1) Why a country like Venezuela impose capital controls?

ANSWER:
Chavez was elected President in 1998 from socialist platform. He reduced poverty by 20% and
expand its social services. Oil production was on peak in late 1990s and early 2000s, after that it
started to decline. Due to two months oil strike, exports and foreign exchange reserves declined.
He fired thousands of PDVSA experienced workers who participated in industry strike in 2002-
2003, which deprived company from many technically skilled persons (1). Beginning in 2005,
Chavez provided subsidized oil to several countries in the region including Cuba, through an
alliance known as Petrocaribe. It resulted in depleting petroleum reserves and almost doubled
government debt. On January 21, 2003 the bolivar was devalued at a record low i.e. Bs1891.50/$
which was Bs722/$ one year earlier (2). Due to this devaluation of bolivar, on February 5, 2003,
the Venezuelan government announced Exchange Regulation Decree. The focus of this decree was
on the following:
 Exchange rate was fixed @ Bs1596/$ for buying and @Bs1600/$for sale
 Establishment of the Comision de administracion de Divasis (CADIVI) is a currency board
which monitors all the exchanges. For buying dollars the board required a lot of paper work
and strict conditions.
 To curb inflation government tried to control prices which was the result of devalued
bolivar.
Capital control is an instrument used for bringing economic and financial system stability. In
Venezuela the purpose of capital control was to sop devaluation of bolivar and capital flight. World
Bank economists suggests that exchange control can have bad effect on trade, economy and
employment. But it can be very effective in eliminating inflation and building confidence on the
currency of a country if it is properly managed with fiscal and monetary policy (2).
One method of controlling inflation is the explicit or implicit currency auctions with the help of
exchange control. When government opt for currency auction, it sells foreign currency to importers
at higher price. They impose tax on imports which results in money drain. It results in decrease in
supply of money in return prices come down. In case of Venezuela this technique is not applied
properly so the banks instead of government get benefit from these auctions (2).
Due to imposition of exchange control, imports has decreased to an alarming extent, increased
unemployment, increased recession took place. At the end of two month strike, reserves started
increasing and the recovery of economy was started. Businessmen and importers did not get dollars
in order to import goods. Major imports mainly consist of food items besides petroleum products.
As a result shortage has occurred in the major cities of the country (2).

2) In the case of Venezuela, what is the difference between the grey market and the black
market?
ANSWER:
Black market is an illegal market and grey market is neither legal nor illegal.
Grey market lies between black and white markets. Grey market is developed by the people who
provide goods/services at lower rate than the black market rate. Goods are genuine but the channel
of distribution is unofficial or unauthorized in order to avoid taxes (3).
Black market provides goods/services which are illegal by laws. Stolen, or lawfully banned illegal
items are traded (3). The price offered in this market is higher than grey market.
In the case of Venezuela getting dollars from black market, bolivar is provided by a banker or a
stockbroker in Venezuela who have offshore account in US $. Black market broker is more risky
in case of failure of completing the transaction properly due to lack of legal resources.
If Santiago wish to obtain dollars through black market, he must deposit bolivars in his broker’s
account in Venezuela. The exchange rate is determined on the day of deposit and normally within
20% band of grey market derived from the leading telecommunications services provider in
Venezuela Telecommunications Company (CANTV) share price. After that Santiago was allowed
to operate a bank account in dollars in other country than Venezuela. Normally transaction take
place in two working days. Black market rate was Bs3300/$.
In case of Venezuela grey market is operated through investing in Caracas stock exchange.
CANTV ADRs are sponsored by Bank of New York. The trade of CANTV ADRs was stopped in
February after Exchange Regulation Decree was presented to determine the legality of trading
according to the new currency control in Venezuela. On May 26, it was concluded that trade was
legal, so the bank resumed trading in CANTV shares. CANTV share price become the primary
method of calculating grey market exchange rate. For example closing rate of shares was
Bs7945/share on February 6, 2004 on the Caracas bourse, CANTV ADRs on New York stock
exchange closed at $18.84/ADR. An ADR is composed of 7 shares of CANTV in Caracas. Gray
market exchange rate is determined as follows:
Implicit gray market rate = 7*Bs7945/share / $18.84/ADR
=Bs2925/$
The official exchange rate on the same day was Bs1598/$. It means that gray market rate of bolivar
was approximately 46% weaker against the dollar according to Venezuelan government rate.

3) Create a financial analysis of Santiago’s choices and use it to recommend a solution to his
problem?
ANSWER:
As Santiago needs $30,000 for fulfilling the orders of his customers. Options of getting dollars are
CADIVI, black market and grey market. It was very difficult for him to get dollars from CADIVI
as he had signed the petition against Chavez. He has been listed as anti-Chavez in the database of
CADIVI. But somehow (through some links or illegal source) on March 10 he had received
$10,000 at exchange rate of Bs1920/$. To get dollars quickly he had paid extra 500 bolivars/$, so
the exchange rate becomes Bs2420/$. Now for getting the remaining $20,000 he is left with
following two options of getting dollars.
1) Grey market is offering Bs2952/$, if he opt the grey market for getting dollars then he must
pay Bs59, 040,000 (Bs2, 952*$20,000).
2) Black market is offering Bs3300/$, if he opt black market for getting dollars then he must
pay Bs66, 000,000 (Bs3, 300*20,000).
By analyzing all the three methods of getting dollars the cheapest is CADIVI even after paying
extra Bs500/$. But this option is not available for him due to anti Chavez petition. According to
my opinion from remaining two options Santiago must choose grey market for getting dollars
because it will save his Bs6, 960,000 (Bs66, 000,000- Bs59, 040,000). This is the cheap way of
getting dollars from the available sources.
Available options of getting dollars are more expensive (his margins decreased by 50%) and not
always legal. Repeatedly devaluation had decreased his margin and cost has risen due to
devaluation of Bolivar in terms of exchange rate.

References
1)https://www.cfr.org/backgrounder/venezuela-crisis
2) https://sites.duke.edu/djepapers/files/2016/08/Fletcher.pdf
3) http://www.differencebetween.info/difference-between-black-market-and-grey-market