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Venezuela's 95% devaluation adds to chaos after drone attack

[SANTIAGO] Venezuelan President Nicolas Maduro carried out one of the greatest currency devaluations in history over the weekend - a 95 per cent plunge that will test the capacity of an already beleaguered population to stomach even more pain.

The official rate for the currency will go from about 285,000 per US dollar to 6 million, a shock that officials tried to partly offset by raising the minimum wage 3,500 per cent to the equivalent of just US$30 a month. While Mr Maduro boasted in Friday night's announcement that the International Monetary Fund wasn't involved in the policies, aspects of the moves bore a resemblance to a classic orthodox economic adjustment, albeit with some confusing twists.

One likely outcome is that inflation, which already was forecast to reach 1 million per cent this year, will get fresh fuel from the measures. Prices are currently rising at an annualized rate of 108,000 per cent, according to Bloomberg's Café con Leche index.

Mr Maduro's new strategy for managing the economy is a desperate response after years of disastrous policies that undercut growth, sent prices soaring and turned what had once been one of Latin America's wealthiest countries into a dysfunctional nation that's spawned a refugee crisis. Pressure is mounting on him to right the ship as calls for his overthrow grow six years after he took over for the late Hugo Chavez. Earlier this month, Mr Maduro started a fresh crackdown on his opponents after a failed attempt to assassinate him using an aerial drone.

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The economic shock measures demonstrate the "government's willingness to do what it takes to stay in power," Raul Gallegos, an associate director at Control Risks, said from Bogota. "Maduro looks vulnerable, clearly something could happen."

The devaluation comes at the same time the governments is redenominating the currency by lopping off five zeros and introducing new bills and a name change. So instead of the new minimum wage being 1.8 million strong bolivars, it will be 1,800 sovereign bolivars.

To make things more complicated, the new bolivar's value will be linked to a crypto currency - believed to be the first time a government has ever employed the technique. The so-called Petro is backed by crude oil and is valued by the government at US$60, or 3,600 sovereign bolivars. The Petro will fluctuate and be used to set prices for goods.

VAT INCREASE

The value added tax will rise 4 percentage points and officials will end some gasoline subsidies, saving the government US$10 billion a year, Mr Maduro said, without providing more details. The central bank will increase the frequency of foreign exchange auctions to three and eventually five days a week.

In some ways, the devaluation is a mere formality. For years now, most people and companies have been unable to access dollars at government-set rates and have been purchasing them in the black market. As a result, the prices on many goods across the country are already based on that exchange rate.

"They had to do this because they ran out of money," Moises Naim, a fellow at the Carnegie Endowment and a former minister in Venezuela, said from Washington. He pointed out that oil production - pretty much the country's sole industry at this point - has plummeted in recent years amid a shortage of equipment and technical expertise, foreign reserves have plummeted and allies such as China and Russia are providing less support.

Amid the cash crunch, Mr Maduro has halted most payments on Venezuela's foreign debt and is now US$6.1 billion in the hole with bondholders, cutting off most sources of new financing. Creditors are also looking at the country's assets abroad with an eye toward seizing them. A small Canadian mining company was awarded the right to collect on an arbitration ruling by taking shares held by the parent of US refining unit Citgo, a verdict Venezuela is appealing.

BLACK FRIDAY

The symbolism of announcing the drastic measures on a Friday night wasn't lost on many Venezuelans. In 1983, President Luis Herrera Campins devalued the bolivar for the first time in 22 years after oil prices crashed. The day became to be known locally as "Black Friday."

When in 1989 Venezuela raised gasoline costs, lifted foreign-exchange controls and let the currency plunge, prices soared 21 per cent in one month alone, leading to riots known as the "Caracazo" that killed hundreds and eventually paved the way for mr Chavez's rise to power.

MILITARY ALLIANCE

It's not clear how the shock measures announced by Mr Maduro will sit with one of his key allies: the military. Top ranking generals have been handed the keys to ministries, the state-run oil company and the lucrative business of food imports. Myriad exchange rates created juicy arbitrage opportunities that enriched many close associates of the state.

"Clearly this will hit Maduro's popularity, but power is being sustained with bullets and not with votes," Mr Naim said. "As long as the military continues to have access to lucrative businesses it will continue to grant support to the government."

The opposition, a fragmented group of parties whose leaders are either in hiding or in jail, called for protests against the measures Tuesday. Several labour unions also called for a 24-hour national strike.

In Caracas this weekend, many small shops were closed while people flocked to supermarkets and gasoline stations to stock up. Online banking services will be suspended for 24 hours starting at 6pm local time in anticipation of the redenomination.

Many private companies, already dealing with hyperinflation, years of brain drain, price controls and threats of seizure, now much deal with even faster inflation and mandatory wage hikes. It's also possible that the exodus of Venezuelans to other countries will increase, even as Ecuador and Peru announced entry restrictions and tensions flared along the border with Brazil.

"People are leaving because of a feeling of despair, and the desperation will now increase," Mr Naim said.

BLOOMBERG