Bolivian Resilience: How The Country Avoided Collapse

Bolivia is currently facing an economic crisis, with the country's international reserves at their lowest point in 15 years and government bonds performing poorly. However, Bolivia has shown resilience in the past, and there are reasons to believe that the country can weather this storm. Bolivia's impressive pandemic recovery, unorthodox economic policies, and prudent fiscal policy have all contributed to its ability to navigate turbulent times. Additionally, Bolivia's large stock of international reserves accumulated during the commodity boom and prudent management of its crawling peg exchange rate have helped to shield the country from the worst effects of the crisis. While there are challenges ahead, Bolivia's experience provides valuable lessons in economic resilience and the benefits of a fixed exchange rate system.

Bolivia's large international reserves accumulated during the commodity boom

Bolivia's reserves were accumulated through high trade and current account surpluses, with little to no contribution from capital flows. The country's financial sector remains highly dollarized, and its monetary policy has been based on an exchange rate anchor. Bolivia's central bank has also been commended for its flexibility in administering the exchange rate, which may explain why the country has fared better than others during economic crises.

The large international reserves have contributed to Bolivia's financial stability and ability to withstand external shocks. However, the country still faces challenges, such as declining gas exports, public debt, and modest international reserves.

The country's crawling peg exchange rate

Bolivia's monetary policy has been based on an exchange rate anchor, with its currency, the Boliviano (Bs), pegged to the US dollar. This system, known as a "crawling peg", allows for gradual currency depreciation or appreciation and is usually seen as a feature of fixed exchange rate regimes.

Bolivia's crawling peg exchange rate system is described as an "incomplete crawling peg", with the exchange rate fixed but undergoing micro-readjustments that are not pre-announced to the public. Since October 2011, the exchange rate has been 6.96 Bs/$1 for selling and 6.86 Bs/$1 for buying. This system has been in place since 1985, with the Bolivian Central Bank administering the rate with some flexibility, which may explain the longevity of the exchange regime.

The crawling peg system offers advantages such as avoiding economic instability and minimizing uncertainty and volatility by keeping exchange rate fluctuations minimal. However, in practice, it may face challenges when dealing with substantial currency flows that can affect the exchange rate, potentially leading to costs for market players.

Bolivia's decision to stick to its crawling peg exchange rate policy, even as other Latin American countries moved away from fixed exchange rates, has been cited as a factor in the country's resilience to economic crises. During the Latin American regional crisis of 1999-2003, for example, Bolivia accelerated the rate of crawl, depreciating its currency, which may have contributed to the country's ability to navigate that turbulent period relatively unscathed.

The crawling peg policy has been part of a broader set of policies and initial conditions that have contributed to Bolivia's economic performance and resilience. These include a high level of international reserves accumulated during the commodity boom, low public external debt, and fiscal policies that have generated significant savings and reduced the need for external financing.

The Bolivian government's management of fuel subsidies

Bolivia has some of the cheapest fuel prices in Latin America, with a litre of high-octane gasoline costing $0.54, and diesel $0.54. A cubic metre of vehicle natural gas costs $0.24, while a cylinder of LPG costs $3.27. The population spends between $1.60 per month on household gas.

Fuel subsidies are a key part of the Bolivian government's policy. According to the Economy Ministry, keeping fuel prices frozen is a state policy, which reduces the risk of a wave of inflation since the energy sector is the driver of economic development. The administration of President Luis Arce considers that "subsidising the price of fuels in the domestic market is the policy with the greatest positive impact for Bolivian families".

However, experts argue that fuel subsidies are unwise, causing corruption, contraband, and inefficient energy use. A 2015 study by El-Katiri & Fattouh found that fuel price distortion results in fewer efforts toward environmental conservation, fuel smuggling, adulteration, and resale on the black market. Bolivia's borders are porous, and the increase in fuel prices in neighbouring countries will increase fuel smuggling.

