Venezuela this week announced it would significantly raise fuel prices and devalue its currency as part of a series of measures to help shore up its flailing economy. Venezuelan president Nicolás Maduro also named a new economy czar: Miguel Pérez, the former head of an industry association. Reuters reports: “Perez has sought dialogue with Venezuela’s private sector and has also spoken of the need to eventually unify Venezuela’s multiple exchange rates.”
While these measures are a step forward, there is much more that needs to be done in order to stabilize the economy.
Let’s look at the numbers. The best estimates and forecasts for the Venezuelan economy have come from Bank of America Merrill Lynch (BOA). Unlike the IMF, which was not even in the ballpark in their forecast for 2015 GDP, BOA was on target. (Using a statistical model, BOA even correctly forecast the December National Assembly election results.)
BOA estimates that Venezuela has a public sector financing gap — which includes principal payments on the debt — of about $24 billion for 2016, and that about $5 billion will be covered by Chinese loans. Looking at the economy as a whole, the current account (mostly trade) deficit was about $18 billion last year. BOA also estimates that the government has about $60 billion in assets that it can sell for U.S. dollars, including its international reserves. So, the country is not broke yet — there is still at least another year to turn the economy around, or possibly more, depending on oil prices.
So where should Venezuela go from here? Here are four measures the country could take to create a path toward economic recovery:
Make living affordable
The economy has large imbalances that will have to be adjusted. Therefore, the first thing to ensure is that poor and working Venezuelans do not suffer from the adjustment. This means setting up a system to make sure that food, medicine, and other essentials are available at affordable prices. There are many governments that have such systems, including the U.S., where more than 45 million people receive food stamps.
The Venezuelan government has shown that it has administrative capacity when it really wants to use it, for example in administering national elections. Last year, the country even reduced significantly the amount of dollars lost to capital flight, which is amazing given the incentives to cheat under the current exchange rate system. Venezuela also has funds to ensure that most citizens have access to necessities at affordable prices. So, it is definitely possible to set up a food-stamp-type system under which people are protected from price increases, and shortages are eliminated.
Stabilize the currency
Once this system is in place, the government can unify the exchange rate. This is the most damaging imbalance in the economy. It has been causing an inflation-depreciation spiral since the fall of 2012. The rising black market rate increases inflation, which then feeds back into the price of the black market dollar, in a continuing vicious circle.
The fastest and best way to break this cycle is to allow the currency to float. It’s hard to say where it would settle, but it would likely be somewhere between 150 and 200 Bolivares Fuertes to the U.S. dollar — nowhere near the current black market rate. Although this devaluation would cause some inflation, in four out of the last five devaluations in Venezuela, the resulting increase in inflation disappeared within a year. Only the last devaluation, which took place in the middle of an inflation-depreciation spiral, contributed to a persistent increase in inflation. But unifying the exchange rate would break that spiral and put an end to the black market.
Once the currency begins to stabilize, a lot of U.S. dollars would come back into the country, since everything would be cheap for those who hold dollars. This is what happened in Argentina in 2002, after a huge devaluation. The government then managed the exchange rate for the next six years at a realistic level, and the economy grew very fast. (The business press predicted hyperinflation and continued deep depression.) Any devaluation in Venezuela that does not break the inflation-depreciation spiral is likely to lead to continued balance of payments crises and more inflation.
By unifying the exchange rate at a realistic level and breaking the inflation-depreciation spiral, the government will also avoid having to lose precious reserves defending an overvalued currency. It will put an end to the chronic balance of payments crises, as well as most of the corruption that stems from the overvalued official exchange rates.
Eliminate dysfunctional price controls
Once these measures are taken, and consumers are protected from rising prices for essential goods, the government can begin to lift some of the dysfunctional price controls. This week’s announcement of a gasoline price increase is a step in the right direction, but there are other price controls on food and household items that will need to be relaxed in order to eliminate shortages. This will save billions of dollars of foreign exchange lost to smuggling, although as noted above, consumers would have to be protected from price increases.
Adjust to lower international oil prices
Adjusting to lower oil prices over the intermediate and longer run will mean diversifying the economy away from oil. In 2011, Venezuela imported about 24 percent of its food; the country could become nearly self-sufficient in food production and pursue other import-substitution and diversification strategies, which would become more feasible with a lower-valued currency.
The government will have to take additional measures to bring down inflation, and there are many other policies that can contribute to economic growth and development. But first the economy has to be stabilized, to put an end to balance of payments crises and chronic shortages, as well as the recession of the past two years.
This column originally appeared in Fortune.