mas - from financial repression to external distress balas · ! 1!!!...

1

From financial repression to external distress: An inquiry into Venezuelan debt outlook

The literature on external default has stressed the existence of the so-‐called debt-‐intolerance puzzle: developing nations tend to default at debt-‐to-‐GDP ratios well bellow those registered in developed countries. The underestimation or plain omission of domestic debt may account for a fraction of that puzzle. We calculate fiscal revenues coming from financial repression using a number of different methodologies for the case of Venezuela, and look at their correspondence with comprehensive measures of capital flight. In particular, we incorporate into the traditional estimation of capital flight the over-‐invoicing of imports, rife in periods of exchange controls. We find that financial repression accounts for public revenues of the same magnitude of those reported for OECD economies, in spite of the latter having domestic debt-‐to-‐GDP ratios four to eight times larger. We also find that financial repression and capital flight are significantly higher over years of exchange control and interest rate caps. We interpret this as significant evidence suggesting a link between domestic disequilibrium and a weakening of external accounts via capital flight: deep negative yields on the domestic market lead to higher leakages in the capital account, that in turn erode the base of inflationary tax in spite of widespread controls.

J.E.L. Codes: E66, F32, F34. Keywords: Financial repression, seigniorage, capital flight, exchange controls

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I. Introduction The literature on external default has stressed the existence of the so-‐called debt-‐intolerance puzzle: developing nations tend to default at debt to gross domestic product (GDP) ratios that are well below the levels at which developed nations normally function. Reinhart and Rogoff (2011) and Reinhart and (2014) have suggested that at least part of the solution to that puzzle is to be found in domestic debt. Statistics on liabilities denominated in domestic-‐currency are hard to come by and the literature on domestic debt tends to be sparse. As a consequence, the importance of domestic debt burden in financial crisis and external defaults is often underestimated or plainly omitted. In this paper we suggest a link between high domestic debt burden and external distress analyzing the Venezuelan case. Over the previous eight years, in spite of the persistent oil price bonanza, Venezuela has amassed an astounding sum of public debt. Soaring foreign and domestic financial liabilities, plus piling up arrears, go to a great length in explaining why the country kept one eluding the ominous predictions of mainstream economics. The figures are quite revealing. Between 2006 and 2013, net consolidated foreign financial debt went up from US $26.9 to US $104.3 billion. Following the standard practice of the Bolivarian revolution, the Central Government only accounted for roughly a fifth of that increment. The difference, US $60.9 billion (78%), was issued by state owned enterprises and the Fondo Comun China-‐Venezuela (FCCV), a special-‐purpose vehicle allowing Venezuela to withdraw from a rolling line of credit at the Chinese Development Bank, in exchange for future shipments of oil. All of the latter scape the scrutiny of the National Assembly and are shielded from any formal mechanism of accountability. Domestic debt has also skyrocketed, going from VEF 36.298 in 2006 to VEF 420.502 million in 20131. The nominal increase of 1058% (CAGR: 42%) was partially offset by 528% of accumulated inflation (CAGR: 30%), resulting in a net increase in real domestic debt of 85% (CAGR: 9%). Alas, the Venezuelan government forced losses on domestic bondholders, by imposing an exchange control and interest caps, and then resorting to printing money and accelerating inflation. We begin by stating the current situation of domestic and foreign debt, given the complicated structure of multiple exchange rates that prevails in the economy. We then move on to analyzing the mechanisms of financial repression that are used by the government to default on its domestic debt obligations. We use two different methodologies to estimate financial repression, a) decomposing its effects into a unexpected inflation component and a ex-‐ante financial repression component (Reinhart), 2014), and b) contrasting the yield on foreign debt with ex-‐ante and ex-‐post returns on domestic financial instruments (Giovanini and De Melo, 1991). We then proceed to show that domestic financial repression tends to accelerate leakages on the capital account in the form of capital flight and over-‐invoicing of imports. Both practices tend to weaken the net foreign asset position, contributing to balance of payments crisis that increase the likelihood of an external default.

1 The latest figure reported by Minister de Finance corresponds to September 30, 2013.

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II. Venezuela debt-‐to-‐GDP ratios and the exchange rate dilemma The coexistence of multiple exchange rates over prolonged periods of time makes it difficult to estimate precise debt-‐to-‐GDP ratios. Nowhere is that more evident than in Venezuela. Throughout 2013 the average parallel exchange rate premium peaked at 478%, while debt-‐to-‐GDP ratios calculated at market rates were 3.9 times higher than those at the official rate (See Figure 1 and Figure 2). As Venezuela has undergone three long periods of exchange controls spanning over 18 of the previous 28 years, we can look at previous episodes to assess where did the debt-‐to-‐GDP ratio stabilized once the exchange rate was unified.

Figure 1

Figure 2

10,5%% 12,0%% 10,1%%12,5%%

14,9%%11,4%% 10,4%%

8,4%% 6,8%%9,3%%

3,3%%

9,6%%13,5%% 12,1%%

16,7%%

9,6%%7,6%% 7,9%%

10,3%%13,5%%

16,2%%18,9%%

14,7%%11,1%%

9,2%%7,3%%

4,5%%7,5%% 8,9%%

11,4%%

15,6%% 15,8%%

46,7%

59,5%

45,4%

53,3%

71,7%

77,4%

68,6%

76,5%

62,9%65,5%

57,5%

64,2%60,0%

54,6%58,8%

43,0%38,7% 37,6%

32,6%34,6%

46,0%

53,5%

39,6%

32,3%

23,7% 24,1%20,7%

28,0%

40,7% 42,3%43,2%

39,8%

1982% 1983% 1984% 1985% 1986% 1987% 1988% 1989% 1990% 1991% 1992% 1993% 1994% 1995% 1996% 1997% 1998% 1999% 2000% 2001% 2002% 2003% 2004% 2005% 2006% 2007% 2008% 2009% 2010% 2011% 2012% 2013%

Consolidated%Public%Debt%(%%of%GDP%at%average%official%market%rates)%

Domes1c%Debt% Foreign%Debt% Total%Public%Debt%

10,5%% 12,0%% 10,1%% 12,5%%14,9%%

11,4%% 10,4%% 8,4%% 6,8%% 9,3%%3,3%%

9,6%%13,5%% 12,1%%

16,7%%9,6%% 7,6%% 7,9%% 10,3%% 13,5%%

16,2%% 18,9%% 14,7%%11,1%% 9,2%% 7,3%% 4,5%% 7,5%% 8,9%% 11,4%%

15,6%% 15,8%%

46,7%

109,1%

79,0%87,0%

117,6%114,9%110,8%

76,9%

62,6% 64,7%56,8%

63,8% 64,5%72,6%

62,3%

43,0%38,6% 37,5%

32,6% 34,6%

45,9%

71,2%

52,4%

38,2%

27,1%

42,5%38,0%

65,2%69,7%

73,3%

87,4%

154,3%

1982% 1983% 1984% 1985% 1986% 1987% 1988% 1989% 1990% 1991% 1992% 1993% 1994% 1995% 1996% 1997% 1998% 1999% 2000% 2001% 2002% 2003% 2004% 2005% 2006% 2007% 2008% 2009% 2010% 2011% 2012% 2013%

Consolidated%Public%Debt%(%%of%GDP%at%average%parallel%market%rates)%

Domes1c%Debt% Foreign%Debt% Total%Public%Debt%

4

In 1988 the debt-‐to-‐GDP ratio at the parallel market rate almost doubled the one registered at the official exchange rate (100.3 vs. 58.1%). Once the system of controls was dismantled, in the process of economic reform of 1989 (El Gran Viraje), debt-‐to-‐GDP ratios stabilized at a level (68.2%) that was much closer to the ones obtained using the official exchange rate pre-‐liberalization. Something similar occurred in 1997, when a new attempt at stabilizing the economy (Agenda Venezuela) unified the exchange rate, resulting in debt-‐to-‐GDP ratios very similar to those estimated at the official exchange rate the year before. These experiences are both intuitive and somewhat hopeful.

