Could Venezuela dollarise successfully? - Capital Economics
Latin America Economics

Could Venezuela dollarise successfully?

Latin America Economics Update
Written by Quinn Markwith

Comments by Venezuelan President Nicolás Maduro suggest that the government considers dollarisation as an option to tackle hyperinflation. If implemented, this would probably bring inflation down sharply. But we doubt that this would be sustained so long as the current government is in power.

  • Comments by Venezuelan President Nicolás Maduro suggest that the government considers dollarisation as an option to tackle hyperinflation. If implemented, this would probably bring inflation down sharply. But we doubt that this would be sustained so long as the current government is in power.
  • Last week Mr. Maduro said “thank god” for dollarisation, and that “it could help the country recover”. The US dollar is already widely used in Venezuela; but formal dollarisation would require the government to make the dollar legal tender. This would remove the threat of devaluation. It would also remove monetary policy sovereignty, so that the central bank could not monetise the budget deficit. In principle, that would bring down inflation, incentivise fiscal discipline and reduce investors’ concerns about policymaking.
  • We are not legal experts, and there could be impediments to implementing some formal type of dollarisation in Venezuela. The central bank would need access to dollars in order to convert its bolivar liabilities. And sanctions prevent the US financial sector from dealing with the central bank.
  • Even if formal dollarisation is implemented, it would not guarantee permanently lower inflation. A country stands a better chance of success if it runs twin budget and current account surpluses. The latter allows for a healthy supply of dollars in the economy, sustaining domestic activity. The former removes any need to reissue the domestic currency in order to monetise the budget deficit.
  • The dollarisation experiences of Ecuador ( 2000 ) and Zimbabwe ( 2009 ) are worth exploring. As is the case in Venezuela, both experienced a hyperinflation crisis caused by deficit monetisation. The accuracy of Zimbabwe’s inflation data is widely disputed, but the IMF estimates that inflation fell abruptly just after dollarisation, as it did in Ecuador. (See Chart 1.) Inflation in Venezuela would likely fall too at first.
  • Unlike in Ecuador, where inflation stayed low, hyperinflation eventually returned in Zimbabwe. While Ecuador was able to keep fiscal policy tight in the decade after the transition, Zimbabwe was not. (See Chart 2.) The Zimbabwean government ultimately decided to issue a series of quasi-currencies, (most recently the RTGS dollar), to finance the budget deficit, causing inflation to surge again. (See Chart 1 again).
  • Venezuela would probably be much more like Zimbabwe than Ecuador. For one, Mr. Maduro would probably not abolish the local currency. Indeed, last week when talking about the prospect of dollarisation he said that the country would of course “always still keep the bolivar”. What’s more, Venezuela’s public finances are dire (see Chart 2 again), and there is no political appetite to reduce the deficit significantly. Finally, the combination of US sanctions and capital flight would likely cause an outflow of dollars, causing a painful contraction in domestic demand. This would push policymakers to start reissuing bolivars.
  • Dollarisation would be difficult to implement in Venezuela in any circumstances. That said, a new government would face a better chance at success. This chimes with historical experience which suggests that political change almost always precedes a countrys’ sustained exit from hyperinflation.

Chart 1: Ecuador & Zimbabwe Consumer Prices
% y/y, (T=Year of Dollarisation)

Chart 2: Government Budget Balance
(% of GDP)

Sources: IMF, Capital Economics

Source: IMF


Quinn Markwith, Latin America Economist, +44 20 7808 4072, quinn.markwith@capitaleconomics.com