Inside South America's Oil-Fueled Currency Battle

  • Colombia's plunging peso is sucking commerce out of Ecuador
  • Venezuela crackdown roils border as smugglers seek arbitrage

What’s the best currency regime for an oil economy? It’s become a pressing question after the crude-price shock. In one corner of the Andes, three neighbors arrived at different answers -- and things are getting chaotic in the border areas where their mismatched systems meet.

Colombia’s free-floating peso has plunged in line with oil; Venezuela combines price controls with a pegged currency that’s way overvalued at official rates; Ecuador uses the U.S. dollar. The result is a boon for anyone who can arbitrage the differences, and a nightmare for authorities trying to stop them.

A state of emergency is in force along swathes of Venezuela’s frontier with Colombia, where President Nicolas Maduro has sent troops to seal off towns, triggering a mass exodus of migrants. The declared targets are smugglers seeking to trade off a lucrative price gap. 

Venezuelan soldiers watch as people cross the border to Colombia
Venezuelan soldiers watch as people cross the border to Colombia
Photograpaher: Rederico Parra/AFP via Getty Images

Assuming you can get hold of them in Venezuela’s shortage-plagued economy, goods like milk, shampoo or toothpaste can be sold in Colombia for several times the purchase price -- even 1,000 times, in the case of gasoline. That’s because Venezuela maintains fixed exchange rates, even as the black-market alternative dropped off the charts amid rampant inflation.

Ghost Town

Hundreds of miles to the southwest, trouble is also brewing and it has similar roots. The oil rout pushed Colombia’s peso to a record low last month: it’s down 35 percent against the dollar in the past year. That makes the country’s goods cheaper for anyone with dollars to spend -- like Ecuadoreans. The neighboring state also exports crude but lacks its own currency, having adopted the greenback during a spasm of inflation a decade and a half ago.

The upshot is that commerce is being sucked across the border, turning the Ecuadorean side into a ghost town. Meanwhile in the town of Ipiales, two miles inside Colombia, business is booming.

“We need more staff,” says Ana Maria Manosalves, who works there at a clothing and grocery store. “Ecuadoreans come very frequently now. Before it was only weekends, now it’s every day.”

Once, it was the other way round. Colombia’s peso surged during the oil boom that began in 2009, gaining 10 percent against the dollar that year and peaking in 2011. The tender, which gained 2 percent on Wednesday, is still down 33 percent in the past 12 months.

In those days, many Colombians came shopping in Ecuador. Now, says Oscar Acosta, a 58-year-old hotel owner in Tulcan, Ecuador, “they don’t come.” Visitor numbers are down about 60 percent, he says, “and I think the same is happening in other businesses, if not more.” Ecuadoreans are shutting down stores and even leaving the border region to find work elsewhere, he said.

From Acosta’s hotel balconies, a few blocks from Tulcan’s largely empty central plaza, you can see idle fruit-sellers and shoe-shiners standing around waiting for customers under a harsh Andean sun. In Ipiales, by contrast, there’s noise and bustle as honking cars push their way through crowds of shoppers.

Ecuador’s President Rafael Correa has tried to crack down on cross-border shopping sprees, by limiting the amount Ecuadoreans can bring home and slapping tariffs of as much as 45 percent on goods arriving by land from Colombia.

Correa, a socialist ally of Maduro, is no fan of the dollarized regime he inherited. “This is one of the historical errors, the traps, that they left us,” he fulminated last month. It’s a complaint he repeats regularly, suggesting that if changing a currency regime was easy, Correa would have done it.

Hands Tied

Ecuadoreans, though, would probably be opposed. Dollarization has helped stabilize the economy since it was adopted in 2000. About 85 percent of the population said they approved, in a December survey by Quito-based pollster Cedatos-Gallup.

Dollarization isn’t desirable, and Ecuador’s current plight shows why not, said Francisco Monaldi, a fellow in Latin American Energy Policy at the Baker Institute at Rice University in Houston. Yet for all its flaws, the policy can at least help a country avoid the kind of mess Venezuela has gotten into.

Money changers
Money changers
Photographer: Nathan Gill/Bloomberg

It “totally ties the hands of the central bank from printing money to finance itself,” Monaldi said. In Venezuela, “what you have now is a government with massive deficits that has to print money like crazy.”

Whatever the pitfalls of changing currency regimes, the 52 percent oil slump in the past year has hit some exporting nations hard enough to make them at least weigh the option. Kazakhstan has actually done it: Central Asia’s biggest energy producer cut the tenge loose last month. Other pegs in crude-producing nations are set to follow as the world enters a “new era” of low oil prices, according to Karim Massimov, the Kazakh prime minister.

Even the Saudis?

Even the Persian Gulf’s well-entrenched dollar pegs have been called into question. In August, traders increased bets that oil giants like Saudi Arabia, the world’s top exporter, and the United Arab Emirates may loosen their ties to the greenback. Saudi Central Bank chief Fahad Al-Mubarak sought to damp the speculation this month, saying the peg would be around “for many years to come.”

In the Andean currency experiment, Colombia’s flexible regime is emerging as the winner. Economists surveyed by Bloomberg expect the Colombian economy to grow 3 percent this year, almost twice as fast as Ecuador.

For Ecuador, “not having monetary and exchange-rate policy in a moment like this is a strait-jacket,” said Credit Suisse economist Juan Lorenzo Maldonado. “You don’t have a shock absorber.”

Venezuela’s situation is even worse. The International Monetary Fund says its economy will shrink every year through 2019 -- an outlook unmatched for gloom in any of the other Latin America and Caribbean nations the Fund surveys.

To be sure, Venezuela’s problems run deeper than its currency policy, and predate the oil slump too. Even in 2013, with crude averaging almost $100 a barrel, the country ran up a budget deficit of about 17 percent of GDP.

“I doubt any of the measures the government is implementing is a long-term solution,” said Alejandro Arreaza, an economist at Barclays Capital Inc. “More likely, they are looking for a scapegoat to contain the political cost.”

Too Late?

It may be too late for that -- Maduro’s party is trailing badly in the run-up to December’s parliamentary ballot, and he’s finding it hard to win over voters who struggle to get staple goods. The border closure isn’t helping. “It’s a disaster, you can’t find anything,” said Jenny Vaiz. The ice-cream shop where she worked in the frontier town of San Antonio was closed due to a shortage of milk.

No currency regime works out well for everyone all the time, of course. Foreign investors in Colombia’s local debt have had to swallow a 34 percent average loss in dollar terms in the past year as the peso plunged. Colombians have to pay more for imports, pushing inflation to a six-year high. And, even though economic growth is slowing, traders are betting that the central bank will soon have to raise the benchmark interest rate, which has stayed at 4.5 percent for more than a year.

Colombian policy makers know the drawbacks of a free float during oil booms, too. It may seem a dim memory now, but it’s not so long ago that Colombia was complaining loudly about the peso’s over-appreciation. “The mother of all problems,” Finance Minister Mauricio Cardenas called it in 2013.

Looking at the neighbors today, he might conclude that there are worse problems you can have.

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