When traveling to Venezuela with your euros or US dollars you might wonder how much your money is actually worth when converting it into Venezuelan bolívares (VEF), the local currency since 2008. Well, the answer is: it depends. Venezuela is well known to have one of the most complicated foreign exchange regimes in the world. At the moment, the South American nation handles four different exchange rates, among which just three are functioning within the legal framework. Besides the country’s official exchange rate, the Venezuelan government set up two alternative exchange rates, called Sicad and Sicad 2. The fourth exchange rate, the illegal one, has been created by the black market.
But how did Venezuela ended up having such a complicated exchange regime? Having the largest proven oil reserves in the world, Venezuela’s oil revenues represent about 95 per cent of the country’s export earnings. Since the industrialisation of the oil sector about 100 years ago, today, this sector accounts for about 25 per cent of Venezuela’s gross domestic product. In consequence, the important role of oil exports is the explanation why a change in world oil prices has significant influence on Venezuela’s economic structure and exchange rate system. The figure below demonstrates the high correlation between world oil prices and the equilibrium real exchange rate in Venezuela.
Source: International Financial Statistics, World Economic Outlook
Higher world oil prices result in higher prices in the domestic oil sector and to an increase of capital inflow and government expense, which in turn leads to an increase in prices of non-tradable goods. As a consequence, the local currency becomes stronger in comparison to other foreign currencies and the real exchange rate appreciates. This phenomenon is known as the Dutch disease, a mechanism that can be observed in countries that experience a high increase in natural resources. As seen in the figure above, the high fluctuation of the real oil price has been leading to an unstable equilibrium exchange rate for VEF. Besides a production decline and an increasing appreciation pressure due to recent macro-policies, the high fluctuation of oil prices and the government’s policy responses have been the determinants for the troubled exchange rate system Venezuela experiences today. (IMF, 2006)
In order to overcome the high fluctuation of its real exchange rate, the Venezuelan government has had numerous exchange rate regimes and foreign exchange controls over the past several decades. A notable fixed exchange rate regime, which was maintained from 1930 to 1983, led the Venezuelan currency to be perceived as one of the most stable in the region during that period. In 2003, after national oil strikes brought the country into a severe recession, Venezuela’s president at that time, Hugo Chavez, opted again for a fixed exchange regime by pegging the local currency to the US Dollar (USD) and applying additional currency controls.
Besides the positive aspects of having fixed exchange rates, countries dealing with peg regime often face its disadvantages. In the case of Venezuela, one of the most pressing economic problems resulting from the fixed exchange rate has been the overvaluation of its domestic currency. When Chavez pegged the exchange rate in 2003, the Venezuelan currency was already overvalued by about 32.4% relatively to the USD. Additionally, Venezuela’s inflation has been much higher in comparison to its major trading partners in the last decade. Holding the nominal exchange rate fixed, led to a currency appreciation in real terms and to an increasing overvaluation of the VEF. As a consequence, Venezuela’s imported goods became by far cheaper than domestic production and this has been harming the development of non-oil sectors, especially manufacturing. The overvaluation of the domestic currency, combined with currency controls imposed by Chavez, led to the existence of an illegal parallel exchange rate for US dollars in Venezuela. Meanwhile, in order to tackle the rapid overvaluation, the Venezuelan government began to devaluate the domestic currency on an irregular basis. The high number of devaluations, (the last official devaluation took place in 2013 and was the fifth one in nine years), led people to lose confidence in the domestic currency. This scenario where people were loosing trust in their domestic currency was further aggravated by the restrictions imposed by the government on the amount of US dollars they could own and demand from the government.
All this led to an increasingly larger gap between the official and the black market exchange rates to the extent that on 2 October the non-official exchange rate traded at 96.6 VEF per USD, while the fixed exchange rate trades at 6.3 VEF per USD. The government, in order to reduce the gap and ease the shortage of dollars, firstly introduced Sicad in 2013, which is a currency exchange operating at a floating rate, and later in 2014 the Sicad 2, promoted as a free-market platform where people would be able to buy and sell dollars without restriction on a daily basis. How the government should proceed at this point is hard to say, it is clear that from any new policy there is both to gain and to lose for a country with a troubled economy such as Venezuela.
Giulia Casagrande, 745
Karoline Hormann, 756