LIMA — Surely there have been sufficient experiments in Latin America with exchange and price controls, enough to foresee their consequences. Just cross the supply and demand curves on a Cartesian plane to see what happens when prices are fixed for a long time, at rates notably below their level of equilibrium: There are shortages, as demand begins to exceed supply. Meanwhile, the goods in question are only plentiful in illegal markets — but at a considerably higher price.

The same tends to happen with dollar rates. There is sufficient historical experience to show that indiscriminate subsidies do not necessarily lead to a progressive redistribution of incomes in favor of the less fortunate.

For example, selling a liter of gasoline for two cents (as happens in Venezuela) benefits those with cars more than it does public transport users. Subsidizing electricity is more beneficial to companies than to households. Worse, when subsidy levels become unsustainable and corrections necessary, the inflation these adjustments generate tends to be harmful to those who have less, as fewer properties can keep their value over prolonged periods of rising prices.

This seems to be the scenario currently facing the Argentine and Venezuelan economies. The Argentine government recently allowed the devaluation of its currency and announced it would cut subsidies on gas, electricity and water.

On the one hand, devaluation helps preserve foreign exchange reserves as the Central Bank sells fewer dollars to maintain its currency’s exchange rate. On the other hand, cutting subsidies helps reduce the fiscal deficit, which is a potential source of inflation.

In the short term, however, both decisions create economic problems, with an increase in the price of imported goods and services and of the subsidized services. So while necessary in the long term, such measures can be problematic.

The protest effect

It’s no accident then that these measures are being taken in the political context of distant elections, not due for more than a year in Argentina and with sitting President Cristina Kirchner unable to run for another presidential term. It is also arriving in the context of an approximate two-to-one difference between the official and unofficial rates.

The difference with Venezuela is that while no elections are due there for more than a year, the government faces the most significant opposition protests since 2002, and a referendum to end the presidential mandate is a technical possibility in two years’ time.

There is also a 13-1 difference between the official and free-market dollar rates, while the inflation rate is at a record high. In Venezuela, subsidies for some goods and services are singularly abnormal, so Caracas authorities would have to undertake more serious adjustments than Argentina, and in a more complicated political context.

While devaluation of Venezuela’s currency, the bolívar, would help moderate the trade balance and spending deficits, it would have a much greater immediate impact on prices than in Argentina, as Venezuela imports around 70% of the goods it uses in its economy. A bolívar devaluation would be less of an incentive for local exports than in Argentina, as oil and gas constitute 96% of Venezuela’s exports and demand for them is relatively inelastic.

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Venezuelan bolivars — Photo: Jorge Andrés Paparoni Bruzual

For these reasons, instead of devaluating the official exchange rate (of 6.3 bolívars to the dollar), the Venezuelan government has opted for a more surreptitious devaluation, creating a parallel dollar market that would compete with the informal market. The first bid to do this was called Sicad 1, in which some business groups were allowed to participate in a weekly dollar auction worth up to $220 million. But since rates reached in that market were around 10-12 bolívars to the U.S. dollar, it was not enough to impact the informal market’s rates (which reached a peak of 88 bolívars to the dollar last February).

The government created another dollar auction market (Sicad 2), in which the dollar reached rates of 51.85 bolívars. The new mechanism managed to bring down the informal dollar rate to 58 bolívars.

The ultimate goal of this scaled exchange system is to modulate the transfer of currencies from one mechanism to another, and allow a gradual reduction of distortions in the Venezuelan economy while minimizing possible social conflict. While a step in the right direction, the magnitude of distortions and proven incompetence of Venezuela’s rulers make this a risky bet, with an unpredictable outcome.

*Farid Kahhat is an international analyst and professor at Pontifical Catholic University of Peru’s Department of Social Sciences.