Figure 3

Before the controls are dismantled, the economy functions at a level of prices that seems to respond to the average exchange rate prevailing in the economy. As exchange rate controls typically come coupled with price controls, the level of prices embedded in the nominal GDP does not reflect the marginal (parallel) exchange rate, but rather the average rate. Surely there is a lot of uncertainty on domestic importers and producers about the rate at which they will be able to get the next allotment of foreign currency, but that uncertainty cannot always be transferred to prices due to the existence of price controls. Within those circumstances, debt-‐to-‐GDP ratios calculated at parallel market rates overshoot, as the average marginal exchange rate is used to convert foreign debt into domestic currency (or alternatively, nominal GDP and domestic debt into foreign currency), but nominal GDP has not yet incorporated the full price effects implicit on that rate. Once the unification takes place, often coupled with elimination of price ceilings, inflation takes off and nominal GDP jumps, stabilizing the debt-‐to-‐GDP ratio at a level much closer to the one previously calculated at the official exchange rate.

97,2%

68,9%74,5%

102,7%103,5%100,3%

51,0%

60,5%

45,7%52,2%

37,7%

27,1%

17,9%

35,2% 33,4%

57,7%60,9% 61,9%

71,9%

138,6%

36,3%

47,5%

35,3%40,8%

56,9%

66,0%58,1%

68,2%

56,1% 56,2% 54,3% 54,6%46,4%

42,5% 42,1%

33,4% 31,2% 29,7%22,3% 21,1%

29,8%34,6%

24,9%21,2%

14,5% 16,8% 16,2%20,5%

31,8% 31,0% 27,7%24,0%

1982% 1983% 1984% 1985% 1986% 1987% 1988% 1989% 1990% 1991% 1992% 1993% 1994% 1995% 1996% 1997% 1998% 1999% 2000% 2001% 2002% 2003% 2004% 2005% 2006% 2007% 2008% 2009% 2010% 2011% 2012% 2013%

Consolidated%Public%Foreign%Debt%(%%of%GDP)%

Average%Parallel%Market%Rate% Average%Official%Rate%

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It all depends, as it turns out, on the average exchange rate at which the economy is functioning. For example, take the last unresolved episode of exchange controls and financial repression. According to Barclays Bank (2014), during 2013 the average exchange rate was 16,0 VEF per dollar, which is somewhere in between the official rates (6,3 and 11,4) and the average parallel market rate (35,0). At that rate, total debt-‐to-‐GDP ratios result in 78%, which is closer to the lower bound at the official rate (39,8%) than to the upper bound estimated at the parallel market rate (154,3%). III. Different approaches to financial repression Financial repression is the equivalent of defaulting on domestic debt. That default is engineered through exchange controls that keep liquidity trapped, as interest rate ceilings well below inflation force losses on domestic bondholders. Since the banking system is usually the one purchasing government debt, these losses are transferred to depositors in the form of even lower negative real rates, which operate as an effective tax on savings. We will use two different conceptual frameworks to assess the impacts of financial repression. The first one will be based of a modified version of Reinhart and Sbrancia (2013), which introduced a theoretical differentiation between the effects of unexpected inflation and those of ex-‐ante financial repression; i.e. domestic interest rates below expected inflation. The second approach is conceptually based on Giovanini and De Melo (1999), who proposed using the differentials in returns between foreign debt issued in international markets and domestic debt as a proxy for financial repression. We compare these estimates with the ex-‐post financial repression resulting from the differential between inflation and domestic interest rates. 1. Unexpected inflation and ex-‐ante financial repression We use the approach of Reinhart and Sbrancia (2013), introducing a small modification to allow for differentiation between foreign and domestic debt. The approach departs from the consolidated public budget in real terms, differentiating between cash outlays and inflows: (1) 𝑔! +

!!!!!!!!!!

𝑏!!! +!!!!!!

∗

!!!!∗𝑒!𝑏!!!∗ = 𝜏! + 𝑏! + 𝑒!𝑏!∗ + ℎ! −

!!!!!!!!

On the left hand side we have got total cash outflows: • Real government expenditure 𝑔! • Real debt service on domestic debt !!!!!!

!!!!𝑏!!!

• Real debt service on foreign debt, !!!!!!∗

!!!!∗𝑏!!!∗ multiplied by the real exchange rate 𝑒!

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Note that the ex-‐post real interest rate for domestic debt and foreign debt is a function of the ex-‐ante nominal interest rate 𝑖!!! 𝑎𝑛𝑑 𝑖!!!∗ and realized inflation 𝜋! 𝑎𝑛𝑑 𝜋!∗ respectively. On the right hand side of the equation are the three sources of income: • Taxes 𝜏! • New real issuances of debt, both domestic 𝑏! , and foreign 𝑏!∗ • Seigniorage (ℎ! being the monetary base). Let 𝑖!!!! be the interest rate that would be levied on domestic debt in the absence of financial repression, and 𝜋!! the expected rate of domestic inflation in period t. By adding and subtracting !!!!!!! !!!!!!!!

!!!!!𝑏!!! from the left hand side of (1) and working out the algebra (see

Appendix 1) we get to:

𝑔! + 1 + 𝑟!! 𝑏!!! + 1 + 𝑟!∗ 𝑒!𝑏!!!∗ − 1 + 𝑡!!𝜋! − 𝜋!!

1 + 𝜋!𝑏!!! −

𝑖!!!! − 𝑖!!!1 + 𝜋!!

𝑏!!! = 𝜏! + 𝑏! + 𝑒!𝑏!∗ + ℎ! −ℎ!!!1 + 𝜋!

where:

1+ 𝑟!! = !!!!!!!

!!!!! , the ex-‐ante real return on domestic debt in absence of financial repression,

1+ 𝑟!∗ = !!!!!!

∗

!!!!∗ , the real return on foreign debt

1+ 𝑟!! = !!!!!!

!!!!! , the ex-‐ante real return on domestic debt

We can now rearrange the consolidated real public budget in the following way: (2) 𝑔! − 𝜏! + 𝑟!

!𝑏!!! + 𝑟!∗𝑒!𝑏!!!∗ + ∆𝑏! + 𝑒!∆𝑏!∗ = 1 + 𝑟!!!!!!!

!

!!!!𝑏!!! +

!!!!! !!!!!!!!!

! 𝑏!!! + ℎ! −!!!!!!!!

Unanticipated inflation Financial repression Seigniorage Now we have on the left hand side financing needs without either financial repression or seigniorage. We have grouped those into primary fiscal balance 𝑔! − 𝜏! , real interest rate payments on domestic debt in the absence of financial repression 𝑟!

!𝑏!!! , real interest payments on foreign debt in domestic currency 𝑟!∗𝑒!𝑏!!!∗ , and the net increase in domestic ∆𝑏! and foreign debt 𝑒!∆𝑏!∗ . On the right hand side we obtained a theoretical differentiation of three sources of fiscal revenues that are in essence quite different: Unanticipated inflation 1 + 𝑟!!

!!!!!!

!!!!𝑏!!!, ex-‐ante

financial repression arising from differences between free market and realized domestic interest

7

rates !!!!! !!!!!!!!!

! 𝑏!!! , and seigniorage ℎ! −!!!!!!!!

. Seigniorage and its corresponding inflation tax are applied over those holding high-‐powered money, while the tax base for financial repression are government bonds. Moreover, neither inflation is a prerequisite for financial repression nor interest rate ceilings are required to impose inflation taxes. That is not to say there are no complementarities between financial repression and inflation taxes. As a matter of fact, given interest rate ceilings and within certain non-‐hyperinflationary limits, both are a positive function of the rate of inflation. However, from a conceptual standpoint, it is important to differentiate between these components: As financial liberalization takes place, inflation-‐tax will most likely hold while fiscal revenues derived from financial repression vanish. It is also important to distinguish between the effects of inflation surprises and ex-‐ante financial repression. The former results from agents’ failure to forecast inflation accurately. The latter responds to pure expected financial repression effects, i.e. even if economic agents are able to forecast inflation accurately, interest-‐rate ceilings below expected inflation still force real losses on their holdings of domestic bonds. In periods of financial repression, one would think that the government has a higher potential to surprise agents with unexpected inflation, given the fact that prices do not fully adjust to supply and demand forces, but rather follow price control lists that are adjusted spasmodically. The modification that we have introduced in the framework of Reinhart and Sbrancia (2013) allows for two conceptual differentiations that are essential to understand the Venezuelan fiscal outlook. First, it explicitly states that failure to refinance foreign debt results in a higher need to resort either to financial repression or seigniorage. Second, it incorporates the effects of a real depreciation as a financing mechanism, which usually translate into higher money supply (printing more domestic currency in exchange for unit of dollar exports) on the right hand side of the equation. Data and Calculations We estimated the right hand side of the equation for Venezuela over the 28 years spanning from 1986 to 2013. Given the large changes that occur from year to year in the stock of domestic debt and the fact that the maturities of these instruments seem is short, we have used the average stock of domestic debt as the basis for the calculations. In order to pin down the first and second components we relied on two assumptions. The first one is related to expected inflation, while the second one is the nominal interest rate that would have prevailed in the domestic market in the absence of financial repression. We have estimated expected inflation following a standard ARMA model. To estimate free-‐market nominal domestic interest rates we have separated years of financial repression (18 out of 28) from those where free-‐market conditions prevailed (10). Within this division, every year that begun with price, interest rate and exchange controls is considered among the former, including the two years where significant reform programs aimed at liberalizing the economy were introduced. We believe this is the right approach since in both cases, El Gran Viraje (1989)

