By Miguel Octavio

As the swap exchange rate soared this week to an all time high, all eyes were on CADIVI and the Government, wondering if there would be a policy change in the next few weeks or if foreign currency flows will remain tight and the Government will decide to ignore the soaring swap market.

CADIVI has not given out any information on approvals or actual payments at the official rate of exchange to importers or others. What is known is that many sectors have yet to receive foreign currency this year or have stopped receiving it after an encouraging beginning of the year.

Car manufacturers have been particularly hard hit, as the Government owes the sector a couple of billion dollars and the Minister of Commerce said this week that they will not give any foreign currency for importing cars in 2009. The problem is these companies have huge debts, as they have financed part of the imports, but their plants are likely to cease operations were the current situation to continue.

Banks that make payments in foreign currency to credit card holders are also feeling the pinch, with some of them restricting dollar payments to travel essentials like hotel, food and drugstores. But many banks have not dared to implement similar policies for fear of getting in trouble with the Government. Airlines are also owed not only for airline tickets they have sold at the official rate of exchange, but also for aircraft parts which were promised by the authorities.

And while everyone talks as if flows to food and medicine distributors and manufacturers were normal, this is not the case. We know for a fact that some pharmaceutical companies have not received foreign currency for raw materials in the last two and a half months and some companies in the food sector have also begun complaining as well.

The big question is what the Government’s strategy is at this point -- if any. It would appear as if the Government has set a monthly quota for imports (US$ 2.5 billion?) and priorities are established with food at the top. But clearly, for a country that imported over US$50 billion last year, a pace that turns over only US$30 billion is simply problematic without alternative policies in place.

The first direct effect of this scarcity of foreign currency will be the recurrence of shortages in a variety of items. So far, there are shortages in paper and some dairy products such as butter and margarine, but one also notices a reduction in the number of brands for certain products in supermarkets.

But at the same time, restricting foreign currency flows slows down economic activity, while fueling inflation, as companies reduce production and what little is made is increased in price as foreign currency needs to be purchased in the swap market. With the swap rate reaching an all time high this week, there seems to be no end in sight to the rate short term, if the Government does not supply dollars to the swap market.

With all this, the Government seems to be setting the stage for stagflation, as the economy stalls simultaneous with a sharp rise in prices due to the combined effect of a soaring swap rate, increased monetary liquidity and a reduction in the supply of goods which outweighs the reduced purchasing power of workers.

The problem is that the Government has to define policy at some point in the next few months. Corporations are facing total uncertainty in their plans as they are owed foreign currency and their most recent requests have yet to be approved. At the same time, many products are regulated and the Government always delays price increases. In fact, this week the Government actually lowered the price of some food products under the argument that international prices are down. However, this fails to take into account the high inflation levels of Venezuela in the last few years, which make recent price drops pale in comparison.

The Government faces the quandary that it cannot simply ignore the swap rate, but has fewer weapons to fight it this year. As importers and retail investors drive the rate higher, the Government does not appear to be intervening, as sellers are few and far in between. While it is reasonable for the rate to go up, given the stealth devaluation which is in fact in place, the problem is that the difference between the official and the swap rate is simply so large, that it creates too many distortions.

At the same time, the Government needs local currency, but the recent sale of local bonds can supply its needs for the time being. By allowing the swap rate to rise, the Government obtains Bolivars at a higher rate, so perhaps their allowing it to rise may not be as undecided as it seems at first sight.

Miguel Octavio is Executive Director in charge of research at BBO, Venezuela's leading investment bank.