Early in 2018, Venezuela’s central bank announced that it was devaluing its official exchange rate by more than 99% and launching a new foreign exchange platform called the DICOM. According to the central bank, the first auction of its new DICOM system gave 30,987.5 bolivars per euro, equivalent to around 25,000 per dollar. Reuters reported that the move represented a devaluation of 86.6% with respect to the previous DICOM rate and 99.6% from the subsidized rate of 10 bolivars per dollar, which had already been eliminated.
Venezuela is undergoing a major crisis, which is evidenced by inflation in quadruple digits and shortages of food and medicine. Many economists blame the 15-year-old currency control system for dysfunctional commerce and industry.
In the past, the government has repeatedly created foreign exchange mechanisms similar to DICOM, but they failed to provide a steady supply of hard currency. To overcome the hard currency shortage, a black market for dollars grew as Venezuelans would buy dollars on the cheap and sell them for a profit. Most of the government's foreign exchange platforms were unsustainable next to the black market rate.
Exchange Rate System
The Venezuelan bolivar (VEF), the official currency of Venezuela, has been under a controlled system for over 15 years. Although it has undergone periodic devaluations, it is still overvalued at the “official” exchange rate. Venezuela has had a complex multi-layered exchange rate system that offered different exchange rates. The first exchange rate offered has been the official exchange rate intended for importing food and medicine. The second exchange rate for priority sectors was supposedly auction-based, and was called the Ancillary Foreign Currency Administration System I or SICAD I. Another rate, SICAD II, was introduced in March 2014.
The last exchange rate before the introduction of the DICOM was the SIMADI. The rate was reserved for the purchase and sale of foreign currency to individuals and businesses. The government controls all of the rates. Outside the government setting, however, is the bitter reality—the black market. In 2016, the black market exchange rate was around 900 bolivars to the US dollar.
Although Venezuela is a major crude oil exporter, it is dependent on imports for almost everything else. Thus, dollars earned on oil exports are precious as they are used to pay the import bill. The government has been issuing its petrodollars at artificially maintained subsidized rates, and this “subsidy” on dollars has given rise to economic and social problems because the benefits are not being felt by the common man.
The Venezuelan exchange rate system offers different rates to different people depending on the purpose. While it might be passable to give a preferred rate for essential imports, problems arise when the preferred rates are accessible only by the influential. This, along with a system that supports arbitrage of the currency because of the different rates for dollars within the country, has been destroying the balance. For example, if an influential business owner puts in a request to the government for $100,000 to import pain relief spray. The individual needs to pay 100,000 X 64 = 6,400,000 VEF to get the dollars. The individual can use these dollars to their advantage by importing relief sprays worth just $10,000 dollars and selling the rest of dollars on the thriving black market to get 90,000 X 900 (assumed) = 81,000,000 VEF. So, the business owner has earned a lot more than was initially invested—but in the process, the individual created a “shortage” of pain relief sprays, which will now be sold at even higher rates than they cost, feeding inflation.
The overvaluation of the domestic currency is detrimental. In situations where the official exchange rate is fixed and devaluation is not uncommon, people tend to hold dollars instead of their own currency and sell those dollars when the currency undergoes devaluation (or they sell dollars in the parallel market to get more of the domestic currency). As more people start making easy money, there is a demand for dollars and, in cases where they are scarce, the black market price goes up. This further pushes up inflation and higher inflation again pushes the price of the dollar. Thus, in a way, inflation and the dollar rate feed each other. (To learn more, read: The Importance Of Inflation And GDP)
The Bottom Line
The Venezuelan government has long been criticized for its management of its hard currency. Over the past four years, the ruling Socialist Party has continued to create auction systems all of which have failed because they set artificially low exchange rates. Buyers sought more dollars than the central bank had available to sell. The exchange rate mechanisms have included SITME, SIMADI, SICAD, SICAD II, DIPRO, DICOM. The gap between “artificiality and reality” has to be gradually filled for the economic health of the country in the long term as this will curb currency arbitrage and the black market for currency and goods.