8

and the Agenda Venezuela (1996), policy packages caught the general public largely by surprise and involved large fiscal revenues derived from unexpected inflation and financial repression. Over the ten years of free market conditions (1990-‐1993 and 1997-‐2002) average nominal interest rates on domestic bonds came up 1.10 times the inflation rate, in contrast with 0.71 on the 18 years of financial repression. Therefore, we have assumed that within the financial repression years, nominal interest rates on domestic bonds would have yield 1.10 times the rate of inflation. Following this approach results in a lower-‐bound estimate for financial repression, given that controls are typically imposed on years of economic hardship, where presumably a higher premium over inflation would have been demanded. Results Results are reported in Table I, where financial repression years are shadowed. At an aggregate level, it is noteworthy the fact that unidentified free-‐market financial needs averaged 5.26% of GDP over the twenty-‐eight years studied. As expected, periods of financial repression and price controls exhibit much higher free-‐market financing needs (6.78%) than otherwise (2.53%). Out of the three sources of financing on the right hand side of equation (2), seigniorage is by far the largest, representing on average 4.19% of GDP per year. Governments tended to resort more on printing money for generating fiscal revenues in times of repression (4.64%) than in free-‐market periods (3.36%), but in any case deficit monetization is significant and pervasive across the board. This points out to a chronic disequilibrium within the Venezuelan fiscal accounts, most likely related to: a) the temptation of obtaining more domestic currency in exchange for oil exports by means of devaluation, and b) large real exchange rate volatility. Ex-‐ante financial repression contributed on average 0.91% of GDP every year. As expected, fiscal collections via repression were higher (1.40% of GDP) in times of controls and on average almost nonexistent in free-‐market years (0.01%). Interestingly, liquidation years2 somewhat overlap with financial repression, but are not unheard of during free market periods. Within the twenty-‐eight year sample, twenty-‐one (75%) were liquidation years; fourteen of those (66%) under financial repression years and the remaining seven (33%) on free-‐market periods. The contribution of unexpected inflation to finance fiscal financing needs on average is low (0.17% of GDP), but when we consider financial repression years and free market years a significant difference shows up. Unexpected inflation generated 0.73% of GDP in fiscal revenues in years of financial repression, compared to -‐0.85% in free-‐market years. According to the functional form assumed for expected inflation, the government seems to have more capacity to surprise economic agents in periods of financial repression. This might be a consequence of persistent price controls that regulate inflation and do not permanently adjust to market forces but are rather updated with significant time lags in reaction to scarcity.

2 Liquidation years are defined as years where real average yield on government bonds was negative (see Reinhart and Sbrancia, 2013)

9

Table I

The sheer size of fiscal revenues generated via financial repression is quite significant, given that the average ratio of domestic debt-‐to-‐GDP averaged 10.9% over the whole period (11.8% over the years of controls). Reinhart and Sbrancia (2013) have documented fiscal revenues in the range of 2-‐3% of GDP coming from financial repression in the United States and the United Kingdom, but one must take into account that domestic debt to GDP ratios in those countries were anywhere between four and eight times larger than Venezuela’s. In other words, it takes a lot more financial repression to generate fiscal revenues in Venezuela, given that the relative size of its domestic debt its much smaller.

VEF$Million %$GDP VEF$Million %$GDP VEF$Million %$GDP

1986 1 0.22 0 10.05$ 9 1.891987 10 1.43 13 1.81 21 3.071988 8 0.91 15 1.70 27 3.071989 34 2.24 70 4.65 48 3.161990 -5 10.23$ 29 1.26 106 4.641991 -22 10.74$ 29 0.97 205 6.751992 -29 10.69$ 20 0.48 131 3.171993 6 0.11 36 0.66 146 2.671994 145 1.67 223 2.57 436 5.031995 157 1.15 247 1.80 436 3.181996 774 2.63 1,187 4.03 1,239 4.211997 -602 11.43$ 45 0.11 1,888 4.501998 -726 11.45$ -223 10.45$ 1,504 3.011999 -1,204 12.03$ 14 0.02 1,902 3.202000 -1,085 11.36$ -1,425 11.79$ 1,566 1.972001 -1,099 11.24$ -1,399 11.57$ 1,332 1.502002 625 0.58 461 0.43 2,410 2.232003 2,712 2.02 2,217 1.65 5,400 4.022004 -727 10.34$ -4,027 11.89$ 7,065 3.322005 -2,616 10.86$ -4,275 11.41$ 8,633 2.842006 -1,292 10.33$ 872 0.22 25,067 6.362007 1,563 0.32 3,681 0.74 27,608 5.582008 3,379 0.50 7,862 1.16 35,119 5.182009 1,399 0.20 7,412 1.05 32,561 4.602010 -25 10.00$ 9,062 0.89 46,711 4.592011 -1,708 10.13$ 16,556 1.22 76,315 5.622012 -12,692 10.77$ 10,213 0.62 124,277 7.582013 62,627 2.35 119,638 4.49 272,982 10.24

Average 1,772 0.17 6,020 0.91 24,112 4.19Average'Repression/Control'Years 2,986 0.73 9,498 1.40 36,886 4.64

Average'Free'Market'Years -414 10.85$ -241 0.01 1,119 3.36

Unanticipated$Inflation$Effect

Ex1ante$Financial$Repression$Effect Seigniorage

Unanticipated'Inflation,'Financial'Repression'and'Seigniorage'in'Venezuela'(1986E2013)

10

Take as an example the years 1989, 1996 and 2013, where fiscal revenues via ex-‐ante financial repression totaled 4.65%, 4.03%, and 4.49% of GDP respectively. Given that domestic debt-‐to-‐GDP ratios were relatively low, in order to achieve that size of collections financial repression had to be rampant. As can be gathered from Figure 5, negative interest rates on government bonds in those years were 37.73%, 23.26% and 25.20%.

Figure 4

2. Domestic and foreign cost of borrowing The second approach we will use to measure financial repression is based on the difference between the domestic and foreign cost of borrowing (Giovanini and de Melo, 1991). As foreign yields do reflect free-‐market risk perception, and assuming that domestic and foreign bonds are perfectly substitutable, we can estimate the fiscal effects of financial repression by calculating domestic debt service at yields demanded by international market on foreign bonds. This approach assumes that there are no transaction costs, no risk differentials between domestic and foreign bonds, and that taxes levied on domestic and foreign debt instruments are similar. Data and Calculations Our choice of indicator for sovereign debt returns is different form the one used by Giovanini de Melo (1991). They have used an ex-‐post measure consisting effective interest rate payments plus arrears, divided into average outstanding stock of both domestic and foreign debt. From there, they proceed to calculate government revenue from financial repression by computing the differential between foreign borrowing cost (translated into domestic currency) and domestic borrowing cost, times the average stock of domestic debt.

