The Venezuelan Bolivar Black Market:

It’s late afternoon on March 10th, 2004, and Santiago opens the window of his office in Caracas,
Venezuela. Immediately he is hit with the sounds rising from the plaza—cars honking, protesters
banging their pots and pans, street vendors hawking their goods. Since the imposition of a new
set of economic policies by President Hugo Chávez in 2002, such sights and sounds had become
a fixture of city life in Caracas. Santiago sighed as he yearned for the simplicity of life in the old
Caracas. Santiago’s once-thriving pharmaceutical distribution business had hit hard times. Since
capital controls were implemented in February of 2003, dollars had been hard to come by. He
had been forced to pursue various methods— methods that were more expensive and not always
legal— to obtain dollars, causing his margins to decrease by 50%. Adding to the strain, the
Venezuelan currency, the bolivar (Bs), had been recently devalued (repeatedly). This had
instantly squeezed his margins as his costs had risen directly with the exchange rate. He could
not find anyone to sell him dollars. His customers needed supplies and they needed them
quickly, but how was he going to come up with the $30,000—the hard currency—to pay for his
most recent order? Political Chaos Hugo Chávez’s tenure as President of Venezuela had been
tumultuous at best since his election in 1998. After repeated recalls, resignations, coups, and
reappointments, the political turmoil had taken its toll on the Venezuelan economy as a whole,
and its currency in particular. The short-lived success of the anti-Chávez coup in 2001, and his
nearly immediate return to office, had set the stage for a retrenchment of his isolationist
economic and financial policies. On January 21st, 2003, the bolivar closed at a record low—
Bs1853/$. The next day President Hugo Chávez suspended the sale of dollars for two weeks.
Nearly instantaneously, an unofficial or black market for the exchange of Venezuelan bolivars
for foreign currencies (primarily U.S. dollars) sprouted. As investors of all kinds sought ways to
exit the Venezuelan market, or simply obtain the hard-currency needed to continue to conduct
their businesses (as was the case for
Santiago), the escalating capital flight caused the black market value of the bolivar to plummet to
Bs2500/$ in weeks. As markets collapsed and exchange values fell, the Venezuelan inflation rate
soared to more than 30% per annum.
Capital Controls and CADIVI
To combat the downward pressures on the bolivar, the Venezuelan government announced on
February 5th, 2003, the passage of the 2003 Exchange Regulations Decree. The Decree took the
following actions: 1. Set the official exchange rate at Bs1596/$ for purchase (bid) and Bs1600/$
for sale (ask); 2. Established the Comisin de Administracin de Divisas (CADIVI) to control the
distribution of foreign exchange; and 3. Implemented strict price controls to stem inflation
triggered by the weaker bolivar and the exchange controlinduced contraction of imports.
CADIVI was both the official means and the cheapest means by which Venezuelan citizens
could obtain foreign currency. In order to receive an authorization from CADIVI to obtain
dollars, an applicant was required to complete a series of forms. The applicant was then required
to prove that they had paid taxes the previous three years, provide proof of business and asset
ownership and lease agreements for company property, and document the current payment of
Social Security. Unofficially, however, there was an additional unstated requirement for
permission to obtain foreign currency: authorizations would be reserved for Chávez supporters.
In August 2003 an anti-Chávez petition had gained widespread circulation. One million
signatures had been collected. Although the government ruled that the petition was invalid, it had
used the list of signatures to create a database of names and social security numbers that CADIVI
utilized to cross-check identities on hard currency requests. President Chávez was quoted as
saying “Not one more dollar for the putschits; the bolivars belong to the people.

