Chavez Causes Chaos in Venezuela's Forex Market

Monday, 17 May 2010 01:40 PM

Venezuela's foreign exchange market is paralyzed after socialist President Hugo Chavez threatened to close brokerages and signed a new law to put a free-floating "parallel" market under central bank control.

The parallel market, where the bolivar is traded freely via securities, has provided currency to buy about half of Venezuela's imports.

Elsewhere, the government sells dollars at two official rates of 4.3 and 2.6 bolivars per U.S. dollar for essential items, but supplies at those prices are limited. Here are possible scenarios:

The most likely outcome of the rule changes is that the market re-emerges but is less liquid. Past form suggests the government will not be an efficient financial manager, causing bottlenecks that slow supply and cause new distortions.

The most likely result of this would be higher inflation and sporadic shortages of consumer goods—a dangerous mix for Chavez politically with legislative elections in September.

Markets would also worry about political and economic uncertainty, particularly at a time of recession. Fitch Ratings has said it fears Venezuela could become a net external debtor despite being an oil exporter and said the nation's creditworthiness could be affected.

Despite Chavez's threats to do away with brokerages, the government is apparently aiming to keep the parallel market alive, maybe limiting the bolivar's range between bands.

The central bank has yet to catch up with the reform rushed through the National Assembly and needs to write detailed bylaws that will define how it is implemented.

That could take a while, and with prison sentences possible for illegal exchange activities, the market will likely remain practically closed until there is clarity about the new system.

"The central bank now has to make the mechanism agile, whatever it is," said one trader. "If this is published in the Official Gazette, and the government does not have a Plan B, a black market will open where the dollar could really reach never-before-seen levels."

If the interim period drags on, Chavez risks faster price rises and shortages of imports that make up most consumer goods, including food. To limit damage, the state could release more dollars at official rates or issue short-term bonds.

Many economists believe the new regulations will not stop the bolivar's slide and predict new sovereign debt issues later this year to meet demand for dollars and to slow price rises.

The parallel market in its current form is opaque and open to manipulation by unscrupulous traders. There is no common trading platform, oversight or detailed regulation.

The new rules could in theory correct these issues and create a more transparent system that better reflects the real value of the bolivar judged by supply, demand and risk.

"If the new system is agile and transparent, and banks choose to participate actively, the transactional cost of foreign exchange transactions could come down," economic think-tank Global Source Partners said in a research note.

"Moreover, if unscrupulous players are excluded from the market, the price of the dollar would be a better reflection of fundamentals and risk perceptions."

Even then, the bolivar would not regain value without a greater supply of dollars in the market place. Some pressure will be taken off the parallel market if the government begins to supply more dollars at the two pegged rates.

But the impetus to change bolivars for dollars is also driven by inflation—which hit a record 5.2 percent in April alone for an annualized 30.4 percent rate—and Chavez's aggressive stance toward the private sector.

"If foreign borrowing and the central bank's reserves will be the only source of funds to fill the gap between demand and supply in the newly created segment of the foreign exchange market, stabilization efforts will hardly succeed," Global Source Partners said.

Chavez has been increasingly strident in his criticism of "money-bags" traders who, he says, are a part of a wide-reaching conspiracy to discredit his government. He has threatened to eliminate brokerages, and websites quoting the currency's parallel price have disappeared.

If Chavez carries out threats to outlaw currency trading all together, serious problems could be expected, including a deeper recession, massive inflation, and shortages.

To offset the loss of the parallel market, the government would have to massively ramp up the amount of dollars it supplies businesses at the fixed rates. Without a big jump in oil prices, that would likely mean drawing on reserves, which are slightly below ideal levels, or issuing more debt.

Ratings agencies could also chose to downgrade Venezuela.

A new, illegal black market would almost certainly emerge, where the bolivar would be even weaker. Shortages of imported goods and higher inflation would be bad for Chavez. His popularity has dropped to below 50 percent this year, largely because of a recession exacerbated by electricity and water shortages.

If the economy worsens, Chavez is likely to blame opponents by accusing wealthy businessmen of raising prices and betting against the bolivar.

As well as more sovereign debt issues, some economists say the government could be eventually forced to devalue the bolivar from the 4.3 and 2.6 pegs set in January.

Prices for Venezuelan bonds respond more than anything to oil prices, but a major deterioration in the economic situation would almost certainly drive them down. That said, Venezuela's ratio of debt to gross domestic product is low, and its obligations next year appear manageable.

© 2019 Thomson/Reuters. All rights reserved.

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Venezuela's foreign exchange market is paralyzed after socialist President Hugo Chavez threatened to close brokerages and signed a new law to put a free-floating parallel market under central bank control. The parallel market, where the bolivar is traded freely via...
Monday, 17 May 2010 01:40 PM
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