34,2%31,4%

38,1%

60,8% 59,9%

99,9%

50,0%

35,8%

23,6%

16,2%12,5%

22,4%

31,1%

19,2%14,3%

16,9%

22,6%

32,4%28,6% 27,8% 27,6%

19,9%

56,1%

20,1%

27,1%31,7%

41,0%

54,7% 53,4%49,1%

25,4%

47,9%

31,1%

21,0% 22,1%

38,5%

32,2%

15,6%12,9%

7,8% 9,6%14,5% 12,8%

15,5% 17,5% 16,8%

1991# 1992# 1993# 1994# 1995# 1996# 1997# 1998# 1999# 2000# 2001# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012# 2013#

Average%Nominal%Domes;c%Bond%Yield%and%Infla;on%%

Infla0on# Average#Yield#on#Domes0c#Bonds#

11

While this approach is correct from an accounting standpoint, it misses some important sources of differentials that influence borrowing costs from an economic perspective other than interest rate payments. In particular, it ignores the fact that large swing in prices of sovereign debt help to adjust for the difference between the coupon rate of foreign debt and the yield demanded by international markets. The fact that these price adjustments do not occur in most of the domestic debt markets of developing countries, since the marketability of domestic debt instruments tends to be limited and most of them as hold until maturity, is yet another feature of financial repression. We have chosen the Merrill Lynch maturity-‐adjusted index of sovereign yield on Venezuelan foreign debt (GDVE)3 as a proxy for foreign borrowing cost. The only limitation is that the GDVE is only available from 1991 onwards, since the Venezuelan foreign debt did not float on international markets up until the Brady Bond exchange occurring that year. For domestic debt yields, we have taken the average yields on national public debt reported by the International Monetary Fund (IMF)4. Using GDVE yields in dollars, and the realized loss of value in domestic currency vis-‐à-‐vis the dollar, we calculated equilibrium domestic interest rates for domestic public debt instruments for every year. For those years were exchange control prevailed we have used the average depreciation of domestic currency coming the parallel market. Results Figure 6 below presents the dollar returns on foreign and domestic debt calculated at the official exchange rate for the twenty-‐three years spanning from 1991 to 2013. The patterns mirror the particularities of the adopted exchange rate policy in Venezuela: Periods of fixed exchange rate (2003-‐2013) or dirty floating within bands that lag significantly behind inflation (1994-‐1995 and 1999-‐2002), typically followed by large devaluations leading to deep dives in the dollar return on domestic government bonds. At the official exchange rate the picture is not so startling, as fifteen years (65%) present positive dollar returns, albeit only half of them are above the yield of foreign debt instruments. The problem is that these calculated returns are hard to realize, as access to dollars at the official exchange rate are far from granted, and almost closed for capital account transactions. A more realistic approach to dollar returns on domestic debt instrument is presented on Figure 7, which has been drawn using depreciation of the domestic currency in the parallel exchange rate market. There are eleven years (48%) of positive dollar returns on domestic debt instruments; only six of those with yields that are higher than those demanded by international markets. Average returns on negative return years are very large (20.5%), and in particular 2013 where someone investing in a basket of domestic bonds at the beginning of the year would have seen 63.3% of the dollar value of its investment sunk by year end. 3 Obtained form Bloomberg and coded GDVE Index Merril Lynch. 4 Effective weighted average yield on national public debt bonds traded in the Caracas Stock Exchange. From January 1999, weighted average yield on national public debt.

12

Figure 5

Figure 6

In order to calculate government revenues coming from financial repression, we have computed the difference between equilibrium domestic borrowing cost as described above and average yield on national public debt bonds, times the average stock of domestic debt on the year. Results are reported in Table II (using official exchange rate) and III (parallel market rates).

11,9$15,0$

10,7$

21,3$

16,0$

9,8$ 9,6$

16,0$14,4$

13,3$

14,7$13,1$

8,9$

7,7$

7,1$

6,6$

9,1$

21,6$

14,1$

13,9$ 13,7$

9,4$

13,8$

-0,6$$

5,6$$

-0,3$$

-13,7$$

30,3$$

-35,0$$

27,3$$

11,9$$

33,7$$

16,8$$

13,7$$

-23,9$$

-0,0$$

12,7$$

3,2$$

10,9$$

7,8$$9,5$$

14,5$$

-36,0$$

2,1$$

17,5$$

-18,3$$

1991# 1992# 1993# 1994# 1995# 1996# 1997# 1998# 1999# 2000# 2001# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012# 2013#

Financial$Repression:$US$$Yields$on$Foreign$and$DomesCc$Debt$(@Official$Exchange)$

Average#US$#Yield#on#Foreign#Debt# Average#US$#Yield#on#DomesAc#Bonds#@Official#

11,9$15,0$

10,7$

21,3$16,0$

9,8$ 9,6$

16,0$ 14,4$

13,3$

14,7$ 13,1$8,9$

7,7$

7,1$ 6,6$9,1$

21,6$

14,1$ 13,9$ 13,7$9,4$

13,8$

-0,6$$

5,6$$

-0,3$$

-21,4$$

0,6$$

-14,7$$

38,1$$

11,9$$

33,7$$

16,8$$

13,7$$

-23,9$$

-33,8$$

12,6$$

22,2$$

14,8$$

-36,4$$

10,7$$

-15,7$$

-5,9$$-2,3$$

-9,6$$

-63,3$$

1991# 1992# 1993# 1994# 1995# 1996# 1997# 1998# 1999# 2000# 2001# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012# 2013#

Financial$Repression:$US$$Yields$on$Foreign$and$DomesCc$Debt$(@Parallel$Exchange)$

Average#US$#Yield#on#Foreign#Debt# Realized#US$#Yield#on#DomesCc#Bonds#@Parallel##

13

Table II

Table III

VEF$Million %$GDP

Expost'Financial'Repression'@Official'Exchange'Rate

Merryl$Lynch$Ave$Yield$(US$)

Devaluation Equilibrium$Yield$Domestic

Equilibrium$Domestic$Yield$D$Average$Government$Yield

Financial$Repression

1991 11.88 20.83 35.19 15.13 33 1.091992 15.00 20.43 38.49 11.35 24 0.571993 10.71 32.04 46.18 14.52 48 0.881994 21.33 63.36 98.19 57.16 486 5.601995 15.98 18.78 37.76 D16.97$ D240$ D1.76$1996 9.83 135.99 159.18 105.80 3,476 11.811997 9.58 17.07 28.29 D20.80$ D930$ D2.22$1998 16.01 12.07 30.01 4.60 180 0.361999 14.38 10.62 26.52 D21.36$ D908$ D1.53$2000 13.31 12.26 27.20 D3.92$ D254$ D0.32$2001 14.71 6.43 22.09 1.06 107 0.122002 13.08 60.43 81.42 59.30 8,728 8.092003 8.89 38.56 50.88 12.37 2,648 1.972004 7.72 17.21 26.26 D5.89$ D1,665$ D0.78$2005 7.13 12.00 19.98 4.41 1,430 0.472006 6.57 1.81 8.50 D4.43$ D1,550$ D0.39$2007 9.14 0.00 9.14 1.33 481 0.102008 21.56 0.00 21.56 12.01 3,994 0.592009 14.13 0.00 14.13 D0.34$ D144$ D0.02$2010 13.88 76.28 100.75 87.91 63,073 6.202011 13.73 13.17 28.71 13.18 16,105 1.192012 9.38 0.00 9.38 D8.12$ D16,610$ D1.01$2013 13.76 42.99 62.66 45.90 155,102 5.82

Average 1.60Average'Repression/Control'Years 2.13

Average'Free'Market'Years 0.78

VEF$Million %$GDP

Expost'Financial'Repression'@Parallel'Market'Rate

Merryl$Lynch$Ave$Yield$(US$)

Depreciation Equilibrium$Yield$Domestic

Equilibrium$Domestic$Yield$E$Average$Government$Yield

Financial$Repression

1991 11.88 20.83 35.19 15.13 33 1.091992 15.00 20.43 38.49 11.35 24 0.571993 10.71 32.04 46.18 14.52 48 0.881994 21.33 79.50 117.78 76.75 652 7.521995 15.98 53.78 78.35 23.62 335 2.451996 9.83 79.87 97.55 44.17 1,451 4.931997 9.58 7.97 18.31 E30.78$ E1,376$ E3.28$1998 16.01 12.07 30.01 4.60 180 0.361999 14.38 10.62 26.52 E21.36$ E908$ E1.53$2000 13.31 12.26 27.20 E3.92$ E254$ E0.32$2001 14.71 6.43 22.09 1.06 107 0.122002 13.08 60.43 81.42 59.30 8,728 8.092003 8.89 109.35 127.96 89.45 19,153 14.272004 7.72 17.38 26.44 E5.71$ E1,614$ E0.76$2005 7.13 E5.45$ 1.29 E14.28$ E4,634$ E1.52$2006 6.57 E1.59$ 4.87 E8.06$ E2,818$ E0.72$2007 9.14 69.51 85.01 77.20 27,878 5.642008 21.56 E1.07$ 20.26 10.71 3,561 0.532009 14.13 35.86 55.05 40.58 16,986 2.402010 13.88 19.96 36.61 23.77 17,057 1.682011 13.73 18.22 34.44 18.91 23,115 1.702012 9.38 29.96 42.15 24.66 50,472 3.082013 13.76 217.85 261.58 244.82 827,209 31.03

