The Law of Unintended Consequences: SITME and Venezuela's Currency Market
Travel to any country where the official currency exchange rate is fixed and what you will typically find is that two exchange rates are in use -- the official exchange rate and the real (or black market) rate. The heterodox experiment that is Venezuela in the Chávez-era, however, has gone one better. Alongside the official and the black market rate, there's another rate that is overseen -- but never quite acknowledged -- by Venezuela's central bank.
Known as SITME (the Spanish acronym for the System of Foreign Currency Transactions), the third rate is a tightly regulated trading platform allowing individual and corporate investors to buy Venezuelan public debt with local currency -- the bolivar -- and then sell that debt on for U.S. dollars. As Asdrubal Oliveros, who heads Caracas consulting firm Econanalítica, puts it, "SITME is a foreign exchange market that works through bonds, [but is] not a market for bonds."
Though Venezuela's central bank introduced the system in June 2010 and continues to host it, it appears increasingly clear that the market's strategists failed to foresee its potential effects. SITME has given rise to a slew of unintended consequences, many of which run counter to the ideology of President Hugo Chávez's government, and some of which seem to be adding to the mountain of distortions riddling Venezuelans' everyday lives with economic anomalies, banking and finance experts tell Universia Knowledge@Wharton.
SITME acts as an escape valve for an exchange control regime that has never been able to supply enough cheap official-rate dollars to Venezuela's import-oriented economy. "As in any controlled mechanism, the supply [of SITME-transactable bonds] is very limited -- just 30% to 35% of the demand for dollars," says Oliveros. "This has led to major bottlenecks and the rise of a black market alongside the central bank-controlled system."
For all the limitations, however, the availability of a legal source of foreign exchange is always noteworthy amid the ongoing dollar drought hitting the Venezuelan private sector. Under SITME, investors must have their banks sell the bonds they buy in the secondary market abroad, for dollars, at prices set unilaterally by the central bank. Firms participating in the system are subject to a slew of regulations to ensure SITME transactions finance imports rather than fueling capital flight. Maximum SITME disbursements are fixed at the equivalent of US$350,000 per month per investor -- a relatively tiny amount for any large corporation.
The platform has spawned a variety of arbitrage opportunities, petty scams and, by various accounts, serious "noise" in the valuation of Venezuela's sovereign debt. Paradoxically, the system has empowered some of the Chávez regime's critics, while contributing to a massive, and unsustainable, increase in the country's total debt. How did a system as convoluted as SITME come into being? And how have Venezuelans figured out how to exploit the opportunities SITME creates?
A Short History Lesson
The SITME story dates back to 2003, soon after the Chávez administration imposed strict controls that cut off access to foreign currency for a broad swath of Venezuelan firms and individuals. It soon was clear that the currency control legislation contained an important loophole: While locals could not trade bolivars for U.S. dollars freely, there was nothing preventing them from buying certain financial instruments locally, with bolivars, and immediately reselling them abroad for hard currency. At first, this was done using stock for the (then private) national telecoms firm, CANTV, and its corresponding American Depositary Receipts on the New York Stock Exchange. When CANTV was nationalized in 2007, however, public sector debt became the swap-paper of choice.
Although such operations ran counter to the spirit of exchange control restrictions, they stayed -- just barely -- within the letter of the law. Soon, dollar-bond swapping dominated Venezuela's moribund financial sector, with stockbrokers charging lucrative commissions for managing the transactions. Anyone with the political connections to obtain dollars at the lower official rate and to then sell them for bolivars at the higher parallel rate enjoyed enormously profitable arbitrage opportunities.
Meanwhile, in Venezuela's economy, where oil is exported and the bulk of consumer goods are imported with the proceeds, demand for dollars consistently exceeded the small sums the government released through the official market. The resulting parallel market for "swap dollars" came to be tolerated because officials realized that too strict of an interpretation of exchange controls would cut off a key mechanism for financing imports, and could exacerbate an already serious problem with shortages.
By early 2009, however, the dollar swap market was undermining the effectiveness of the official exchange rate peg as an inflation anchor. By that time, it was common knowledge among importers that prices throughout the tradable goods sector shadowed the swap market price: When the swap rate hit 5 bolivars per U.S. dollar, a US$10,000 car would sell in Venezuela for 50,000 bolivars, even if the car's importer had had access to the official rate and bought it for 21,500 bolivars.
Soon, however, the Chávez administration convinced itself that inflation could not be controlled until the swap market was brought to heel. In May 2010, the government cracked down. By that point "the permuta" [or swap market] had gradually come to hinder the government to such an extent that they decided to get rid of it," Oliveros notes.
The unregulated free-for-all was supplanted by the centralized SITME, cutting out the brokerage houses but now including the banks under very tight central bank regulation. Crucially, the implicit price of dollars does not float freely. Instead, while keeping one eye on the dollar prices of key swappable bonds, the central bank sets the local price of the corresponding bond. This meets the government's key policy goal of controlling the price of the dollars traded, but at an unintended cost.
