have been very serious, suggesting that the demand for dollars will surge once the controls are lifted.

It should also be noted that this goal is in open conflict with that of keeping interest rates relatively low; to induce the exchange rate to fluctuate within the band limits it will be necessary to spend reserves and raise interest rates enough to encourage the economic agents to hold bolivares.

Maintenance of relatively low interest rates is of key importance, especially in today's fiscal scenario, since the authorities have been making strenuous efforts to swap bonds nearing maturity and avoid an "unsustainable" spiral of internal indebtedness. To accomplish that, both interest rates and the volume of new borrowing must be lower.

In pursuit of that goal, the Finance Ministry held the seventh internal debt swap auction last Thursday, placing 58% of the offered bonds; it offered 803 billion bolivares and was able to swap 465 billion bolivares of those securities. The most striking thing about the auction is that nearly half the debt was taken up by State agencies; in addition, the average yield on the new securities came to 44%.

There is no question that the intention of lifting the controls and returning to a band system would run up against the obstacle of the country's grave fiscal problems, management of which requires low interest rates. But low interest rates would undermine the band' credibility and might drag the country to a new stage of this economic policy circle in which we would again be offered a floating exchange rate or an exchange control system as a solution to the problem.

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