Average 3.40Average'Repression/Control'Years 5.16

Average'Free'Market'Years 0.66

14

Average fiscal revenues from financial repression range from 1.60% of GDP (official rate) and 3.40% of GDP (parallel market). Within the fourteen years of financial repression in the period 1991-‐2013, government revenues averaged 2.13% of GDP at the official rate and 5.16% at the parallel market rate. In 2013 alone, given that the average dollar price in VEF increased 217.85% and that average dollar yield of foreign debt was 13.76%, equilibrium domestic returns on domestic government bonds would have been 244.82%. This figure is in stark contrasts with realized yields (16.76%), and results in revenues coming from financial repression equivalent to no less than 31.03% of GDP. Tables II and III also show how parallel market rate estimates of financial repression tend to precede those at the official exchange rate. Take for example the three years of exchange controls ranging from 1994-‐1996. The parallel market rate was legal, exhibiting a premium over the official exchange rate of 10%, 42% and 8% respectively. As the official exchange rate tends to lag inflation and the parallel exchange rate, the estimates on financial repression at the official rate result in lower fiscal revenues for 1994 (5.60% of GDP vs. 7.52%) and 1995 (-‐1.76% of GDP vs. 2.45%). In 1995 the official exchange rate adjusted 70.83% closing the premium on the parallel exchange rate market from 89.93% to 14.90%. That year estimates of revenues coming from financial repression at the official exchange rate were more than twice those at the parallel exchange rate (11.81% of GDP vs. 4.93%). Something similar occurred in the period 2005-‐2010. Between March 2005 and December 2009, in spite of cumulative inflation of 165.11%, the official exchange rate remained fixed at 2.15 bolivars (VEF) per dollar. Throughout that period, the parallel exchange rate premium went from 32.5% to 175.8%, resulting in cumulative fiscal revenues 2005-‐2009 from financial repression at the parallel market rate (9.53% of GDP) twelve times higher than those obtained at the official exchange rate (0.74%). In 2010 there was a two-‐step exchange adjustment between January and February totaling a devaluation of 50%. As a consequence, in 2010 fiscal revenues from financial repression resulted at 6.20% of GDP at the official exchange rate, as opposed to 1.68% at the parallel market rate. In general, as the parallel market rate maintains a significant premium throughout the whole exchange control period (see Figure 8), revenues coming from financial repression tend are much higher than at the official exchange rate. One should keep in mind when looking at these results that average domestic debt throughout the sample period represented 11.1% of GDP. As fiscal revenues are higher than the ones obtained elsewhere in the literature for countries with much higher domestic debt to GDP ratios (see Reinhart and Sbrancia, 2013), one can only conclude that financial repression during years of exchange controls in Venezuela was rampant, and well beyond any other recorded precedent for such a long period of time.

15

Figure 7

3. Summary of government revenues from financial repression Table IV below summarizes the three different measures of financial repression we have used, and adds a fourth ex-‐post one computed out of the simple difference between inflation and domestic government bonds yields, times the average stock of domestic debt. The sample has been restricted to the twenty-‐years spanning form 1991 to 2013, the only period for which the information required by all indicators is available.

!25,00&

75,00&

175,00&

275,00&

375,00&

475,00&

ene!91&

dic!91&

nov!92&

oct!93&

sep!94

&

ago!95&

jul!9

6&

jun!97&

may!98&

abr!99&

mar!00&

feb!01

&

ene!02&

dic!02&

nov!03&

oct!04&

sep!05

&

ago!06&

jul!0

7&

jun!08&

may!09&

abr!10&

mar!11&

feb!12

&

ene!13&

Deprecia(on+vs.+Devalua(on+Twelve!month&Moving&Average&(%)&

DepreciaKon&(Parallel&Market)& DevaluaKon&Official&Exchange&Rate&

16

Table IV

Three ideas are salient. First, regardless of the methodology, government revenues coming from financial repression thrive on periods of interest-‐rate ceilings, exchange and price controls, and come close to zero when none of these restrictions prevail. The range of averages is quite significant given the fact that Venezuelan domestic debt-‐to-‐GDP ratios are relatively small. Second, large misalignments across these indicators on a year-‐to-‐year basis most likely mirror misalignments across domestic government bond-‐returns, foreign yields, inflation, and exchange rate movements. As these are pervasive throughout the sample, one can only conclude that calling years without controls “free-‐market years” in Venezuela may be a euphemism, helpful from a conceptual standpoint and yet inaccurate. After decades of heavy government intervention and widespread regulations going well beyond outright controls, the capacity for resource-‐allocation of the relative price system may be seriously impaired. Third, as estimates based on dollar-‐yields of sovereign bonds are consistently higher, one could infer that foreign and domestic debt instruments are not perfect substitutes. A number of domestic regulations different from price, exchange and interest rate controls, seems to drive domestic investors to hold domestic debt in spite of its yields being significantly lower in dollars (i.e. allowing banks to include government issued bonds within their minimum legal reserve

Government)Revenues)from)Financial)Repression)(%)GDP)

Equilibrium)Yields)@Official

Equilibrium)Yields)@Parallel

Exante)Financial)Repression

Expost)Financial)Repression

1991 0,97 1,02 1,09 1,091992 0,48 0,22 0,57 0,571993 0,66 0,39 0,88 0,881994 2,57 1,94 5,60 7,521995 1,80 0,54 F1,76) 2,451996 4,03 5,19 11,81 4,931997 0,11 0,10 F2,22) F3,28)1998 F0,45) 0,81 0,36 0,361999 0,02 F1,74) F1,53) F1,53)2000 F1,79) F1,21) F0,32) F0,32)2001 F1,57) F0,97) 0,12 0,122002 0,43 0,04 8,09 8,092003 1,65 F1,18) 1,97 14,272004 F1,89) F1,72) F0,78) F0,76)2005 F1,41) F0,13) 0,47 F1,52)2006 0,22 0,35 F0,39) F0,72)2007 0,74 1,08 0,10 5,642008 1,16 1,12 0,59 0,532009 1,05 0,84 F0,02) 2,402010 0,89 1,06 6,20 1,682011 1,22 1,09 1,19 1,702012 0,62 0,30 F1,01) 3,082013 4,49 4,99 5,82 31,03

Average 0,70 0,61 1,60 3,40Average)Repression/Control)Years 1,23 1,10 2,13 5,16

Average)Free)Market)Years F0,13) F0,15) 0,78 0,66

17

requirements). We can think of this set of regulations as a more subtle way to impose financial repression than utter controls. IV. From financial repression to external distress Rampant financial repression coupled with inflationary tax cannot be considered isolated, domestic mishaps, without any connection to the countries’ external balance 5 . Heavily depressed returns on domestic investments inevitably lead to a flight towards safety in the form of foreign assets, impairing the external balance. The literature (Makinen and Woodward, 1990) has emphasized the idea that, depending on the existence of exchange controls, financial repression and inflationary tax could either be substitutes or complements. Without exchange controls, high inflationary tax stimulates capital flight, which in turn dries out financial markets and produces a drop in money demand, eroding the basis for financial repression (substitutes). By the same token, exchange controls create a captive market for financial repression, which tends to increase the higher the inflationary tax (complements). In this section we argue that, in spite of substantial transactions costs and large penalty risks, financial repression may induce higher capital flight in years where exchange controls prevail. In other words, deep negative yields on domestic instruments lead to higher leakages in the capital account, which in turn erode the base of the inflationary tax in spite of the controls. In order to account for capital flight we relied on two different indicators. The first one is the classical formula first introduced by Carlos Diaz-‐Alejandro and widely used in the capital flight literature (Diaz-‐Alejandro 1984a, 1984b, 1985, and Rodriguez, 1987). To the balance of international reserves at the beginning of the year, it is added the current account balance, direct investment, portfolio investment and other variation in net public assets (including debt service payments), and the ending balance of international reserves. It is the equivalent of calculating what would have been the accumulation of international reserves in the absence of changes in the net accumulation of private assets abroad and errors and omissions. Our second measure of capital flight accounts for a broadly extended practice under periods of exchange controls and large parallel market premiums: Over-‐invoicing imports. We approximate the amount of leakages thereby subtracting the values of imports comprised in the Venezuelan balance of payments, with the sum of all exports to Venezuela reported by all the countries in the world6. Note that these two indicators are additive, since the capital flight formula mentioned above assumes that all imports are effective as reported by the Central Bank. At last, we create a more comprehensive measure of capital flight, adding these two magnitudes and evaluating its behavior under periods of exchange controls and free markets.

