Macrinomics on the Caribbean?

Mauricio Macri managed to dismantle Argentina's foreign exchange control regime in very little time, and with surprisingly little pushback. Could something like that work here?

Mauricio Macri successfully dismantled a strict FX control regime in Argentina within the first few days of his government. Many doomsayers had called it a suicidal move. Despite the fear-mongering pushed by Kirchnerismo and the legitimate concerns about the social impact raised by several economists, Macri’s devaluation and dismantling of FX controls is so far a success. And he did it without calling the IMF.

Macri’s move had all the potential to be chaotic, dealing a significant blow to the first non-Peronist government in decades in its first days. Instead, nightmare scenarios were averted. The cepo – as the FX control was known – is gone. It’s like it never existed.

Can a reform like this be applied in Venezuela if a new government takes office? Well, It’s unlikely.

Conditions in Argentina were far from favourable, just like they would be in Venezuela if the controls are lifted in the near future. Macri took office in a country with rising inflation, record-low international reserves, amid a commodity prices downfall, rigorous price controls, export and imports restrictions, and political controversy pretty much everywhere.

How did Macri dismantle the cepo in just a few days?

The first thing you need to lift a FX control like the cepo is dollars. A lot of dollars. And you need them fast, readily available from day one. The first consequence of FX controls is the creation of a parallel market and a high demand of hard currency due to restraints to the supply of greenbacks through official channels. When controls are lifted, this demand will flow into the new open market. If there are not enough dollars to satisfy it, the price will shoot up.

To satisfy the initial demand for dollars, countries usually depend on their hard currency stocks held in the Central Bank’s international reserves. But these were pretty much gone in Argentina. Reserves could have been replenished before lifting the controls, but the only way to achieve that quickly would’ve been with loans from a multilateral organization like the IMF, or by issuing lots of debt.

How did Macri get those additional dollars with record low international reserves? His plan was to have other people’s dollars flood into the open market. It would satisfy the pent-up demand, and keep the initial devaluation from overshooting to undesirable levels.

There’s no blueprint for what Macri did, as conditions vary from country to country. For starters, Argentina’s greenbacks’ laying goose is the private sector; specifically agro-exporters – from soybeans to wheat. When Macri’s victory started to look more likely, these producers started hoarding their products and hard currency by delaying exports or the exchange from dollars to pesos. One of Macri’s main campaign promises was lifting the cepo, so they waited for more favourable exchange rates once he delivered on his pledge.

Once the cepo was lifted, they flooded the market with dollars. The process was coordinated with policymakers in negotiations that took place before lifting the controls. In addition, Macri eliminated export regulations and taxes to boost hard currency inflows and to keep the FX market active with fresh supply, alongside additional loans from international banks.

There’s also a subjective component in the recipe: confidence. If the people, the private sector, and the local financial system have no confidence in the government’s word and actions, the FX system and rate goals could be shattered. Macri got the confidence he needed in a simple way: he did exactly what he promised in his campaign. His crystal clear promise and proposals gave him the mandate to do so, as it could be argued that Argentines had voted to lift the cepo.

Venezuela is a completely different animal in terms of the source of foreign currency. Non-oil exports are registering their worst performance in two decades, thus the “export delay” strategy used by Argentina’s agro-exporters doesn’t apply here. 

With the Venezuelan oil basket selling well below $30 per barrel, PDVSA – which generates 96 out of every 100 US dollars coming into the country – will not be able to provide the greenbacks needed to get our precarious economic system (corruption included) functioning. And the company – due to under-investment, poor incentives, lack of maintenance and other factors – doesn’t have the technical capacity to significantly increase its oil output overnight.

Worse, international reserves are alarmingly low, and the country and PDVSA have to make foreign debt payments of more than USD 10 billion in 2016. Under this scenario, the initial picture of lifting the Cencoex/Cadivi FX cepo à la Macri is as scary as a Luis Salas paper on inflation (or should I say on “bourgeois speculation”?).

But there’s a way to get some of the needed greenbacks supply back. And no, I’m not going to talk about that same old argument on “sembrar el petróleo” or about issuing more external debt, as this is a Ludacris move at current bonds prices.

Did you know that Venezuela’s private sector has a net foreign position of around USD 147.5 billion abroad? If not, check BCV’s website in Balanza de Pagos and “Posición de Inversión Internacional”. Granted, we don’t know what portion of this money is liquid or easily convertible to cash, but this is private sector money, from Venezuelans. From the middle class professional that fled to Miami to the richest businessman running a successful transnational. This position has increased by more than 550% since 1998, precisely because so much capital has fled the country.

It’s money that could come back if conditions in the country are suitable and sufficient to guarantee not only a safe return on investment, but also the legal security to scare any “exprópiese” ghost from chavismo. Even just a small portion of this money abroad could help in holding back a large devaluation.

All the fears that have kept this money from coming back could dissipate quickly under a reform-minded government. Moreover, in terms of Purchase Parity Power, Venezuela would be more than attractive for investors holding hard currency if local conditions favor fresh investments.

But it’s not as simple as it sounds. These resources will not come back as easily or as fast as we’d need them to to stabilize the forex market, at least not at first. As Macri’s economic team assertively explained, in order to lift an FX control you need money instantly. Available in the short-term. In weeks, to be more specific.

Money follows incentives. Someone has to decide whether those incentives are good enough, and that that takes time. Time we cannot afford during the early stages of an FX transition.

The reasons for capital flight are not only economic ones. To me, they’re mostly politically-driven. A major overhaul of the legal framework to protect investment flows pushed by a responsible and credible new government, and enough political stability to boost Foreign Direct Investment (from Venezuelans and non-Venezuelans alike), would probably need to be in place first, just to make thinkable the elimination of the FX controls without an extreme overshoot of the exchange rate.

None of this could happen in Macrinomics standard time. We’re just starting from too far behind.

Sadly, Venezuela does not have the capacity to lift its FX controls in the short term without loans from multilateral organizations. At least not without enduring a huge, politically destabilizing devaluation. It’s too late for that, even if we get a new government that enacts deep pro-market reforms across all economic activities, and is trusted to competently rule over the messiest inheritance in Venezuela’s modern history.

Before lifting controls, the Venezuelan government would need to devise a medium-term strategy. It would take at least months to bring in enough hard currency FDI inflows, replenish international reserves, and persuade foreign oil companies to open up shop in the country. It’s not only a slow process, but would also require extending FX controls for a while longer, no matter how ugly, disruptive and corruption-inducing the delay might be.

This leaves one option to get it done in the short-term without a massive devaluation: a bailout. And as we have been debating in the blog for months, the IMF is the most suitable party to grant a big loan quickly. No one will like the strings attached to this money. Everyone can see it could be politically harmful to a transition government. But, so far, nobody’s had a better idea.