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