5 See for instance Rodríguez (2014) in Bank of America Merrill Lynch’s “Venezuela’s Red Adjustment”. 6 Venezuelan imports have been adjusted by average freight and insurance charges (8.8%) to make them comparable to other countries´reported exports (FOB) to Venezuela.

18

Data and Calculations We have computed capital flight out of the reported balance of payment statistics published by the Venezuelan Central bank for the twenty-‐seven years spanning from 1986 to 20127 8. For estimations on over-‐invoicing of imports, we have used the statistics of trade reported by the United Nations on their comtrade database9. We have subtracted the dollar imports reported by the Venezuelan Central Bank from the sum of exports to Venezuela reported by all the countries in the database. The resulting figure is positive (indicating over-‐invoicing of imports) in fourteen out of the seventeen years of exchange control in Venezuela. Incidentally, the last two years of the sample (2011 and 2012) result in large negative figures (i.e. under-‐invoicing of imports). To get a better understanding of the capital account leakages and avoid any misinterpretation resulting from accounting issues (i.e. multiple exchange rates), we have presented the results in four different ways: as a percentage of GDP, both at the official and parallel exchange rate; in constant 2012 dollars, and as a percentage of total exports. Results As reported in Table V and Appendix II, capital flight has been a pervasive feature in the Venezuelan economy, representing on average 4.9% of GDP at the official rate and 7.1% of GDP at the parallel market rate, while siphoning away 17.5% of total exports. Exchange controls have not only being unable to stop capital flight, but have even exacerbated it according to some of our indicators. Capital flight was higher in years of exchange controls when measured as a percentage of GDP at the average parallel market rate (8.2% vs. 5.2%) or in constant 2012 terms (US $10,360 billion vs. 6,630). When measured as a percentage of GDP at the official rate or as a percentage of exports, free-‐market years registered higher capital flight: 5.2% vs. 4.8% and 20.3% vs. 16.6% respectively. While we believe the estimate at the official rate makes little sense, as massive overvaluation tends to overstate GDP in dollar terms, the fact that they represent a higher percentage of exports is indeed significant. In any case, the evidence reported in Table V is mixed, pointing out to the incapacity of exchange controls to put a halt to capital flight.

7 All statistics have been downloaded from the webpage of the Venezuelan Central Bank www.bcv.org.ve 8 The balance of payments of 2013 has not been published yet by the Venezuelan Central Bank, pending the final revision of the fourth quarter. 9 Exports to Venezuela have been obtained at www.comtrade.un.org , in particular the second revision of the Standard International Trade Code statistics (SITC-‐R2).

19

Table V

It is worth commenting on the actual means through which capital flight takes place even in the context of harsh exchange control regimes. In the case of Venezuela two mechanisms can be identified. The first one came through the government’s creative practice of issuing dollar-‐denominated debt to be acquired by domestic citizens with domestic currency. The so-‐called bolivar-‐dollar bonds, used widely in the previous decade, were an attempt by the Venezuelan government to avoid issuing directly in the international markets, while at the same time benefiting from the large exchange premiums on the domestic parallel exchange market. Issuing dollar-‐denominated debt in exchange for domestic currency, allowed to reaping fiscal benefits from domestic currency depreciation without devaluating. The domestic agents to which these bonds were allocated in a fairly opaque and discretionary process, would sell them at a discount in the international markets, at an implicit exchange rate lower than the parallel exchange rate. It all resulted in a sort government-‐sponsored capital flight. The second mechanism is more standard: Over-‐invoicing of imports. As reported in Table VI and Appendix III, over-‐invoicing imports – regardless of the indicator used – was between three and

UnitsUS$ Million

Capital Flight

% GDP - @ Official

Capital Flight

% GDP - @ Parallel

Capital Flight

Constant 2012 US$ Million

% of Exports

Capital Flight

1986 7091987 $403'1988 $1,205'1989 2,7681990 3,0141991 2,4501992 1,0011993 $907'1994 3,2931995 3,3861996 2,4661997 5,7571998 6,0981999 4,0832000 6,1182001 9,4032002 9,8412003 3,7832004 8,7972005 11,7382006 7,3642007 17,9482008 20,5692009 23,5052010 20,2552011 19,2612012 11,968

AverageAverage'Repression/Control'Years

Average'Free'Market'Years

1.6$1.0'$2.7'7.16.34.61.7$1.5'5.74.43.56.76.74.25.27.710.64.57.88.24.07.86.57.17.56.13.1

4.94.85.2

2.9$1.6'$4.7'7.26.34.61.7$1.5'6.26.23.86.76.74.25.27.710.66.811.810.45.016.313.520.114.512.28.1

7.18.25.2

1,509 8.3$827' $3.9'$2,378' $12.0'5,213 21.45,385 17.34,201 16.41,666 7.2$1,466' $6.2'5,188 20.45,189 17.73,673 10.48,381 24.38,738 34.75,697 19.68,257 18.212,497 35.312,776 36.74,820 13.910,856 22.214,007 21.18,570 11.220,068 25.622,464 21.624,991 40.821,218 30.819,596 20.811,968 12.3

8,973 17.510,360 16.66,613 20.3

20

five times higher in years of exchange controls than otherwise. It represented between 1.2% and 2.1% of GDP, 1,659 constant 2012 dollars, and no less than 4.9% of exports.

Table VI

At last, we have added to the traditional measure of capital flight, the difference between reported Venezuelan imports and the world’s reported exports to Venezuela. The result is a more comprehensive measure of capital flight as reported in Table VII and Appendix IV. These results are unequivocal: Our broader measure of capital flight is higher in exchange control periods as a percentage of GDP (either at the official rate of the parallel exchange rate), in 2012 constant dollars. As a percentage of exports capital flight is still higher in free-‐market years, but the difference is not significant (22.1% vs. 21.3%). Total broadened capital flight within 1986-‐2012 totaled 275.914 million of constant 2012 dollars, equivalent to roughly twice the size of the Venezuelan 2012 GDP measured at the average parallel market rate, and 21.4% of total oil exports.

!Exports!to!Venezuela!

!Venezuela!Imports!

US$$Million US$$Million Current$US$$Million

Overinvoicing!of!Imports

% GDP - @ Official


% GDP - @ Parallel


Constant 2012 US$ Million

% of Exports


1986 6,790 7,866 1,0761987 8,071 8,870 7991988 9,928 12,080 2,1521989 6,419 7,283 8641990 7,064 6,807 :257$1991 9,835 10,131 2961992 12,304 12,714 4101993 11,023 11,390 3671994 8,893 8,480 :413$1995 11,450 12,069 6191996 10,984 9,937 :1,047$1997 15,022 13,678 :1,344$1998 15,739 15,105 :634$1999 12,547 13,213 6662000 14,452 16,865 2,4132001 16,919 19,211 2,2922002 12,731 13,360 6292003 8,469 10,483 2,0142004 15,369 17,021 1,6522005 21,200 24,008 2,8082006 31,940 33,583 1,6432007 41,416 47,252 5,8362008 48,698 51,490 2,7922009 34,931 41,192 6,2612010 36,702 38,539 1,8372011 51,941 46,813 :5,128$2012 63,535 59,339 :4,196$

AverageAverage!Repression/Control!Years

Average!Free!Market!Years

2.42.14.82.2:0.5$0.60.70.6:0.7$0.8:1.5$:1.6$:0.7$0.72.11.90.72.41.51.90.92.50.91.90.7:1.6$:1.1$

1.01.20.4

4.43.28.32.2:0.5$0.60.70.6:0.8$1.1:1.6$:1.6$:0.7$0.72.11.90.73.62.22.51.15.31.85.41.3:3.2$:2.9$

1.52.10.4

2,291 12.61,639 7.74,248 21.31,627 6.7:460$ :1.5$507 2.0682 2.9593 2.5:651$ :2.6$948 3.2

