Venezuela: Monetary Policy

Background:

On January 1, 2008, Venezuela declared that 1000 old bolivars would be equal to one new bolivar, dubbing the new currency the bolivar fuerte (VEF), or strong bolivar. In 2003, Venezuelan President Hugo Chavez imposed currency controls pegging the VEF’s exchange rate at VEF2.15/USD. A National Exchange Control Administration (CADIVI) must approve all legal purchases of foreign currency, which led to a thriving parallel (permuta) market, where offshore corporations are used to swap bonds denominated in the two currencies, and the exchange rate was far higher. Venezuelan companies and individuals relied on this market when they could not get government authorization to purchase dollars at the official exchange rate.

On January 8, 2010, Chavez announced that the VEF would be devalued to fixed rates of VEF4.3 for machinery and VEF2.6 for food and medicine from VEF2.15 against the USD. On December 30, 2010, these two fixed rates were unified at the VEF4.3/USD level. Aside from the official rates, a parallel market supplied additional currency at market rates higher than the official rates. After a sharp depreciation of the VEF (USD/VEF 8.2) through mid-May 2010 in the parallel market, the government decided to shut it down and replaced it with a new FX system managed by the central bank of Venezuela (BCV), called SITME, which is funded with the trading of USD-denominated government and PDVSA bonds. The SITME is a managed float regime that aims to meet the needs of capital account transactions and the financial market.

Swelling government expenditures, fueled by oil revenues, have driven inflation to astronomical levels. The CPI increased by 26.9% in 2009 and is projected to close 2010 near 30%, after gaining 31.9% in 2008, 18.7% in 2007 and 13.7% in 2006. Inflation dynamics have been closely linked to the value of the currency, and further devaluations will have negative impacts on the CPI.