Venezuelan President Hugo Chavez has devalued the bolivar in a measure that is raising questions about benefits and fallout for the country's economy and for the leftist's political fortunes in an election year. Here are some of the major issues surrounding the devaluation of Venezuela's currency:
What does Chavez gain from devaluing the bolivar?
Mr. Chavez gets more near-term fiscal stability, more cash as dollar-based oil revenues yield more local bolivars and a possible stimulus to an economy hit by global recession. The devaluation at the start of the year may have been a calculated move by Mr. Chavez to offset any negative fallout with voters. The measure helps Mr. Chavez unleash spending on social programs and state worker salaries in the months before September's legislature election. That vote could be a barometer test for the leftist whose popularity has been challenged by water and power shortages, inflation and crime.
What negative fallout could he face?
While he may gain fiscally, Mr. Chavez could face negative reactions from the poor - his key support base - who are likely to be the most squeezed as inflation increases the cost of goods. Venezuelans already face a challenging economy and the news of the devaluation sent shoppers on buying sprees. Since oil is king in Venezuela, the country relies heavily on imports from electronic goods to food, which leaves consumers open to broad price hikes. Mr. Chavez could take a hit in his popularity, which currently stands at 50 per cent. Last year the former soldier resisted calls for a currency adjustment and faces increasing criticism from opponents about economic mismanagement.
"We think the magnitude of the devaluation and the public response to it could represent a meaningful challenge for the Chavez administration," Morgan Stanley wrote in a report.
What is the likely impact on the economy?
In economic terms, the devaluation clearly helps reduce Venezuela's debt financing needs, narrows its fiscal deficit and allows the central bank to generate more revenues for the government. A Royal Bank of Scotland report sees Venezuela's central government fiscal deficit cut to 3.2 per ent of GDP from 7.4 per cent while borrowing financing needs will be reduced by $10-billion (U.S.) for 2010. That will reduce issues of dollar debt and push up bond prices. But even the government admits the measure will also drive up inflation. Already at 25.1 per cent last year, Wall Street analysts now predict prices could reach as much as 40 per cent this year after the devaluation. That will cut into consumer spending power and, in turn, could arrest economic recovery.
Moody's rating agency said the devaluation will prolong the recession into the second half of the year as consumption falls and business steer away from increasing manufacturing output.
What about foreign businesses in Venezuela
The outlook for foreign companies looks mixed. Analysts say U.S. consumer companies such as Colgate-Palmolive Co. and Avon Products Inc. are likely to feel the pinch on earnings as many of their goods sold in Venezuela will be considered nonessential and must use a higher exchange rate. Colgate, which gets 6 per cent of its sales from Venezuela, said it would report a one-time first-quarter gain and larger charges throughout 2010 on the devaluation.
Importing raw materials into Venezuela to manufacture goods will costs some foreign companies more. Companies have already struggled to get access to currency to repatriate profits under the country's strict currency control system.
But the new currency regime may bring benefits. Some companies had turned to a more costly unofficial parallel exchange to get dollars to repatriate profits instead of waiting for the government to approve their transactions. The new multi-tier exchange rate means some companies could now get currency at cheaper official rates or benefit if the parallel exchange rate falls as expected.
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