:1,560$ :4.4$:1,957$ :5.7$:908$ :3.6$929 3.23,257 7.23,046 8.6816 2.32,566 7.42,039 4.23,350 5.01,912 2.56,525 8.33,049 2.96,657 10.91,924 2.8:5,218$ :5.5$:4,196$ :4.3$

1,311 3.81,659 4.9651 1.8

21

Table VII

V. Conclusions We have analyzed financial repression within the context of the Venezuelan economy, and found significant evidence suggesting a link between domestic disequilibria and a weakening of external accounts via capital flight. Over 18 of the previous 28 years the economy has been forced by government regulation into large domestic distortions: highly negative domestic interest rates on government bonds and bank deposits, stiff exchange and price controls. In these periods, fiscal revenues coming from financial repression are similar in size to others reported in the literature for countries with much higher domestic debt-‐to-‐GDP ratios. Large inflation tax derived from deficit monetization, coupled with financial repression, has spurred a significant wave of capital flight. In spite of high transaction costs and large penalties involved, exchange controls have proved to be inefficient in putting a halt to capital flight. According to some of our indicators, capital flight tends to be higher under exchange controls than in free-‐market years. The ambiguity dissipates once the capital leakage produced by sheer over-‐invoicing of imports is considered: Capital flight as a percentage of GDP and also in constant dollar terms, is much higher in periods of financial repression. These results seem to reinforce the idea that domestic disequilibria might play a significant role in external distress dynamics.

Capital'Flight 'Over/Invoicing'of'Imports'

US$$Million US$$Million US$$Million

'Total:'Capital'Flight'+'Overinvoicing'

% GDP - @ Official


% GDP - @ Parallel


Constant 2012 US$ Million % of Exports


1986 709 1,076 1,7851987 2403$ 799 3961988 21,205$ 2,152 9471989 2,768 864 3,6321990 3,014 2257$ 2,7571991 2,450 296 2,7461992 1,001 410 1,4111993 2907$ 367 2540$1994 3,293 2413$ 2,8801995 3,386 619 4,0051996 2,466 21,047$ 1,4191997 5,757 21,344$ 4,4131998 6,098 2634$ 5,4641999 4,083 666 4,7492000 6,118 2,413 8,5312001 9,403 2,292 11,6952002 9,841 629 10,4702003 3,783 2,014 5,7972004 8,797 1,652 10,4492005 11,738 2,808 14,5462006 7,364 1,643 9,0072007 17,948 5,836 23,7842008 20,569 2,792 23,3612009 23,505 6,261 29,7662010 20,255 1,837 22,0922011 19,261 25,128$ 14,1332012 11,968 24,196$ 7,772

AverageAverage'Repression/Control'Years

Average'Free'Market'Years

4.11.02.19.45.75.22.420.9$4.95.22.05.16.04.87.39.511.36.99.310.14.910.37.49.08.24.52.0

5.86.05.6

7.31.63.79.45.75.22.420.9$5.47.42.25.16.04.87.39.511.310.514.012.96.121.615.325.515.88.95.3

8.510.25.6

3,800 20.9812 3.81,870 9.46,840 28.14,925 15.84,708 18.32,349 10.12873$ 23.7$4,536 17.96,137 21.02,113 6.06,424 18.67,829 31.16,627 22.811,514 25.415,544 43.913,592 39.17,386 21.312,895 26.317,357 26.110,482 13.726,593 34.025,514 24.631,648 51.723,142 33.614,379 15.27,772 8.0

10,219 21.611,957 21.37,264 22.1

22

Appendix I

We begin by taking equation by adding and subtracting !!!!!!! !!!!! !!!!!!!!!!

𝑏!!! from the left

hand side of (1)

𝑔! +1 + 𝑖!!!1 + 𝜋!

+1 + 𝑖!!! + 𝑖!!!! − 𝑖!!!

1 + 𝜋!!−1 + 𝑖!!! + 𝑖!!!! − 𝑖!!!

1 + 𝜋!!𝑏!!! +

1 + 𝑖!!!∗

1 + 𝜋!∗𝑒!𝑏!!!∗ = 𝜏! + 𝑏! + 𝑒!𝑏!∗ + ℎ! −

ℎ!!!1 + 𝜋!

𝑔! +1 + 𝑖!!!!

1 + 𝜋!!𝑏!!! +

1 + 𝑖!!!∗

1 + 𝜋!∗𝑒!𝑏!!!∗ +

1 + 𝑖!!!1 + 𝜋!

−1 + 𝑖!!!1 + 𝜋!!

𝑏!!! −𝑖!!!! − 𝑖!!!1 + 𝜋!!

𝑏!!! = 𝜏! + +𝑏! + 𝑒!𝑏!∗ + ℎ! −ℎ!!!1 + 𝜋!

𝑔! +1 + 𝑖!!!!

1 + 𝜋!!𝑏!!! +

1 + 𝑖!!!∗

1 + 𝜋!∗𝑒!𝑏!!!∗ +

1 + 𝑖!!! 1 + 𝜋!! − 1 + 𝑖!!! 1 + 𝜋!1 + 𝜋! 1 + 𝜋!!

𝑏!!! −𝑖!!!! − 𝑖!!!1 + 𝜋!!

𝑏!!!

= 𝜏! + 𝑏! + 𝑒!𝑏!∗ + ℎ! −ℎ!!!1 + 𝜋!

𝑔! +1 + 𝑖!!!!

1 + 𝜋!!𝑏!!! +

1 + 𝑖!!!∗

1 + 𝜋!∗𝑒!𝑏!!!∗ +

1 + 𝑖!!! 1 + 𝜋!! − 1 − 𝜋!1 + 𝜋! 1 + 𝜋!!

𝑏!!! −𝑖!!!! − 𝑖!!!1 + 𝜋!!

𝑏!!! = 𝜏! + 𝑏! + 𝑒!𝑏!∗ + ℎ! −ℎ!!!1 + 𝜋!

𝑔! +1 + 𝑖!!!!

1 + 𝜋!!𝑏!!! +

1 + 𝑖!!!∗

1 + 𝜋!∗𝑒!𝑏!!!∗ −

1 + 𝑖!!! 𝜋! − 𝜋!!

1 + 𝜋! 1 + 𝜋!!𝑏!!! −

𝑖!!!! − 𝑖!!!1 + 𝜋!!

𝑏!!! = 𝜏! + 𝑏! + 𝑒!𝑏!∗ + ℎ! −ℎ!!!1 + 𝜋!

This we will rewrite as:

𝑔! − 𝜏! + 𝑟!

!𝑏!!! + 𝑟!∗𝑒!𝑏!!!∗ + ∆𝑏! + 𝑒!∆𝑏!∗ = 1 + 𝑟!!!!!!!

!

!!!!𝑏!!! +

!!!!! !!!!!!!!!

! 𝑏!!! + ℎ! −!!!!!!!!

,

where:

𝑟!! = !!!!!!

!

!!!!!− 1 is the ex-‐ante real interest in the absence of financial repression,

𝑟!∗ =!!!!!!

∗

!!!!∗− 1 is the real interest rate on foreign debt,

∆𝑏!∗ = 𝑏!!!∗ − 𝑏!∗ , net change in foreign debt in real domestic currency ∆𝑏! = 𝑏!!! − 𝑏! , net change in real domestic debt 1+ 𝑟!! = !!!!!!

!!!!! , the ex-‐ante real domestic interest rate.

1+ 𝑟!∗ = !!!!!!

∗

!!!!∗ , the real interest rate in foreign currency.

