Venezuela devalued its currency by half - to reduce imports that aren’t strictly necessary

Reading - Venezuela devalued its currency by half - to reduce imports that aren’t strictly necessary

CARACAS – President Hugo Chavez, harried by recession and declining popularity, announced a major currency devaluation late Friday to shore up government finances and stimulate economic growth before key elections this year.

The move cuts Mr. Chavez's two-year-old "strong bolivar" currency by half – to 4.3 per dollar from 2.15 per dollar – for most imports and transactions. The central bank will also subsidize a stronger 2.6-per-dollar rate for imports of food, medicine and other essential items, Mr. Chavez said.

The move reflects the increasingly difficult economic and political trade-offs faced by Mr. Chavez, who has been in power for more than a decade and veered the country's economy sharply to the left through steps like nationalization of key industries, rampant government spending, and currency and price controls.

While those unorthodox policies can work for a few years, they usually set the stage for deeper problems down the road – troubles which have started to surface and which led to the currency devaluation. The move is also a humiliating turn for a currency renamed the "strong bolivar" two years ago, when Mr. Chavez chopped three zeros off the old currency and declared the beginning of an era of monetary fortitude.

The staunchly anti-U.S. leader is gambling that the benefits of a weaker currency will offset faster inflation, which threatens the purchasing power of his mostly poor backers. Finance Minister Ali Rodriguez said devaluation, which makes the price of imported goods more expensive in local currency terms, may add 5 percentage points to the 27% inflation rate – already among the fastest in the world.

In Mr. Chavez's favor, the measure helps narrow a growing budget shortfall, could provide limited relief to a moribund local industry, and instantly gives his oil-rich government more local currency to spend per barrel of oil exported by the state petroleum company, PDVSA. That's a key consideration with Congressional elections looming in September.

The 55-year-old former soldier's popularity has slid amid corruption scandals, a shrinking economy, rising crime and shortages of food and electricity. Increased spending could paper over some of these problems and boost Mr. Chavez's popularity.

Devaluation brings "more room to increase public spending as way to spur economic activity," says Maikel Bello, an analyst with the Caracas-based research firm Ecoanalitica.

This year's congressional elections are especially important because, after previously boycotting some elections to protest Mr. Chavez's growing power over democratic institutions in Venezuela, traditionally fragmented opposition parties are making a push to dramatically improve their representation in Congress.

For years, Venezuela has been able to defend an overvalued currency thanks to currency controls. Venezuelan citizens and companies can get dollars at the official rate only with government permission. That has led to a thriving black market, where those who don't get government permission buy the U.S. currency. Even the Venezuelan government uses the black market to some degree, economists say.

On Friday, that black market rate stood at about 6.25 per dollar – well below the former official rate of 2.15 and still below the new rate of 4.30. Economists say one of the reasons for the move was an attempt to deflate the black market, a catalyst for inflation that has also spawned a frenzy of schemes to defraud the central bank of dollars.

Economists will be watching the black market rate on Monday to see whether the devaluation was big enough to cause Venezuelans to go through the legal route to get dollars or whether they will keep buying them at the unofficial rate.

In theory, the devaluation could fortify Mr. Chavez on a range of fronts. Announcing the devaluation on state television, Mr. Chavez predicted that a weaker currency would breathe new life into a domestic economy that has become almost totally dependent on imports for everything from beef and milk to automobiles during his 11-year presidency.

Devaluation "will give a boost to the productive economy, will stop imports that are not strictly necessary and will stimulate exports," Mr. Chavez said.

The measure may buttress the banking system, which has been rocked by the closure of several institutions amid an embezzlement scandal. Many Venezuelan banks head into the devaluation holding large stocks of dollars.

Holders of dollar-denominated bonds issued by Venezuela and PDVSA will be encouraged by the move. Devaluation narrows Venezuela's financing gap to around 3% of economic output from around 7%, according to Royal Bank of Scotland economist Boris Segura.

"This is good news," said Mr. Segura.

However, the devaluation does little to assuage the deeper problems plaguing the Venezuelan economy, economists say.

Foremost, devaluation by itself is not enough to revive a domestic manufacturing base that's atrophied amid a hostile operating environment. Few investors are willing to brave Venezuela's maze of price caps, currency controls and the ever-present fear of nationalization.

Higher inflation from the move will also keep chipping away at the value of the bolivar, even at its new peg.

What's more, by keeping a subsidized dollar rate for importing food, medicine and essential items, Mr. Chavez removes any incentive for Venezuelans to produce what they need most. It will almost certainly remain cheaper to import beef from Brazil, for example, than to produce it.

The fact that Venezuela has ceased to produce meaningful amounts of food, medicine and other basic goods under Mr. Chavez puts his government in a Catch-22 bind. Mr. Chavez can't use devaluation to stimulate production of the most essential products because doing so would instantly make the imported versions too expensive for his mainly poor constituents.

Official devaluations are nothing new for Venezuelans, with many getting their first taste of currency controls in 1961. The peg imposed then was kept for 22 years but a decline in oil revenue forced the government to devalue in 1983, marking the beginning a downward spiral that included several adjustments to the foreign currency rate. A devaluation in 1994 amid a deep economic crisis spurred a wave of popular unrest that Chavez eventually tapped to win the presidency five years later.

Mr. Chavez is returning Venezuela to an official dual-exchange rate last tried during the economic turmoil of the 1980s. Dual exchange rates around the world are associated with corruption by bureaucrats who decide which businesses get the preferential rate, and by importers who have an incentive to falsify import invoices.

It also adds to general confusion. Venezuelans will wake up Monday to a country with three exchange rates, if you include the black market rate.

The devaluation is a humiliating turn for a currency renamed the "strong bolivar" two years ago, when Mr. Chavez chopped three zeros off the old currency and declared the beginning a of an era of monetary fortitude.

But the currency became grossly overvalued amid galloping inflation and government spending. Pressure to devalue rose as the bolivar plunged to around of third of its value on the black market.

In a bid to stem central bank dollar losses amid the black market crash, the government restricted sales of dollars. But that only made things worse, by spurring the black market to new heights and punishing companies, such as importers, that need those dollars to do business.

"Companies had frozen their activities because they couldn't buy dollars at the official rate," said Pedro Palma, an economics professor at IESA business school in Caracas.

Mr. Chavez maintained unfettered access to dollars for importers of staples who supplied the government's subsidized food markets. But even that backfired. Late last year, the government jailed the nation's biggest such importer, billionaire Ricardo Fernandez. In part, he is accused of using access to dollars to enrich himself.

Mr. Fernandez has denied wrongdoing.

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