Venezuela: Parallel dollar soars past 1,200 VEF following implementation of new exchange rate system
March 15, 2016
The Venezuelan government announced the replacement of the convoluted three-tier system exchange rate system with a more simplified system in February. The government introduced the new system in an effort to improve dollar supply and to correct the market inconsistencies the previous currency system had created. The new system, which came into effect on 10 March, is composed of the already-existing primary exchange rate system, renamed “Dipro”, and a new free-floating tier called “Dicom”.
The Dipro is the former primary exchange rate that traded at 6.30 VEF per USD prior to its 37.0% devaluation on 17 February. Following the devaluation, the Dipro now stands at 10.00 VEF per USD and will be used exclusively to purchase essential goods such as medicine and food products. The government stated that future rate adjustments are on the table if the circumstances deem it necessary. The former Simadi system was transformed into the free-floating Dicom. The Dicom will also englobe the Sicad system, which was for foreign travels only. The Dicom will open at 206.92 VEF per USD, the same rate at which that currency was trading in the Simadi. With the Dicom, the government anticipates that market movements of supply and demand will improve liquidity and correct the inconsistencies of the defunct three-tier system. According to Economy VP Miguel Pérez Abad, the government is aiming for the Dipro and Dicom exchange rates to converge into a single rate in the future.
The government believes that the Dicom system will improve the supply of essential goods and services and contribute to controlling inflation. Unlike in the former Sicad system, the government, the state-owned oil enterprise PDVSA and foreign investors can inject funds into the system. Pérez Abad expects that dollar supply will reach up to USD 30 million on a daily basis. The new system, however, does not specify a fixed percentage of U.S. dollars that PDVSA or the government should inject into each tier.
Reflecting the lack of confidence in the new system, the parallel dollar continued its depreciating trend. On 11 March, a day after the Dipro went into effect, the Bolivar traded in the parallel market fell to 1,211 VEF per USD and hit a new all-time low. The result represented a 19.4% depreciation over the same day of the previous month and a whopping 476% depreciation over the same day last year. The parallel dollar has lost 23.1% of its value this year largely due to intense dollar shortages and an increase in the supply of bolivars.
Analysts remain highly sceptical regarding whether the new exchange rate system will improve Venezuela’s fiscal position. Analysts are unsure if the government will commit to the floating exchange rate. The government has already intervened in foreign exchange markets and has never allowed the exchange rate to be set by market forces. The Dicom is the country’s fourth currency exchange system since 2013 that was intended to be free-floating. In the former Simadi system, for instance, individuals and businesses alike were supposedly able to purchase greenbacks. However, this pledge never materialized. It is very unlikely that the Dicom will alleviate shortages of goods and services because the government still maintains price controls and numerous legal hurdles for imports. Lastly, the cash-strapped government will struggle to inject liquidity into the new currency exchange rate system because international reserves are being used up to pay international debt payments due this year. According to economist Homero Gutiérrez from Dinámica Venezuela:
“Our understanding is that the Dicom will become a sort of Bolivarian-style “crawling peg” in which the political criteria prevail over the technical criteria. This would avoid re-establishing competitiveness in the exchange rate and, without an orthodox fiscal adjustment, there’s a risk that high inflation will persist. We don’t expect fiscal accounts to improve given that additional revenue will be put toward sustaining a spending rhythm that will inevitably lead to the need to pick up the pace of devaluation. The continuation of currency controls will keep out foreign investment and capital flows, and therefore balance of payments problems will continue.”
The FocusEconomics panel is split on whether Venezuelan government will modify the exchange rate system before the year’s end. For 2016, only four panelists expect the current exchange rate system to remain unchanged while the remaining panelists expect a devaluation in the official rate this year. By the end of 2017, all panelists foresee a change in the currency exchange rate system.