Santiago’s Alternatives
Santiago had little luck obtaining dollars via CADIVI to pay for his imports. Because he had
signed the petition calling for President Chávez’s removal, he had been listed in the CADIVI
database as anti-Chávez, and now could not obtain permission to exchange bolivar for dollars.
The transaction in question was an invoice for $30,000 in pharmaceutical products from his
U.S.-based supplier. Santiago intended to resell these products to a large Venezuelan customer
who would distribute the products. This transaction was not the first time that Santiago had been
forced to search out alternative sources for meeting his U.S. dollar-obligations. Since the
imposition of capital controls, his search for dollars had become a weekly activity for Santiago.
In addition to the official process—through CADIVI—he could also obtain dollars through the
gray or black markets. The Gray Market: CANTV Shares In May 2003, three months following
the implementation of the exchange controls, a window of opportunity had opened up for
Venezuelans—an opportunity that allowed investors in the Caracas stock exchange to avoid the
tight foreign exchange curbs. This loophole circumvented the government-imposed restrictions
by allowing investors to purchase local shares of the leading telecommunications company
CANTV on the Caracas’ bourse, and to then convert those shares into dollar-denominated
American Depositary Receipts (ADRs) traded on the NYSE. The sponsor for CANTV ADRs on
the NYSE was the Bank of New York, the leader in ADR sponsorship and management in the
U.S. The Bank of New York had suspended trading in CANTV ADRs in February after the
passage of the Decree, wishing to determine the legality of trading under the new Venezuelan
currency controls. On May 26th, after concluding that trading was indeed legal under the Decree,
trading resumed in CANTV shares. CANTV’s share price and trading volume both soared in the
following week.3 The share price of CANTV quickly became the primary method of calculating
the implicit gray market exchange rate. For example, CANTV shares closed at Bs7945/share on
the Caracas bourse on February 6, 2004. That same day, CANTV ADRs closed in New York at
$18.84/ADR. Each New York ADR was equal to seven shares of CANTV in Caracas. The
implied gray market exchange rate was then calculated as follows: Implicit Gray Market Rate =
7 * Bs7945/Share $18.84/ADR = Bs2952/$ The official exchange rate on that same day was
Bs1598/$. This meant that the gray market rate was quoting the bolivar about 46% weaker
against the dollar than what the Venezuelan government officially declared its currency to be
worth. Exhibit A illustrates both the official exchange rate and the gray market rate (calculated
using CANTV shares) for the January 2002 to March 2004 period. The divergence between the
official and gray market rates beginning in February 2003 coincided with the imposition of
capital controls.4 The Black Market A third method of obtaining hard currency by Venezuelans
was through the rapidly expanding black market. The black market was, as is the case with black
markets all over the world, essentially unseen and illegal. It was, however, quite sophisticated,
using the services of a stockbroker or banker in Venezuela who simultaneously held U.S. dollar
accounts offshore. The choice of a black market broker was a critical one; in the event of a
failure to complete the transaction properly there was no legal recourse. If Santiago wished to
purchase dollars on the black market, he would deposit bolivars in his broker’s account in
Venezuela. The agreed upon black market exchange rate was determined on the day of the
deposit, and usually was within a 20% band of the gray market rate derived from the CANTV
share price. Santiago would then be given access to a dollar-denominated bank account outside
of Venezuela in the agreed amount. The transaction took, on average, two business days to settle.
The unofficial black market rate was Bs3300/$. In early 2004 President Chávez had asked
Venezuela’s Central Bank to give him “a little billion”—millardito—of its $21 billion in foreign
exchange reserves. Chávez argued that the money was actually the people’s, and he wished to
invest some of it in the agricultural sector. The Central Bank refused. Not to be thwarted in its
search for funds, the Chávez government announced on February 9, 2004, another devaluation.
The bolivar was devalued 17%, falling in official value from Bs1600/$ to Bs1920/$.

With all Venezuelan exports of oil being purchased in U.S. dollars, the devaluation of the bolivar
meant that the country’s proceeds from oil exports grew by the same 17% as the devaluation
itself. The Chávez government argued that the devaluation was necessary because the bolivar
was “a variable that cannot be kept frozen, because it prejudices exports and pressures the
balance of payments” according to Finance Minister Tobias Nobriega. Analysts, however,
pointed out that Venezuelan government actually had significant control over its balance of
payments: oil was the primary export, the government maintained control over the official access
to hard currency necessary for imports, and the Central Bank’s foreign exchange reserves were
now over $21 billion. Time Was Running Out Santiago received confirmation from CADIVI on
the afternoon of March 10th that his latest application for dollars was approved and that he
would receive $10,000 at the official exchange rate of Bs1920/$. Santiago attributed his good
fortune to the fact that he paid a CADIVI insider an extra 500 bolivars per dollar to expedite his
request. Santiago noted with a smile that “the Chávistas need to make money too.” The noise
from the street seemed to be dying with the sun. It was time for Santiago to make some
decisions. None of the alternatives were bonita, but if he was to preserve his business, bolivars—
at some price—had to be obtained.
Mini-Case Questions
1. Why does a country like Venezuela impose capital controls?
2. In the case of Venezuela, what is the difference between the gray market and the black
market? 3. Create a financial analysis of Santiago’s choices. Use it to recommend a solution to
his problem.