Copyright © 2004 Thunderbird School of Global Management. All rights reserved. This case was prepared by Nina Camera, Thanh Nguyen, and Jay Ward under the direction of Professor Michael H. Moffett for the purpose of classroom discussion only and not to indicate either effective or ineffective management. Names of principals involved in the case have been changed to preserve confidentiality.

[Return to reference]
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 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 5, 2003, the passage of the 2003 Exchange Regulations Decree. The Decree took the following actions:

Set the official exchange rate at Bs1596/$ for purchase (bid) and Bs1600/$ for sale (ask);

Established the Comisin de Administracin de ­Divisas (CADIVI) to control the distribution of foreign exchange; and

Implemented strict price controls to stem inflation ­triggered by the weaker bolivar and the exchange ­control-induced 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.”2

2 “Venezuela Girds for Exchange Controls,” The Wall Street Journal (Eastern edition), February 5, 2003, p. A14.

[Return to reference]
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

3 CANTV’s share price continued to rise over the 2002 to 2004 period as a result of its use as an exchange rate mechanism. The use of CANTV ADRs as a method of obtaining dollars by Venezuelan individuals and organizations was typically described as “not illegal.”

[Return to reference]
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
×
Bs

7945
/
share
$

18.84
/

ADR

Bs

2952
/
$

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

4 Morgan Stanley Capital International (MSCI) announced on November 26, 2003, that it would change its standard spot rate for the Venezuelan bolivar to the notional rate based on the relationship between the price of CANTV Telefonos de Venezuela D in the local market in bolivars and the price of its ADR in U.S. dollars.

[Return to reference]

Exhibit A Official and Gray Market Exchange Rates for the Venezuelan Bolivar
Note: All prices and rates are Friday closing values.

Figure A Full Alternative Text
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/$ (see Exhibit A). 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”5 according to Finance Minister Tobias Nobriega. Analysts, however, pointed out that the 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.

5 O’Grady, M. A. (Feb. 13, 2004). “Money Fun In the Venezuela Of Hugo Chavez”.

[Return to reference]
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.” Santiago found some solace in the fact that he would receive one-third of the funds he needed from CADIVI. He now turned to his second most attractive option, the Venezuelan bond market.

The Ministry of Finance announced on March 5, 2004, a new complex issuance, a security basket, which was composed of three different individual issuances, with each carrying an equal value. The buyer must buy a basket combination:

A $500 six-month “treasury bill” which was U.S. dollar-denominated, carrying a coupon of
LIBOR
+
�
%
.
The bill would be purchased at the official exchange rate of Bs1920/$. This U.S. dollar issue would be governed by New York law.

A bolivar denominated Vebono (Venezuelan government bond) of Bs960,000 which was due in March 2008, bearing a coupon of 14.93%. This was officially equal to $500 at the official rate of Bs1920/$.

A bolivar denominated Vebono, also Bs960,000 in principal, due in September 2008, with a coupon of 14.85%. It also was theoretically $500 in value at the official exchange rate of Bs1920/$. Both Venezuelan bolivar issues would be governed by Venezuelan law.

The total combined face value of a basket was Bs2,880,000. The first series of the issues was for a total of $375 million at the official exchange rate (250,000 bonds, Bs1920/$, at Bs2,880,000 each). The Ministry of Finance intended to issue more than $1.5 billion over the coming year. When brought to market the basket issue was priced at a premium of 9% over par, or Bs3,139,200 each. Fitch and other ratings services rated the issues.
“
�
−
”
speculative grade in-line with Venezuela’s own current
�
−
rating. If sold immediately, the two Vebono components would probably yield 88% of face value. The U.S. dollar component, being only six months in maturity, would likely yield 97.125% of face value, or $487.56, as seen in Exhibit B.

Exhibit B Construction and Valuation of the Venezuelan Basket Issuance of March 2004
Component
Maturity
Coupon
Face Value
Yield on Sale
Currency of Issue
Currency Yield on Sale
Treasury bill

     6 months

1.15%

           $500

97.2125%

dollars

    $487.56

Vebono (a)

March 2008

14.93%

Bs960,000

88.000%

bolivars

Bs844,800

Vebono (b)

    Sept 2008

14.85%

Bs960,000

88.000%

bolivars

Bs844,800

Totals

                          $1500 or Bs2,880,000

                                           $487.56 and Bs1,689,600

Percent of Face Value on Issue:

              109%

Initial Basket Sales Price:

Bs3,139,200

Effective Exchange Rate for Dollars Acquired:

Bs2973.16/$

Note: All bolivar to dollar valuations assumes the official fixed exchange rate of Bs1920/$. Effective exchange rate is calculated as follows:

Effective Rate

Bs3,139,200
−
Bs 1,689,600
$
487
.

56

Bs2973
.
16
/
$

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
Why does a country like Venezuela impose capital controls?

In the case of Venezuela, what is the difference between the gray market and the black market?

Create a financial analysis of Santiago’s choices. Use it to recommend a solution to his problem.

Postscript. Although President Chávez died in 2013, and the Venezuelan bolivar has been devalued repeatedly and renamed the bolivar fuerte since the time of this case, it remains a currency that is overvalued by its government and restricted in its exchange, and therefore continues to lead a double life—officially and unofficially.
Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2018). Multinational Business Finance (15th ed.). Pearson Education (US). https://online.vitalsource.com/books/9780134796673