BRV BOND OFFERINGS TARGET PARALLEL DOLLAR MARKET

C O N F I D E N T I A L CARACAS 002186

SIPDIS

SIPDIS

HQ SOUTHCOM ALSO FOR POLAD
TREASURY FOR MMALLOY
NSC FOR JCARDENAS AND JSHRIER
COMMERCE FOR 4431/MAC/WH/MCAMERON

E.O. 12958: DECL: 11/08/2017
TAGS: ECON EFIN VE
SUBJECT: BRV BOND OFFERINGS TARGET PARALLEL DOLLAR MARKET

REF: A. CARACAS 2130


B. CARACAS 2084

C. CARACAS 1292

Classified By: Economic Counselor Andrew N. Bowen for reasons 1.4 (b) a
nd (d).


1. (C) Summary: The Ministry of People's Power for Finance
(MPPF) recently announced a new series of dollar and
bolivar-denominated debt issuances for the coming five
months. The BRV's stated reason for these issuances was to
optimize its debt profile and cover upcoming amortizations.
Local analysts unanimously believed that the true reason was
to contain the parallel market, where the number of bolivars
(Bs) needed to purchase one dollar climbed 30 percent in
October. The MPPF adjudicated the first issuance, a USD 1.5
billion combo offering, on November 12. As the MPPF did not
announce the methodology for adjudication in advance, there
is speculation that at least part of the offering was fixed.
Analysts are divided over whether the BRV's five-month plan,
if executed, would halt the rise in the parallel rate. End
summary.

--------------
The Five Month Plan
--------------


2. (U) The MPPF announced on November 6 a new series of
sovereign debt issuances for the coming five months. These
planned issuances include (1) a USD 1.5 billion combined
offering of dollar and bolivar-denominated bonds, to be
adjudicated November 12; (2) weekly issuances of
bolivar-denominated bonds for a total issuance of Bs 500
billion (USD 232 million at the official exchange rate of
2,150 Bs/dollar) in November and December and another Bs 500
billion from January through March; and (3) weekly issuances
of combined offerings of short-term debt for a total issuance
of USD 600 million in November and December 2007 and USD 1.2
billion from January through March 2008 in dollar-denominated
bonds, and the equivalent amount in bolivar-denominated
notes. Rodrigo Cabezas, the Minister of Finance, claimed
that the purpose of these issuances was to cover upcoming
amortizations and to optimize Venezeula's debt profile.

-------------- -
Surprise, Surprise: Questionable Transparency
-------------- -


3. (U) The terms of the initial USD 1.5 billion bond
offering, known as "El Venezolano I," were similar to
previous combined debt issuances except for the auction and
adjudication process. El Velezolano I has three components:
a dollar-denominated bond with a 7 percent coupon maturing in
2038 and two bolivar-denominated bonds with variable rates
maturing in 2014 and 2015 respectively. The total face value
of the issuance was USD 1.5 billion, of which the
dollar-denominated bond accounted for USD 750 million and the
two bolivar-denominated bonds USD 375 million each (at the
official exchange rate). Interested buyers could submit bids
by November 8 in USD 2000 increments, split between the three
component bonds at the same 2:1:1 ratio as the overall
offering. Per an addendum to the initial bidding
instructions, no entity could submit bids on more than 20
percent of the total offering (including both its own bid and
bids submitted for others). Unlike previous large bond
issuances in 2007, the MPPF did not set a single price.
Instead, it set a minimum price of 114 percent of face value,
to be paid in bolivars at the official exchange rate. The
MPPF declined to announce in advance the methodology for how
it would adjudicate the offers it received, saying that both
methodology and results would be announced on November 12.


4. (C) The fact that the MPPF did not announce its
methodology in advance led some to question the transparecy
of the process. Economist Orlando Ochoa (strictly protect)
noted that previous bond sales run by the MPPF had clearly
been corrupt (ref C). He speculated that some portion of
this auction might be fixed in advance, with favored banks
told how much they should bid for and at what price. The
gains from fixing could be large and instantaneous. Assume
that the parallel rate remains at 6,000 Bs/USD; that the
dollar-denominated bond can be sold for 85 percent of its
face value in secondary markets; and that the
bolivar-denominated bonds can be sold for 80 percent of their
face value. Then an individual who pays Bs 5 million to buy
USD 2,000 worth of El Venezolano I at 116 percent of face
value (the minimum price plus a 2 percent commission) could
turn around and sell them for Bs 6.8 million (using the
parallel market to convert the USD proceeds into Bs),an
instantaneous profit of Bs 1.8 million (USD 850 at the
official rate, or USD 300 at the parallel rate).