Running on Empty
But one aspect of the new system soon came to the fore: For SITME to work, Venezuela's public sector must issue more and more fresh debt -- under the system, Venezuelan banks must buy public debt locally, in bolivars, and sell it on abroad, for dollars. Because the SITME exchange rate trades well below the going rate in the black market, however, no bonds make the return journey from the dollar market to the bolivar market. It stands to reason that no one would pay US$1 for a bond that sells in Venezuela for 5.50 bolivars when the same greenback will buy closer to 9 bolivars in the black market. As a result, every bond transacted in SITME is a bond that exits the bolivar zone and is, thereafter, transacted only in dollars. That being the case, the bolivar zone tends to "run out" of SITME bonds over time, creating periodic bond liquidity crises.
When SITME liquidity starts to falter, pressure mounts on the Venezuelan state to revive it. "SITME feeds on bonds," Econanalítica's Oliveros points out. "And to the extent that bonds become scarce, the easiest way the government has to face the situation is to create more of them."
Venezuela's public sector debt has risen extremely fast since SITME was introduced: In the two years since SITME was instituted, public sector debt has jumped 50%, from just under US$60 billion to US$90 billion. That's one reason why spreads on Venezuelan debt have shot up to more than 1,000 basis points.
According to Miguel Octavio, a Miami-based independent financial analyst, "it's that drip-drip-drip of bonds to the international market that's pushing up yields." The rise is driven largely by very fast growth in the debt of state-owned enterprises.
A case in point: PDVSA. Morgan Stanley expects debt at Venezuela's state-owned oil giant to climb from US$32 billion to over US$46 billion by the end of the year. And, sure enough, PDVSA debt has for most of the last two years been SITME's transaction instrument of choice. Whether SITME as such has independently helped fuel that rise is debatable, however.
Daniel Volberg, a New York-based Latin American economist for Morgan Stanley, says SITME is the administrative solution the government found for financing an unacknowledged balance of payments shortfall. "If you look at the fundamentals, you have a growing value of imports," Volberg notes. "But do you have enough hard currency inflows to cover dollar liabilities?" Though government numbers are opaque, he suggests that the answer is no.
The recent borrowing binge would have been needed to cover Venezuela's external shortfall, Volberg argues, quite apart from the institutional mechanism used to transact it. The evidence, then, is mixed.
It's clear that PDVSA has had reasons to issue debt aggressively over the past few years, quite apart from any concern to keep SITME liquid. The oil firm has had serious cash flow problems and fallen behind on its investment targets. Yet the introduction of SITME coincided with a sharp spike in Venezuelan bond spreads. So whatever its independent effect, SITME has coincided with what has become the central anomaly of the Venezuelan macro-economy under Chávez: The Western hemisphere's number-one oil producer, which has some of the world's largest proven crude reserves and a below average debt-to-GDP ratio, pays a higher risk premium for its debt than countries on the verge of default, like Greece.
Making Winners (and Losers)
Aside from the macro-level debates, SITME is known for the distortions it has created at the micro level, too. From the point of view of Venezuelan importers who gain access to it, SITME has become a sort of subsidy and, in effect, a key source of rents.
"There are 1,000 shady deals built around that exchange rate," notes Octavio, who had previously been part of a brokerage house involved in the permuta market. "You just think up something that can be imported and they'll give you a monthly sum. It's madness."
Or, as another Caracas financier who asked to remain anonymous says, "Practically anything you can import at 5.50 bolivar per U.S. dollar is going to make you a lot of money -- chocolate, air conditioner parts, furniture ... you name it. If you can bring it in through SITME, you'll make a killing."
It's easy to see why. In an economy whose reference exchange rate for pricing imports is still often the black market rate (which hovers around 8 bolivars to 9 bolivars per dollar), access to SITME dollars is access to risk-free profits. That is why ensuring access to the market has become a goal for Venezuelan businesses in the tradable sector.
Remarkably, this has been hugely empowering for Venezuelan banks, which have wide latitude in deciding which clients will be awarded the dollars. "Banks have tended to use SITME to reward their most loyal and profitable customers," says Oliveros. "If you walk in off the streets with a SITME request, of course, you'll be last in line for the dollars. It's their long established clients, the ones with active lines of credit that use many of the bank's services, that tend to have their requests approved."
What's more, SITME has spawned a cottage industry of firms launched largely to obtain SITME dollars and selling their allowance. There is plenty of demand for such services, according to experts. Importers that count their imports in the millions or tens of millions now rely on networks of such smaller firms, each with access to US$350,000 per month.
This kind of creative aggregation explains how importers have managed to keep Venezuelan store shelves relatively well supplied even amid such tight restrictions. One large, local electronics firm, Oliveros notes, "has simply asked each store in its retail distribution network to file a SITME request and channel the dollars they secure back to headquarters."