BRV INTERVENING IN PARALLEL MARKET, AGAIN

C O N F I D E N T I A L SECTION 01 OF 02 CARACAS 001292

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E.O. 12958: DECL: 06/27/2017
TAGS: EFIN VE
SUBJECT: BRV INTERVENING IN PARALLEL MARKET, AGAIN

REF: A. CARACAS 332

B. CARACAS 959

C. CARACAS 1053 AND PREVIOUS

Classified By: Economic Counselor Andrew N. Bowen for reason 1.4(d).


1. (C) SUMMARY: The Ministry for People's Power of Finance
(MPPF) admitted selling dollar-denominated notes to banks
this past week to manage the parallel foreign exchange
market. This marks the first time since 2005 that the BRV
has actively intervened in the market to affect the rate and
the first time they have ever actually admitted to doing so.
In selling dollar-denominated notes held by the National
Development Fund (FONDEN) to local banks, MPPF increased the
supply of dollars on the parallel market, thus lowering the
exchange rate from around Bs. 4350/dollar during the week of
June 18 to Bs. 4100/dollar as of June 27. This marks a
return to 2003-2004 when the MPPF actively managed the
parallel market to keep it between 20 and 30 percent above
the official rate, albeit at a cost of increasing liquidity
and corruption. END SUMMARY.


2. (C) On June 21 The MPPF sold between USD 200 and 300
million in structured, or Credit Linked Notes (CLNs) to the
local financial sector. These CLNs were dollar-denominated
products combining Argentine, Colombian, and Ecuadorian bonds
that FONDEN obtained in 2006. Approximately USD 6.8 billion
dollars in CLNs were purchased by FONDEN in 2005-2006. The
value of these notes has fallen significantly since they were
created due to rising U.S. treasury yields and increased
perceptions of risk associated with the Ecuadorian bonds. As
they were packaged to mature in 2012 and had fallen in value,
FONDEN could not sell the notes without a loss (and much
embarrassment when reporting the loss to Chavez) thus
essentially making a large chunk of its assets illiquid.


3. (SBU) According to a June 27 article in "El Universal,"
the CLNs represent as much as 46 percent of FONDEN's
remaining assets (assuming that FONDEN has received USD
27.235 billion since its inception and has thus far spent USD
12.445 billion). Of the USD 14.790 or so remaining, a
portion is assigned to projects, but not yet spent AND USD
6.8 billion or so could be held in these illiquid notes.
This means that FONDEN has little money left to spend on new
projects, despite receiving USD 6 billion in transfers from
the Central Bank during the first half of 2007 (reftel B).


4. (C) As was explained to Econoffs on May 24 by HSBC's
Representative in Caracas (PROTECT THROUGHOUT),the only
means to get rid of this liability was to sell the notes on
the local market. Given the gap between official and
parallel exchange rates, FONDEN can sell these notes for Bs.
2400-2600/dollar (10-20 percent above the Bs. 2150/dollar
official exchange rate). Although they are trading below
face value, Venezuelans will buy the notes and sell them for
dollars abroad. Even though they take a hit on the exchange
rate and on selling the notes below face value, the
transaction is still worthwhile. If a Venezuelan buys a bond
trading at 60 percent of face value at an exchange rate of
Bs. 2500/dollar, he still makes money, getting dollars for
approximately Bs. 4166/dollar while the parallel rate is at
Bs. 4350/dollar (where it was on June 21). (Note: It is
unclear at what rate the bonds were sold locally and at what
precise discount they could be sold onwards. The CLNs are
structured notes combining different types of bonds with
different values and maturities. End Note). In this
transaction, everyone wins: FONDEN reduces its risk and
obtains bolivars to spend locally at a rate better than it
could obtain from the Central Bank, the lucky banks and
brokerage houses that obtain these bonds get to sell them to
their clients at a profit, the clients get access to dollars
at a slightly better rate, and the parallel market rate
decreases.


5. (C) Estimates range that between 25 and 35 percent of
foreign exchange needs in Venezuela are met by the parallel
market and as it goes up, so do prices for many goods
imported with parallel dollars (reftel C). By keeping the
rate down, the MPPF probably believes that it will lessen
inflation, which is a major BRV preoccupation (reftel A).
Unfortunately, this is not the whole story. By selling the
notes for more than Bs. 2150/dollar, FONDEN is essentially
printing money, turning USD 1, which is worth Bs. 2150, and

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making Bs. 2400 or 2500 instead. (Note: This is in addition
to the Bs. 2150 for every dollar that was created when the
Central Bank received the dollar originally from oil exports.
Thus, for ever dollar entering FONDEN and being sold to the
local market, the BRV is creating as much as Bs. 4650. End
Note).


6. (C) According to a local investment banker, this system
was in use during 2003-2004 under Finance Minister Nobrega.
While it worked to increase the BRV's spending power and
manage the parallel market, it was plagued by corruption.
Given the value of dollar-denominated notes in the Venezuelan
economy and the limited supply, Ministry officials were
reportedly playing favorites with financial institutions in
return for commissions or kickbacks. By discontinuing both
this practice and annual devaluation, Minister Merentes
succeeded in more than doubling the money supply and with it,
the parallel exchange rate.


7. (C) COMMENT: By choosing to intervene in the parallel
market, MPPF Cabezas is demonstrating that the BRV's
inflation concerns and FONDEN's spending demands supersede
combating corruption within its ranks. As was the case in
earlier years of the currency controls, the decisions to
allocate these resources were made behind closed doors,
making it easy for interested parties to facilitate a
favorable sale. Through its transfers to FONDEN, BRV
continues to create money without foreign exchange backing,
weakening the implicit value of its currency and in part
contributing to the increase in the parallel rate. Future
interventions are likely as Cabezas tries to unwind the CLNs
and provide FONDEN more purchasing power. END COMMENT.

BROWNFIELD