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10/20/08

Venezuela parallel exchange rate update

By popular demand here we go with an update of the Venezuelan parallel exchange rate. Click on any of the charts to enlarge them if needed.

When we last looked at the Venezuelan parallel rate back in late August, the "Beracha Factor" had opened a Pandora's box of sorts. That was when main man Moris had casually mentioned in an interview that the gov't wasn't going to float any more debt onto the market. The consequence was a parallel rate that zoomed from Bf3.2 to Bf4+ in days.

There was then something of the hiatus and the rate stuck around the Bf4 level for a while. But with the recent financial crisis (you might have seen a headline or two) the VEF has weakened to Bf5.4 closing tonight. Here are three charts of the same exchange rate.

This one is the long view and dates from May 2006:
Next, this chart shows the forex for 2008:
Finally, this one clearly shows the recent upmove, as the chart only dates from a couple of weeks before Beracha opened his mouth:
What we're looking at in that last chart is a 50% devaluation move in less than three months....that's seriously quick, people. But the question, as always, is whether the fundamentals merit such a downmove or not. There are of course many different parameters, but the one we've tracked on the blog over the months is the relationship between the Venezuela's international currency reserves (in this chart)...

NB: Read this chart from right to left: There are currently over U$39Bn in reserves

.....and the VEF monetary liquidity, or money supply, or M2 (which is basically "how many VEFs are out there") which is shown on this chart:

Put very simply, the basic theory behind this relationship is that if it were necessary the Venezuelan government could recall all the VEFs in existence and swap them for dollars they held in reserves. So at the moment there are around 170Bn VEFs in circulation and they're backed up by around U$39Bn in reserves. Do the calculation more accurately and that means there is a dollar tucked away for every 4.34 Bolivar Fuertes in circulation. This therefore represents a point of equilibrium and suggests the recent move to Bf5.40 has been overcooked.

However, the Chávez government has recently announced that it would take a few billion from international reserves and use it to fund social programs in 2009. That's fair enough, but if the currency reserve suddenly drops to around U$31Bn (as is roughly expected) this means that same "equilibrium point" will sit at Bf5.45, and to a great extent explains the move we're seeing right now.

The moral of the story is that the Chávez gov't can't have its funding cake and eat it. If the gov't wants to use reserves to fund other things that's fine, but unless they stop printing VEFs they will dilute the value of its currency compared to the relative monetary strength of the country. Or in other words, extracting from reserves while adding to money supply is a recipe for inflation like none other.

As for the immediate future of the VEF, it looks like it will stay above 5 to the greenback for the rest of the year (unless the dollar itself suddenly takes a serious nosedive). The method that was being used by the Central Bank to mop up VEF liquidity, both last year and this year, namely the issuance of dollar denominated bonds, doesn't look very likely due to the current world financial climate (and Beracha said they wouldn't until 2009, too). With Venezuela's "country risk" rating well over 1400 basis points it would be very costly to emit debt right now. The exchange rate is therefore very much dependent upon the Central Bank and the gov't taking VEFs off the street via other methods, perhaps by cutting down on the printing rate (a possible when the lower oil barrel price is considered) or by raising the bank reserve levels for the local currency, or by some other method. We shall see.