Last week Venezuela devalued its currency, the bolivar, by 95%, cutting five zeros off the exchange rate. This measure was a desperate response to hyperinflation that reached an astonishing rate of 83,000% YoY in July, with prices doubling every 26 days. The IMF has projected the rate could reach one million percent this year. Cash transactions had become almost impossible, with even restaurant tips being done as bank transfers. The new currency, the “sovereign bolivar,” is linked to the petro, a state-run cryptocurrency that can be manipulated. In other words there is no constraint on the ability of the government to issue this cryptocurrency and print further sovereign bolivars.
Despite Venezuela’s having the world’s largest proven oil reserves, the country’s economy is in a shambles due to the mismanagement since 1999 by the socialist governments of Presidents Hugo Chavez and Nicolás Maduro. The economy dropped by more than a third since 2013 and is now in freefall. Unwise price controls and exchange controls had unintended consequences. Expropriations, corruption, and serious mismanagement of the state-owned oil company further depressed the economy. The government goes on printing money, and the budget deficit now exceeds 30% of GDP. A further increase in the minimum wage to 34 times its previous level, another element of the government’s “magic formula” to counter the economy’s dire state, will likely add to that deficit, since the government will cover the greatly increased cost to private firms for 90 days. Government borrowing to fill the financing gap has led to the issuance of some $60 billion in sovereign bonds and perhaps double that amount in loans.
Life in the country has become difficult, unbearable for many, with 2.3 million of the country’s population of 31.3 million leaving the country since 2014. There are major shortages of food, and child malnutrition is at a record high. In some cities there are water shortages and power cuts, which have been particularly hard for public hospitals, which also face serious shortages of medicine. It is not surprising that Venezuelans are voting with their feet.
The Venezuelan exodus, estimated to be one of the largest forced displacements ever in the Western Hemisphere, is creating increasingly difficult problems for Venezuela’s neighbors, Colombia, Ecuador, Peru, Chile, and Brazil. The first waves of migrants were largely middle class and met no resistance in the neighboring countries, which generally have relaxed immigration policies and governments that saw these migrants as a welcome rebuke to the Maduro regime. However, the flows have surged, and the more recent migrants have tended to be poor. Many exhaust their limited resources as they flee, and they often arrive on foot. Tensions have risen in Brazil, which had been handling the influx well, with some attacks by locals on migrant border camps, leading to extra security forces being sent to the border. Brazilian authorities indicate they have no intention of closing the border.
Both Ecuador and Peru will soon require Venezuelans who wish to enter their countries to have passports. Reportedly, getting a Venezuelan passport can take two years unless a substantial bribe is paid. Most migrants entering Ecuador have been heading to Peru, where the recent influx of Venezuelans has been 5000 a day. In contrast, Columbia continues to welcome Venezuelan migrants, recalling that Venezuela took in more than 700,000 Colombians during that country’s war with FARC guerrillas. In 2017 Colombia was the destination for 600,000 Venezuelan migrants, by far the largest volume among South American destinations. It is notable that the second largest number, 290,224, was taken in not by another South American country but by the United States.
The economic costs to neighboring countries of these inflows of migrants seem to be manageable. However, as the flows continue to increase, which seems likely, tensions could well increase, and the risk of political instability could grow. Rising risks would have negative effects on the region’s economies, raising investors’ concerns.
The economic situation in Venezuela does not look likely to improve under the present government’s policies. While the devaluation was inevitable, major changes in course are needed, including freeing up price controls, adopting responsible fiscal policies, and probably moving to a currency board or accepting dollarization, following the examples of Zimbabwe and Ecuador. Dealing with the external debt problem would require negotiating an adjustment agreement with the IMF and restructuring that debt. President Maduro appears unlikely to take such actions, and his government has already defaulted on some bonds. Maduro’s “Magic Formula” has little chance of ending the economy’s slide. International assistance from the United States and other wealthy countries could make a difference and be justified on humanitarian and regional-stability grounds but is unlikely as long as there is no change in the pro-Cuban, anti-democratic government.
Venezuela’s troubles have not yet had a significant effect on other financial markets in South America. Should the migrant flows eventually lead to political instability in one or more South American countries, investor attitudes toward the countries concerned and possibly toward the region would deteriorate. This is a medium-term risk that we will keep in mind as we adjust our investment strategies.