Banking - Venezuela

How Venezuela is devaluing its currency

How Venezuela is devaluing its currency "through the backdoor"

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The Venezuelan government is currently embarked on a strategy of devaluing its heavily overvalued local currency "through the backdoor," according to a report from Capital Economics.

The official exchange rate is 6.3 bolívares per US dollar while reports say that on the black market the local currency has weakened to around US$64, a discount of more than 90% due to the severe shortage of dollars in the troubled economy.

Several investment banks expect the government to announce a major devaluation of the local currency in the near term, but Capital Economics argues that the government has already launched an unofficial devaluation process and believes that the official exchange rate could be left intact.

THE BACKDOOR DEVALUATION STRATEGY

The government announced at the end of 2013 that so-called Sicad auctions would be re-launched yet again. Under this system, bolívares are auctioned off at a rate somewhere between the official and black market exchange rates. "

"The results are not published, although information was leaked that a recent auction had a prevailing exchange rate of 11.3/$," said Capital Economics. "In addition, it was also announced late last year that a new tourist exchange rate would be introduced (coincidentally at 11.3/$) - and that future foreign oil investments would take place at the latest SICAD rate of 11.3/$."

These measures amount to a 44% devaluation and although the official exchange rate remains at 6.3 bolívares per US dollar, Capital Economics believes that little or no transactions will now take place at this rate, with FX supply instead being switched primarily to the Sicad system. "And since the results of SICAD auctions are rarely published, the government will be able to secretly devalue the bolivar further if they wish over the coming months. All the while, the official exchange rate may appear to remain intact."

However, the switch to using the Sicad will not solve the economy's fundamental shortage of foreign currency, said the London-based research firm. "As a result, until the government can find a sustainable solution to the dollar drought - be it an influx of foreign currency or an increase in the economy's supply potential - inflation will remain high and growth low."

SOARING INFLATION SET TO EDGE HIGHER

While it is difficult to predict the extent to which the local authorities may manipulate the inflation data, Capital Economics predicts that the annual inflation rate could reach 75% this year, which is a forecast also shared by Bank of America Merrill Lynch.

Annual inflation was 56.2% for December last year compared to 20.1% in December 2012, according to the country's central bank.

Venezuela's President Nicolás Maduro is blaming the soaring inflation on private sector "speculators" as well as the political opposition as he believes they are engaged in an "economic war" against his government and the Venezuelan people. To compensate workers and old people for the high inflation, Maduro has now decreed a 10% hike to the minimum salary and pensions, which comes across as a somewhat strange way to tackle runaway inflation.

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