23

Appendix II Capital Flight

(Free-‐markets years in blue, exchange control years in red)

Figure II.1

Figure II.2

1.509&&

'827&&'2.378&&

5.213&&5.385&&4.201&&

1.666&&

'1.466&&

5.188&&5.189&&3.673&&

8.381&&8.738&&

5.697&&

8.257&&

12.497&&12.776&&

4.820&&

10.856&&

14.007&&

8.570&&

20.068&&

22.464&&

24.991&&

21.218&&19.596&&

11.968&&

1986& 1987& 1988& 1989& 1990& 1991& 1992& 1993& 1994& 1995& 1996& 1997& 1998& 1999& 2000& 2001& 2002& 2003& 2004& 2005& 2006& 2007& 2008& 2009& 2010& 2011& 2012&

Capital'Flight'(Constant'US$'2012)'

1,6$$

%1,0$$

%2,7$$

7,1$$

6,3$$

4,6$$

1,7$$

%1,5$$

5,7$$

4,4$$

3,5$$

6,7$$ 6,7$$

4,2$$

5,2$$

7,7$$

10,6$$

4,5$$

7,8$$8,2$$

4,0$$

7,8$$

6,5$$7,1$$

7,5$$

6,1$$

3,1$$

1986$ 1987$ 1988$ 1989$ 1990$ 1991$ 1992$ 1993$ 1994$ 1995$ 1996$ 1997$ 1998$ 1999$ 2000$ 2001$ 2002$ 2003$ 2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$

Capital'Flight'(%'of'GDP'@Official'Exchange'Rate)'

24

Figure II.3

Figure II.4

2,9$$

%1,6$$

%4,7$$

7,2$$6,3$$

4,6$$

1,7$$

%1,5$$

6,2$$ 6,2$$

3,8$$

6,7$$ 6,7$$

4,2$$5,2$$

7,7$$

10,6$$

6,8$$

11,8$$10,4$$

5,0$$

16,3$$

13,5$$

20,1$$

14,5$$

12,2$$

8,1$$

1986$ 1987$ 1988$ 1989$ 1990$ 1991$ 1992$ 1993$ 1994$ 1995$ 1996$ 1997$ 1998$ 1999$ 2000$ 2001$ 2002$ 2003$ 2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$

Capital'Flight'(%'of'GDP'@Parallel'Exchange'Rate)'

8,3$$

%3,9$$

%12,0$$

21,4$$

17,3$$ 16,4$$

7,2$$

%6,2$$

20,4$$17,7$$

10,4$$

24,3$$

34,7$$

19,6$$ 18,2$$

35,3$$36,7$$

13,9$$

22,2$$ 21,1$$

11,2$$

25,6$$

21,6$$

40,8$$

30,8$$

20,8$$

12,3$$

1986$ 1987$ 1988$ 1989$ 1990$ 1991$ 1992$ 1993$ 1994$ 1995$ 1996$ 1997$ 1998$ 1999$ 2000$ 2001$ 2002$ 2003$ 2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$

Capital'Flight'(%'of'Exports)'

25

Appendix III Over-‐Invoicing of Imports


Figure III.1

Figure III.2

2.291%%1.639%%

4.248%%

1.627%%

+460%%

507%% 682%% 593%%

+651%%

948%%

+1.560%%+1.957%%

+908%%

929%%

3.257%%3.046%%

816%%

2.566%%2.039%%

3.350%%

1.912%%

6.525%%

3.049%%

6.657%%

1.924%%

+5.218%%

+4.196%%

1986% 1987% 1988% 1989% 1990% 1991% 1992% 1993% 1994% 1995% 1996% 1997% 1998% 1999% 2000% 2001% 2002% 2003% 2004% 2005% 2006% 2007% 2008% 2009% 2010% 2011% 2012%

Over%Invoicing,of,Imports,(Constant,US$,2012),

2,4$$2,1$$

4,8$$

2,2$$

'0,5$$

0,6$$ 0,7$$ 0,6$$

'0,7$$

0,8$$

'1,5$$ '1,6$$

'0,7$$

0,7$$

2,1$$1,9$$

0,7$$

2,4$$

1,5$$

1,9$$

0,9$$

2,5$$

0,9$$

1,9$$

0,7$$

'1,6$$

'1,1$$

1986$ 1987$ 1988$ 1989$ 1990$ 1991$ 1992$ 1993$ 1994$ 1995$ 1996$ 1997$ 1998$ 1999$ 2000$ 2001$ 2002$ 2003$ 2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$

Over%Invoicing,of,Imports,(%,of,GDP,@Official,Exchange,Rate),

26

Figure III.3

Figure III.4

4,4##

3,2##

8,3##

2,2##

'0,5##

0,6## 0,7## 0,6##

'0,8##

1,1##

'1,6## '1,6##

'0,7##

0,7##

2,1## 1,9##

0,7##

3,6##

2,2## 2,5##

1,1##

5,3##

1,8##

5,4##

1,3##

'3,2##'2,9##

1986# 1987# 1988# 1989# 1990# 1991# 1992# 1993# 1994# 1995# 1996# 1997# 1998# 1999# 2000# 2001# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012#

Over%Invoicing,of,Imports,(%,of,GDP,@Parallel,Exchange,Rate),

8,3$$

%3,9$$

%12,0$$

21,4$$

17,3$$ 16,4$$

7,2$$

%6,2$$

20,4$$17,7$$

10,4$$

24,3$$

34,7$$

19,6$$ 18,2$$

35,3$$36,7$$

13,9$$

22,2$$ 21,1$$

11,2$$

25,6$$

21,6$$

40,8$$

30,8$$

20,8$$

12,3$$

1986$ 1987$ 1988$ 1989$ 1990$ 1991$ 1992$ 1993$ 1994$ 1995$ 1996$ 1997$ 1998$ 1999$ 2000$ 2001$ 2002$ 2003$ 2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$

Over%Invoicing,of,Imports,(%,of,Exports),

27

Appendix IV Capital Flight + Over-‐Invoicing of Imports


Figure IV.1

Figure IV.2

3.800%%

812%%1.870%%

6.840%%

4.925%% 4.708%%

2.349%%

-873%%

4.536%%6.137%%

2.113%%

6.424%%7.829%%

6.627%%

11.514%%

15.544%%

13.592%%

7.386%%

12.895%%

17.357%%

10.482%%

26.593%%25.514%%

31.648%%

23.142%%

14.379%%

7.772%%

1986% 1987% 1988% 1989% 1990% 1991% 1992% 1993% 1994% 1995% 1996% 1997% 1998% 1999% 2000% 2001% 2002% 2003% 2004% 2005% 2006% 2007% 2008% 2009% 2010% 2011% 2012%

Broad&Capital&Flight:&Capital&Flight&+&Over4Invoicing&of&Imports&(Constant&US$&2012)&

4,1$$

1,0$$

2,1$$

9,4$$

5,7$$5,2$$

2,4$$

*0,9$$

4,9$$ 5,2$$

2,0$$

5,1$$

6,0$$

4,8$$

7,3$$

9,5$$

11,3$$

6,9$$

9,3$$

10,1$$

4,9$$

10,3$$

7,4$$

9,0$$

8,2$$

4,5$$

2,0$$

1986$ 1987$ 1988$ 1989$ 1990$ 1991$ 1992$ 1993$ 1994$ 1995$ 1996$ 1997$ 1998$ 1999$ 2000$ 2001$ 2002$ 2003$ 2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$

Broad&Capital&Flight:&Capital&Flight&+&Over4Invoicing&of&Imports&(%&of&GDP&@Official&Exchange&Rate)&

28

Figure IV.3

Figure IV.4

7,3$$

1,6$$

3,7$$

9,4$$

5,7$$ 5,2$$

2,4$$

+0,9$$

5,4$$

7,4$$

2,2$$

5,1$$6,0$$

4,8$$

7,3$$

9,5$$

11,3$$10,5$$

14,0$$12,9$$

6,1$$

21,6$$

15,3$$

25,5$$

15,8$$

8,9$$

5,3$$

1986$ 1987$ 1988$ 1989$ 1990$ 1991$ 1992$ 1993$ 1994$ 1995$ 1996$ 1997$ 1998$ 1999$ 2000$ 2001$ 2002$ 2003$ 2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$

Broad&Capital&Flight:&Capital&Flight&+&Over4Invoicing&of&Imports&(%&of&GDP&@Parallel&Exchange&Rate)&

20,9%%

3,8%%

9,4%%

28,1%%

15,8%%18,3%%

10,1%%

+3,7%%

17,9%%

21,0%%

6,0%%

18,6%%

31,1%%

22,8%%25,4%%

43,9%%

39,1%%

21,3%%

26,3%% 26,1%%

13,7%%

34,0%%

24,6%%

51,7%%

33,6%%

15,2%%

8,0%%

1986% 1987% 1988% 1989% 1990% 1991% 1992% 1993% 1994% 1995% 1996% 1997% 1998% 1999% 2000% 2001% 2002% 2003% 2004% 2005% 2006% 2007% 2008% 2009% 2010% 2011% 2012%

Broad&Capital&Flight:&Capital&Flight&+&Over4Invoicing&of&Imports&(%&of&Exports)&

29

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mas - from financial repression to external distress balas · ! 1!!!...

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