Venezuela: Government enacts sweeping reforms in latest attempt to revive crisis-stricken economy
September 10, 2018
On 20 August, a series of far-reaching economic reforms came into effect as President Nicolás Maduro once again strived to tackle spiraling inflation, stabilize the freefalling currency and overcome the deep economic crisis gripping the country. His economic recovery plan seeks to address various dimensions of the economy, most noteworthy among which are proposed measures for monetary reconversion, an epic devaluation and a substantial minimum wage hike. Although some policy moves could certainly be considered steps in the right direction, inconsistencies, ambiguities and implementation risks of the reform package are likely to compromise its effectiveness, thus suggesting that the laid-out objectives will not be met.
As its headline reform, the government overhauled the currency system by knocking off five zeroes from the bolívar fuerte (VEF) and renaming it as the bolívar soberano (VES). The new currency has been anchored to the petro, the government-created cryptocurrency which is pegged to the price of the Venezuelan oil basket. There are serious doubts, however, over the feasibility of the petro’s use among the public as well as its intended purpose of raising desperately-needed hard currency.
Firstly, the petro remains inaccessible to the general population and, while authorities state that sales have already raised USD 3.3 billion for the government, no verifiable evidence has been presented to support these claims. Furthermore, there is little evidence of buoyant trading activity of the petro and it is not sold on any major cryptocurrency exchange platform. The monetary confusion was increased by the announcement that in addition to the exchange rate, the system of prices and wages will also be tied to the petro. It is not clear, however, what this means in practical terms as prices have been linked to a token which selling price is unknown, and thus lacks market value.
Despite the ambiguities, the value of one petro was set at USD 60 and VES 3,600, implying a VES 60 per USD official exchange rate. This massive currency devaluation of roughly 95%—one of the largest in history—brought the official exchange rate roughly up to par with the one offered in the parallel market, marking the first time that the government recognized the black-market exchange rate. However, given the significant dependence of the economy on imports, such a steep devaluation will have an enormous impact on prices. Imports will become even more expensive, pushing domestic prices higher via pass-through effects. Finally, despite an attempt to unify the official and black-market exchange rates, recent data shows that the gap has continued to widen, indicating that rampant inflation will persist.
Maduro also announced a minimum wage hike, taking effect this month in a bid to shore up household purchasing power, to VES 1,800 (equivalent to half a petro or USD 30), representing a whopping 6,000% increase from the minimum wage last set in June. Monthly pensions were also set at this amount. However, the huge nominal gains are likely to be wiped out in real terms amid the hyperinflationary environment. Moreover, businesses would likely pass on the substantially higher costs to selling prices, thus pushing up inflation. On the other hand, the sudden and sizeable hike in labor costs also runs the risk of squeezing businesses, particularly small- and medium-sized enterprises (SMEs), likely forcing them to lay off workers or shut down operations, especially considering the context of depressed private consumption. Thus, although the measure can be deemed sensible in that it seeks to support buying power for households, it can backfire as it could lead to higher unemployment, lower domestic demand or further inflationary pressures.
Moreover, Maduro pledged to pay the difference between the new minimum wage and private sector salaries in SMEs for a 90-day transition period while holders of the government’s Fatherland Card will receive a one-time reconversion bonus of VES 600 (approximately USD 10) to ease the monetary transition. Simultaneously, Maduro ambitiously promised to eliminate the fiscal deficit and halt its monetization.
These measures reveal major inconsistencies, however. Foremost, the public-sector wage bill will soar due to the hefty increases in the minimum wage and pensions, allotment of bonuses and transitional costs for businesses. Although a series of tax reforms and other revenue measures are in the works, including a 4 percentage point VAT hike to 16%, higher taxes on upper-income households and partial elimination of costly fuel subsidies, analysts contend the government will not be able to raise sufficient revenue, particularly given the economy is in a state of depression, to cover the surge in expenditures. Therefore, contrary to the stated goals, the fiscal gap will likely continue to widen and would force the government to resort to monetary financing once again—only to stoke inflationary pressures further.
All in all, although some measures may appear sensible at first glance—namely the devaluation of the official exchange rate to its effective rate set by the black market and the minimum wage hike to recoup some of the lost purchasing power of households—the reform package as a whole is unlikely to resolve the country’s economic woes. Furthermore, as international financial sanctions continue to constrain the government’s room for maneuver, particularly its ability to access external sources of financing, it is expected that the economy will remain in dire straits.
Venezuela GDP Forecast
Panelists participating in the LatinFocus Consensus Forecast project that GDP will contract 12.1% in 2018, which is down 0.8 percentage points from last month’s forecast. For 2019, panelists expect GDP to drop 4.2%.
Author: Javier Colato, Economist