The consequences of fuel subsidies are significant. A study published in May 2022 by ESD found that while subsidies generate a short-term benefit for the poorest segments of society, they have negative consequences on the fiscal deficit, investment, economic growth, and the environment. The study also observed that more corrupt societies tend to have higher subsidies, while more democratic political systems have higher prices, and that when political power is concentrated within a few, subsidies tend to increase.

Bolivia's government has acknowledged the problem of fuel smuggling. Since 2018, the Bolivian army has been leading the fight against fuel smuggling as part of its so-called 'sovereignty plan'. In January 2024, a government decree established the reduction of tariffs to 0% for the import of crude oil, allowing state energy company Yacimientos Petrolíferos Fiscales Bolivianos (YPFB) to define the volumes of crude oil to be imported based on the needs of the domestic market and the processing capacity of the country's refineries.

In August 2024, President Luis Arce promised public votes on fuel subsidies and the constitutionality of reelection, offering a concrete path out of the country's economic and political crisis. The removal of fuel subsidies is a politically combustible issue, and curtailing the long-established subsidies risks triggering catastrophic price shocks and inflaming outrage among Bolivians. However, the government has nearly gone bankrupt importing and heavily subsidising fuel, and it is struggling to maintain solvent with dwindling foreign currency reserves.

The government's ability to borrow in the domestic market

Bolivia's ability to borrow in the domestic market is closely tied to its fiscal policy and the management of its crawling peg exchange rate. The country's monetary policy has been based on an exchange rate anchor, and its financial sector remains highly dollarized. Bolivia's decision to stick to its exchange rate regime, which involves frequent but unannounced readjustments, has contributed to its relative stability during economic crises.

The Bolivian government's ability to borrow domestically is also influenced by its management of public finances. The country accumulated significant savings in the public sector, reducing the need for external financing. Additionally, Bolivia's low public external debt-to-GDP ratio of 13% in 2008 provided further flexibility. The government's ability to service its debt and maintain access to internal financing played a crucial role in maintaining economic stability.

Bolivia's resilience during the global financial crisis can be attributed to its high level of international reserves accumulated during the commodity boom. These reserves acted as a "rainy day" fund, instilling confidence in the economy and buffering against the adverse effects of the crisis. The country's initial favourable conditions, including these reserves, contributed to its ability to navigate economic shocks without significant distress.

However, Bolivia's economic challenges, such as declining natural gas production and the impact of the COVID-19 pandemic, have led to increased public debt and reduced international reserves. These factors have limited the government's ability to boost growth and created pressure on the foreign exchange market.

In conclusion, Bolivia's ability to borrow in the domestic market has been influenced by its exchange rate policies, prudent fiscal management, and the accumulation of international reserves. These factors have contributed to the country's resilience during economic downturns, but ongoing challenges highlight the need for continued structural reforms to promote sustainable growth.

Bolivia's fixed exchange rate system

Bolivia's exchange rate system is described as an "incomplete crawling peg". This means that while the exchange rate is fixed, it undergoes small adjustments that are not announced to the public. The official exchange rate is 6.96 Bolivianos (Bs) to 1 US dollar for selling and 6.86 Bs to 1 US dollar for buying. This rate has been in place since October 2011.

The Bolivian currency, the Boliviano, is freely convertible at banks and exchange houses. The Central Bank requires that all currency exchange occurs at the official rate ±1 basis point to avoid distortion in the exchange rate market. The parallel rate closely tracks the official rate, indicating that the market finds the Central Bank's policy acceptable.

The stability of the exchange rate is notable given the volatility of Bolivia's economy in recent years. Bolivia has one of the fastest-growing economies in South America, but it is also the second-poorest country in the region. The country has faced challenges such as declining natural gas production, high public debt, and limited international reserves. Additionally, Bolivia is vulnerable to climate-related disasters and the volatility of commodity prices.

To promote economic growth and stability, Bolivia needs to address structural challenges, encourage private sector development, and protect its vulnerable population.

Frequently asked questions