Venezuela, you have a (serious) problem.

Venezuela, you have a (serious) problem.

By The Photographer (Own work) [CC0], via Wikimedia Commons

By: Shaan Fye, Editor-in-chief

Venezuela isn’t doing so well these days.

Shortages across almost every category coupled with domestic upheaval and an oil/government-imposed recession don’t bode well for Nicolas Maduro’s regime, a less polished, less charismatic, and less lucky extension of the late Hugo Chavez’s. The myriad problems the troubled economy is suffering from are rooted in a few core issues, the most prominent of which is currency controls. These controls, imposed in 2003 to help restrict capital outflow from the rapidly less legitimate Venezuelan economy, promise to hamper the country in these problematic days.

Unlike most other global currency arbiters, Venezuela’s government has not allowed their currency, the Bolivar, to float freely. In a tiered system, the currency has been systematically overvalued by the government, encouraging a huge divergence in black market rates. Officially, the government has authorized a 3-tiered official exchange system, 6.3, 12 and 172 bolivars per dollar. The lower the rate, the more harmful it is to the foreign exchange reserves of Venezuela, as the government has to shell out more valuable dollars for each bolivar than the currency is actually worth. Regardless, to stem further inflation, the lower two rates theoretically are used, with a go-ahead by the government, for items like food and medicine. The higher rate, only recently announced to combat the black market, will be for all the remaining unauthorized dollar-seekers.

Unfortunately, even the highest official rate doesn’t mirror the black market rate, 190 bolivars per dollar. For the past several years, as dollars on the official rate have become harder to get, the black market has exploded. For workers paid in dollars, exchanging their income for more bolivars has proved to enrich them in the suffering country. For most, however, their meager bolivar-based salaries have not changed, even in the face of rampant inflation on consumer staples. Owing to the extraordinary difficulty citizens have exchanging their currency officially, most write-off the loss and simply exchange on the black market.

Business-wise, the currency decline has forced companies to revalue their assets, leading to significant balance sheet losses for multi-national firms. Due to the unrealistic possibility of actually repatriating the company’s revenues and asset sales at the official dollar conversion rate, businesses have re-evaluated their assets. This more realistically values a company’s assets in Venezuela. Reuters found that Pepsico’s assets, “valued at $1.13 billion using the 12 bolivars exchange rate,” would be worth “only $79.1 million at the 170 rate.” Ford has already written off much of its exposure in Venezuela, weighing an 800 million dollar devaluation of its assets against its balance sheet. Other companies, like Clorox Co., have pulled out entirely.

Shortages of basic goods have spiraled into a national pandemic brought about by the currency troubles. Importers’ difficulties at getting dollars at the official rate have accelerated inflation, already set in motion by Venezuela’s generous printing policy for its social programs. And when importers do get their hands on officially-exchanged dollars, there is almost no incentive to actually use the dollars to import price-controlled goods. Because the Venezuelan government sets artificially low prices in bolivars for goods, the dollars granted to importers go much further if they are just traded on the black market for bolivars versus importing the goods and then receiving much less back in Venezuelan currency. When importers have to rely on the black market for dollars, it quickly becomes unprofitable to even sell the goods under government-mandated price controls, additionally drying up the market for necessities.

In essence, the currency divergence opens up pockets of arbitrage exploitation, undermining the government’s intent with price and currency controls. Access to dollars determines the ability to import goods, and with the government impeding the free flow of dollars (and certainly capital flight), imports dry up. Ironically, this harms the very same citizens the socialist regimes of Chavez and his successor Maduro had promised to support, hitting hospitals and consumer goods hard.

Oil prices have only accentuated Venezuela’s decline. The government’s dependence on oil money for its foreign currency reserves has steepened the fall. As profitable oil exports decline, there are less dollars in the central bank to maintain the overvalued official exchange rates. Thus, access to the dollar is further lessened, driving a shift to the black market as well as inflating goods. Oil, accounting for 96% of the total products exported, has become almost the sole way to stock up on foreign reserves. The price decline of oil coupled with the high production cost in Venezuela only has further put the country in a hole.

Venezuela is not in a good position, to say the least. How can the county begin to right itself? Several factors must be considered.

Short-term, the country has to slash generous welfare programs, including a huge gas subsidy, costing the country nearly 12 billion dollars a year. It also has to accept the decline in the Bolivar, allowing the black market rate to converge with the official rate. While this will definitely add to the immediate inflation, a unified, free-floating currency is the best option for eliminating perverse incentives for importers and eliminating shortages. This must be coupled with austerity at the printing press; money cannot be freely printed if the Bolivar is expected to gain legitimacy within the country, much less as an international payment. The recently announced 172 Bolivar rate, to be traded officially, is an important step in the right direction. But without any data on volume or transactions, how much an impact that economic maneuver will have on righting the country is uncertain.

In this case, fixing the economy will help to accomplish the stated commitment to reducing poverty within Venezuela, independent of oil prices. Freeing up multinational corporations to conduct business in Venezuela without fear of currency wars or nationalization of their assets will begin to bring investment back into the country, something hard to come by in the present (the exception being a recent 20 billion dollar infusion by the Chinese). Rebuilding Venezuela’s failing infrastructure will require the help of other countries and their firms, something the socialist government will surely scorn at but accept as an inevitability. Economic mismanagement, highlighted by the failed currency management coupled with price-fixing decrees, have driven Venezuela away from its intended goal of reducing poverty. Sure, when oil prices are high, and a mismanaged economy is felt years down the road, all may seem to be well. Chavez did reduce poverty, even if it was at the expense of long-term economic viability, dependent on strong oil prices and short-term handouts. But in rougher times, continuing along a path of unsustainable subsidies domestically and internationally (The Cuban oil deal) will only damage consumers the most. Wealthier people within Venezuela will be able to maintain a greater network in securing basic essentials as well as leaving the country for medical treatment, while the average citizen will not.

Whether Maduro, currently facing domestic upheaval and a 22% approval rate, will immediately embark upon necessary structural reform remains to be seen. So far, he has attributed Venezuela’s basket-case economy to “economic war” with airlines, foreign capitalist forces, and the CIA. In his most recent address to the Venezuelan legislature, he says, “We have serious economic difficulties regarding the country’s revenue. But God will always be with us. God will provide. And we will get, and we have gotten, the resources to maintain the country’s rhythm.”

Whether or not God will help the Venezuelan economy stay afloat, even in the face of little foreign help, is up in the air. Hopefully Maduro can inspire change himself, and if he cannot, a better elected cabinet can reverse the crash course the country is taking with its quite dreadful policies.

Let’s talk. Leave a comment below or email Shaan Fye at shaanfye@atlasbusinessjournal.org.