BILKING THE BRV

C O N F I D E N T I A L SECTION 01 OF 03 CARACAS 001053 SIPDIS SENSITIVE SIPDIS TREASURY FOR KLINGENSMITH AND NGRANT COMMERCE FOR 4431/MAC/WH/MCAMERON NSC FOR DTOMLINSON HQ SOUTHCOM ALSO FOR POLAD E.O. 12958: DECL: 05/30/2017 TAGS: ECON EFIN VE SUBJECT: BILKING THE BRV REF: A. CARACAS 305 ¶B. CARACAS 667 Classified By: The message is classified by Economic Counselor Andrew N . Bowen for reasons 1.4(b) and (d). ¶1. (C) SUMMARY: Venezuela's currency control regime and fixed exchange rate, administered by CADIVI, have become huge wealth generators for Venezuelans and foreigners playing the unregulated parallel market. As has been the case with previous currency control regimes in Venezuela, the current system has led to the birth (or rebirth) of an entire industry devoted to profiting from the arbitrage between the official and the parallel exchange rates. Many of these activities come at government expense and seem only destined to grow as demand for dollars continues, driven by surging imports and capital flight. END SUMMARY. ¶2. (SBU) The Commission for the Administration of Foreign Exchange (CADIVI) was created in 2003 as a response to falling foreign exchange reserves and economic turmoil following the general and PDVSA strikes of 2002-2003. Despite significant growing pains, CADIVI has become an integral part of the Venezuelan economy, being the sole provider of foreign exchange at the official, Bs. 2150/dollar rate. CADIVI approvals have grown substantially in the past years, from USD 15 billion in 2004, to USD 20.6 billion in 2005, USD 27.4 billion in 2006, and USD 14.7 billion so far in 2007. Despite these massive approvals, there remains a vibrant parallel market for foreign exchange for importers and businesses that are unable to obtain CADIVI approvals for a variety of reasons. The parallel rate as of May 25 is Bs. 4100 to the dollar, or almost 100 percent above the official rate. ¶3. (SBU) The wide gap between the two rates has led to a booming industry profiting off of the arbitrage between these rates. Perhaps the best known examples are the dollar-denominated bond issuances: the "bonos del sur" and PDVSA bonds. These issuances (totaling USD 10 billion over the past six months) are sold locally for bolivars, but are dollar-denominated assets and thus can be sold abroad for dollars. Anyone lucky enough to obtain a PDVSA bond could sell the bond in secondary markets for dollars at an implicit rate of around Bs. 2900/dollar. At the time, the dollar was trading in the parallel market at Bs. 3550/dollar, so the investor could have immediately sold the dollars obtained by selling the bond for bolivars and earned almost a 25 percent turn in a matter of days if not hours (reftel B). One banking sector contact recently commented to econoffs that, "everyone wins" with such transactions--the BRV can sell debt at a low interest rates, investors get guaranteed returns, and banks rake in the profits from fees and commissions, all for very little effort. The president of another leading bank opined that the BRV offers these sweetheart deals in order to subsidize the banking sector, which is theoretically taking loses from fixed interest rates below the rate of inflation and directed lending requirements imposed by the BRV. ¶4. (C) The parallel market likely accounts for anywhere from 20 to 35 percent of Veneuzela's total foreign exchange transactions, depending on who is estimating, and most brokerage houses and banks have devoted significant resources to this trade. Before the nationalization of telecommunications firm CANTV, one market contact estimated that as much as 50 percent of stock market activity in Caracas involved transactions buying and selling CANTV shares (which were listed as ADRs on the New York Stock Exchange and thus a means of converting bolviars to dollars). ¶5. (C) One of econoff's contacts recently joined a Venezuelan "Investment Bank," whose main business is buying and selling dollars on the parallel market. He spends his day on the MSN Messenger program connected with traders from the other dozen or so major brokerage houses sending buy and sell offers. The contact noted that on a recent day he had managed to make 100 million bolivars (USD 46,511 at the official rate, or 24,390 at the parallel rate) in less than an hour by buying bolivars before student protests caused some investor flight. The contact claimed that their profits were limited as some government institution entered the market to sell dollars and bring the rate back down. CARACAS 00001053 002 OF 003 ¶6. (C) The real profit, however exists for those that can obtain official dollars and then cycle them back through the parallel market for bolivars, making almost a 100 percent return on every transaction. CADIVI will authorize USD 5,000 per person per year for credit card purchases and up to USD 2,000 for internet purchases. Many small businessmen in Venezuela have resorted to borrowing credit cards from friends and family to import their goods, lacking the time or expertise to deal with the CADIVI bureaucracy. There is a lucrative business in loaning out credit cards, or in purchasing goods from the U.S. with official dollars and selling them here at or near the parallel rate (the USD 200 iPod purchased on-line with CADIVI dollars can be sold here for the equivalent of USD 350). ¶7. (C) A wealthy section contact recently described how he could not wait for his teenage sons to graduate high school and go to college in the U.S. He noted that CADIVI has a relatively easy approval process for education, and that he could send his son to school in the U.S. and obtain as much as USD 50,000 annually from CADIVI for the school bills (which in the U.S. include intangibles such as