5. (C) The MPPF announced on its website November 12 that
every buyer who bid 136 percent or more of face value would
be allocated the full amount of his or her bid; that every
buyer who bid 125 to 136 percent of face value would be
allocated 35 percent of the amount bid (rounded to the
nearest USD 2000 increment); and that every buyer who bid 122
to 125 percent of face value would be allocated 20 percent of
the amount bid (similarly rounded). In other words, the BRV
did not maximize the total sales amount, but it did take the
bid price into account. Assessing the existence or extent of
corruption in this issuance is virtually impossible without
inside knowledge, but the possiblity certainly exists. A
profit-maximizing entity who knew these rules in advance
could have placed a bid for 20 percent of the total offering
at 136 percent of face value. Using the same assumptions as
in paragraph 4, this entity could have made 133 billion
bolivars (USD 62 million at the official rate, or USD 22
million at the parallel rate). (Note: In reality, buyers are
probably more likely to keep the dollars rather than
converting them back to bolivars on the parallel market. The
buyer who was allocated an order placed at 136 percent of
face value would, using the same assumptions as in paragraph
4, be receiving dollars at an implicit rate of 5,000
Bs/dollar. The difference between this implicit rate and the
parallel rate, currently roughly 6,000 Bs/dollar, is another
way of evaluating the rents from the transaction. End note.)

--------------
The Real Target: The Parallel Rate
--------------


6. (C) Local economic analysts unanimously believed that the
real reason behind the BRV's bond issuances was to relieve
pressure on the parallel rate, which rose 30 percent in
October (ref B). "Cabezas could never admit publicly to
caring about the parallel rate because the government insists
it does not exist," explained Asdrubal Oliveros (strictly
protect throughout),Director of Econanalytica, a local
consulting firm. Oliveros argued that the BRV had no
pressing need to restructure its debt and would not have
chosen to issue more dollar-denominated debt except for its
desire to intervene in the parallel market. (Note: By
auctioning dollar-denominated debt payable in bolivars, the
BRV is essentially supplying dollars to the parallel market
at a price more expensive than the offical rate but better
than the parallel rate. The BRV thereby likely hopes to
reduce the number of bolivars needed to buy one dollar on the
parallel market. End note.)


7. (U) The El Venzolano I issuance appears to have had an
immediate but small impact on the parallel market, which fell
from roughly 6,500 Bs/dollar (selling price for dollars) on
November 6 to 6,000 on November 13. It is difficult to
disentangle the effect of the El Venezolano I issuance from
that of the tax on financial transactions imposed November 1
(ref A),which dried up liquidity in the market and increased
the spread between the buying and selling price.

--------------
But Will It Be Enough?
--------------


8. (C) Analysts differed, however, in their assessment of
the medium-term effectiveness of the BRV's intervention.
Oliveros thought that if the BRV followed its plan of weekly
placements of dollar-denominated debt, the parallel market
would stabilize. Adriana Arreaza (strictly protect),country
economist at the Caracas-based regional development bank
Corporacion Andina de Fomento, agreed that regular and
frequent placement of dollar-denominated debt was the BRV's
best chance at controlling the parallel rate, but she
observed that it might not be enough to counter the effects
of political and economic uncertainty. Other analysts
believe that the debt issuances will not be enough to cause
increasing demand for dollars from driving up the parallel
rate. Noting that the BRV in 2007 has already issued or sold
approximately USD 12 billion in dollar-denominated bonds
payable in bolivars, economist Gustavo Garcia told the press
that the announced bond issuances would not be enough to
lower the parallel rate. BBO Financial Services Director
Miguel Octavio (strictly protect) told EmbOffs before the
issuance was announced that he knew two companies that each
had USD 1.5 billion worth of profits that they would try to
repatriate through BRV bond issuances. He speculated that
even issuances in 2008 at a magnitude of USD 8 to 10 billion
might not satisfy the demand in the parallel market.
DUDDY