Caracas Chronicles

On August 19th, journalist and radio host Marisela Castillo gave economists the heebie-jeebies by tweeting that the government was plotting to lower banks’ reserve requirement to invest in urban agriculture funds. Today, 5 weeks later, president Maduro confirmed it. Marisela is too humble to brag about it, but you have to hand it to her: It was sendo tubazo.

There’s a lot flying under the radar with this absurd announcement, where President Maduro asks the Central Bank to cut the reserve requirement (Encaje legal) by 5 percentage points, from 21,5% to 16,5%.

Firstly, the fact that the executive is bajando linea directly and publicly to the Central Bank. It displays an obscene lack of Central Bank independence that well.. We’ve grown used to it by now. It’s also apparently legal in the context of the recently-renewed Economic Emergency Decree.

Secondly, that the change might unleash another wave of inflation and tip us ever closer to full-blown Zimbabwean hyperinflation. To understand why it’s that serious, we have to ask, con qué se come el Encaje Legal? Here is a brief explanation.

In basic terms, the Encaje Legal or Reserve Requirement Ratio (RRR) is the percentage of customer deposits that banks are legally obliged to maintain at the Central Bank at all times. When this money is held at BCV, it can’t be lent or otherwise used.

Why is this relevant? Well, in a financial system, all money from new bank loans must be deposited somewhere. Part of that new deposit is later re-loaned, and part of it is re-deposited, and part of that deposit is re-loaned, etc, etc—and this process effectively multiplies the supply of money in circulation. Toying with the encaje allows the Central Bank to control the money multiplier. Lowering the ratio frees up money to be lent (mo’ money, mo’ credit), and a 5 percentage point reduction is huge.

Maduro claims the move will free up VEF 500Bn to be directed towards “agricultural development”. Based on my understanding of his words, it seems like an absurd ripoff for the banks: they will be force-fed worthless 3-yr, 1% interest VEF-denominated FONDEN garbage in return for about a fifth of their cash held in BCV.

Los certificados que serán emitidos por el llamado del Fondo de Desarrollo Nacional, entre otros entes públicos, tendrán “un plazo máximo vencimiento de tres años, con una tasa de interés entre 1% y 1,5% pagaderos al vencimiento para que puedan ser adquiridos por la banca a cambio del diferencial de encaje legal, el cual se transformará en un encaje productivo”, explicó Maduro.

So, what can we expect to happen in the economy after this?

• After the (increased) money multiplier does it’s magic, the freed-up funds are going to increase monetary liquidity (M2) by just under a trillion bolívares (no joke!), or 15%. At the current rate, that’s a little over 2 months of Madurista money-printing. Qué es una raya más pal tigre?

• As Pedro Rosas argued early this month, the venezuelan financial sector is facing its second-worst recession in history. This measure is just a way to kick them in their teeth while they’re down. The positive side of a lower RRR is neutered because banks are forced to deploy these funds at a ridiculous 1% nominal rate when domestic inflation is north of 500%. This is a horrible deal for banks and it will most certainly worsen their already horrible bottom lines.

• More worrisome is the change in tone of monetary policy. Perez Abad’s measures consisted of severely restricting liquidity in the economy, partially by keeping the encaje at the 21,5% mark. This led to relative stability in the parallel dollar market at the expense of a sharp contraction in domestic credit. Reducing the encaje is a sign that Maduro could be backtracking on this policy to favor populist monetary expansion.

• October-November are months typically associated with higher rates of inflation and money growth; people are getting, and rapidly getting rid of, their aguinaldos. Mixing a monetary expansion with this organic driver seems like the recipe for a perfect inflationary storm for Q4 2016.

• The risks of switching to money bazooka mode: accelerating inflation, depreciation in the parallel rate, worsening fiscal deficits (as inflation this high is effectively cutting real tax revenue)..  Basically another push in the key drivers behind the macro shitstorm the country is currently in.

But hey, some guys see the light at the end of the tunnel! As happened in Zimbabwe and countless other macro-populist ‘experiments’, hyperinflation eventually leads to dollarization and a relative “stability” in prices afterwards. Of course, everybody’s going to be immeasurably poorer at that point than what they are now.