room and board, books, etc.) and keep most of the money as his son could qualify for student loans or scholarships. A friend of his, he noted, had three children at college in the Boston area and was obtaining USD 150,000 annually. ¶8. (C) A potentially larger problem exists for CADIVI with importers who inflate the value of the goods they are bringing in to the country to get excess dollars they can invest abroad. While illegal, it is reportedly a very common practice, and CADIVI now has inspectors at all of Venezuela's ports whose job is to match the CADIVI approval with the actual goods. According to the ports and customs expert at one of Venezuela's chambers of commerce, this just adds another person in the chain to bribe when importing goods (along with customs, the national guard, and the anti-drug police). There have been some enforcement successes, however, including the case of Microstar computers, which allegedly obtained USD 27 million to import computers, almost all of which instead went to its directors off-shore bank accounts (including, supposedly, those of Chavez' son). ¶9. (C) Colinas de Valle Arriba, the upper class enclave where the Embassy and many Embassy officers live was once known as "Colinas de Recadi," Recadi being one of CADIVI's predecessor institutions during the 1980s. As has been the case with previous exchange control regimes here, the law of unintended consequences has become pronounced as the currency controls imposed in the name of "Socialism for the 21st Century" have heavily benefited wealthy Venezuelans with the capacity to request CADIVI dollars and play the foreign exchange market. ¶10. (C) Despite CADIVI's inefficiencies, it remains an important tool for the BRV (allowing it to favor certain types of imports and certain importers) as well as by allowing it to selectively withholding CADIVI approvals from enemies of the regime. Venezuelan airline Aeropostal seems destined for bankruptcy, having been unable to obtain sufficient foreign exchange this year (and thus unable to pay its significant dollar costs for aircraft leases, parts, airport fees in the U.S., etc.). In 2006, Aeropostal requested USD 82 million and received USD 10 million. Rumor watchers consider this a calculated move to force the company into bankruptcy so it can be merged with the government-owned airline Conviasa (which is reportedly controlled by armed forces interests). Stories of opposition supporters and signers of the 2004 recall referendum petition unable to get dollars are commonplace. Recently econoffs were told that Venezuelan magnate Alfonso Rivas (STRICTLY PROTECT) was forced out of the directorship of his company by threats to eliminate his access to CADIVI dollars to import corn (and thus push the food production and distribution conglomerate out of business). ¶11. (C) The BRV also takes advantage of the dual exchange rates. Parts of PDVSA have been rumored for years to be engaged in the foreign exchange trade, selling dollars in the parallel market instead of depositing them at the Central Bank in return for bolivars used to fund local expenses such as the missions. This practice, which supposedly is also employed by development bank BANDES and other state and CARACAS 00001053 003 OF 003 parastatal institutions, creates additional liquidity (one of the primary drivers of Venezuela's 19-plus percent inflation rate) and reduces foreign exchange reserves (by not depositing dollars at the Central Bank). ¶12. (C) A banking contact recently claimed that even such venerable institutions as the Andean Development Fund (CAF) and International Finance Corporation (IFC) have been taking advantage of the overvalued official rate by issuing local bonds in bolivars at very favorable interest rates and then getting CADIVI dollars for them to pay operating expenses and increase their availability of funds. ¶13. (C) COMMENT: All of the methods outlined share the common element of draining the country's foreign exchange reserves. As CADIVI is a currency control regime (read: is trying to limit the outflow of dollars) it does not approve all requests. By flooding the market with requests and scams to get them approved, genuine requests can be crowded out. Many legitimate importers face severe supply shortages due to problems with CADIVI (which are compounded by administrative requirements, including obtaining certificates of no or insufficient local production and the good labor practices certificates). This has contributed to the general problem of shortages in Venezuela, as a lack of primary inputs affect the entire production chain (e.g. feed for animals) and importers have trouble bringing in goods to complement domestic supply. ¶14. (C) COMMENT CONTINUED: Aside from the hypocrisy of promoting a socialist state that rejects wealth creation while at the same time maintaining a financial system allowing people to make huge fortunes, the current system is costing the BRV hundreds of millions, if not billions of dollars. The BRV and its main cash cow, PDVSA, are having cash flow problems (reftel A) and part of their problem surely stems from the number of Venezuelans (public sector and private) diverting and misappropriating funds for personal gain. Venezuela has a long history of these types of shenanigans and Post expects CADIVI to remain in force for some time, if only to plug holes in the dam of capital flight facing the country if currency controls end. As demand for foreign currency seems insatiable, supply via the official rate seems destined not to keep up. This provides the BRV another means to reward its friends and punish its enemies. Some of the greatest benefactors in the Bolivarian Republic, it would seem, are those scrappy capitalists. END COMMENT. BROWNFIELD