Exchange Rate for Oil Sector, Article Review Example

This article focuses on recent economic developments in the country of Venezuela. The government is contemplating a devaluation of the nation’s currency to deal with an increasing number of economic problems: primarily a lower exchange rate for its key oil sector, as well as a slowing domestic economy. This is actually the second potential devaluation the country has experienced over the past twelve months: Venezuela announced an earlier devaluation of the currency in 2012.

The diagram below shows what happens when a currency is depreciated. There are two main effects when a currency is depreciated.  When a currency is depreciated, the main effect is a deterioration of its value.  That is, the affected currency becomes worth less vis-à-vis another one.  In the case of the Venezueula Bolar, this will mean an increase in the number of Bolars needed for exchange for the number of dollars, Euros, etc. There is also the second-order effect: the price of goods for those using Bolars becomes higher, the price of goods for foreigners purchasing Venezuelan goods becomes less expensive.

There are some advantages and disadvantages for the government in pursuing this policy.

The government would increase the revenues that it receives from local currency; in theory, holding all other conditions equal, would mean that its pricing of oil is more competitive than other countries that produce oil in OPEC.  At the same time, however, a devaluation would prevent a much needed economic restructuring towards other sectors and also hurt consumers.

This is a problem for Venezuelan consumers and its major export: oil.  Goods are now more expensive for Venezuelan consumers denting their purchasing power, it also decreases the revenue related to oil for the country’s coffers.  As the article points out, this will mean a greater sacrifice for consumers as the government requires them to pay a higher price for subsidized gas in order to make sure that government revenues are preserved.  At the same time, however, moves to improve the health of government may lead to a worsening of the economy as the government attempts to balance the budget on the backs of consumers, who will then be unable to increase consumption.

Overall, this is likely bad news for the Venezuelan government and the economy.  The government has supported a relatively high standard for the people through generous subsidies financed from oil revenue.  Indeed, the revenue from oil has led to vast subsidization of goods for the consumers and the need to put off structural reform to improve economic efficiency. Indeed, the inability of the economy to remove support for key subsidies and rely on oil revenue has also prevented a forced rebalancing that would shift resources to other areas of the economy.  At the same time, it would also lead to an increase in inflation, which would hurt consumers further.