BRV NOT IMMUNE TO INTERNATIONAL FINANCIAL TURMOIL

C O N F I D E N T I A L CARACAS 001338

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E.O. 12958: DECL: 04/23/2018
TAGS: ECON EFIN VE
SUBJECT: BRV NOT IMMUNE TO INTERNATIONAL FINANCIAL TURMOIL

REF: A. 2007 CARACAS 1292

B. CARACAS 930

C. 2007 CARACAS 2186

Classified By: Economic Counselor Darnall Steuart for reasons 1.4 (b) a
nd (d).


1. (SBU) Summary: The Bolivarian Republic of Venezuelan
(BRV) has not escaped recent problems in the US financial
sector unscathed. The government holds about USD 300 million
and private banks an additional USD 400 million in structured
debt notes issued by the bankrupt Lehman Brothers. The
firm's bankruptcy has reduced the value of these assets, but
the losses should have little impact on the Venezuelan
economy or government finances. Local analysts estimate that
the BRV could hold up to USD 50 billion in foreign currency
assets on top of its official reserves. Of greater concern
to the BRV will be the increased borrowing costs resulting
from market turmoil and the downward pressure that worries
about the outlook for the world economy could put on oil
prices. End Summary.


2. (U) While President Hugo Chavez has publicly reveled in
the problems affecting the US financial sector, the BRV has
not been unscathed by the turmoil roiling international
financial markets, most notably the September 14 bankruptcy
of the investment bank Lehman Brothers. Chavez on September
16 told reporters that the problems at Lehman Brothers would
have little effect on the Venezuelan economy and accused the
firm of unduly criticizing the BRV's economic policies rather
than examining its own books. However, press stories the
same day indicated that about USD 300 million in BRV assets
and about USD 400 million of Venezuelan banking sector assets
were tied to Lehman Brothers.


3. (SBU) The BRV assets in question are held in the National
Development Fund (FONDEN). They are notes structured by
Lehman Brothers and backed by a mixture of emerging market
sovereign bonds purchased by the BRV in 2006 or earlier (ref
A). The Ministry of Finance has admitted to holding these
notes and announced that it plans to review its options to
minimize losses. The BRV may have to sell these instruments
at as much as a 75 percent discount, according to local press
reports, but this estimate probably exaggerates the impact
the problems at Lehman Brothers will have on the government's
finances because the notes at risk lost much of their value
soon after their purchase. (NOTE: The potential losses from

these notes are also small relative to total public sector
assets. Local analysts estimate that FONDEN currently holds
as much as USD 20 billion in assets itself, and the BRV could
hold up to a total of USD 50 billion in foreign currency
assets across multiple funds in addition to its official
reserves. END NOTE)


4. (C) The $400 million in banking sector assets exposed to
the Lehman Brothers bankruptcy are made up of the "other
structured notes" that banks had been using to circumvent a
regulatory ceiling on foreign currency assets (ref B). While
the problems at Lehman Brothers have certainly made these
assets riskier for the banks holding them, it does not appear
that problems in the US financial sector will significantly
increase losses for Venezuelan banks. Asdrubal Oliveros
(PROTECT),Director of the economic consulting firm
Ecoanalitica, told Econoffs September 22 that Venezuelan
banks had sold most of their notes issued by Lehman Brothers
prior to its bankruptcy and that the notes still outstanding
were held at two small banks who could lose all but 25
percent of their initial investments. Jesus Bianco
(PROTECT),Chief Economist for the Venezuelan Banking
Association, told Econoffs September 16 that the notes tied
to Lehman Brothers, if held to maturity, would likely be
respected because they were backed by contracts and tied to
underlying assets.


5. (C) More troubling for the BRV is the effect that the
problems on Wall Street will have on emerging market debt as
a whole. Distress in financial markets has increased risk
aversion and made investors less willing to hold emerging
market bonds. Spreads on Venezuelan sovereign debt increased
by about 250 basis points following the announcement of
Lehman Brothers' bankruptcy and Merrill Lynch's acquisition
by Bank of America. A shift toward safer assets will
probably increase the cost of the BRV's strategy of issuing
dollar-denominated debt (or buying and reselling Argentine
debt) to limit liquidity growth and control the parallel
exchange rate (ref C). Borrowing costs will probably rise
further as Lehman Brothers and other investment banks who had
been acting as counterparties and purchasing Venezuelan bonds
in secondary markets exit the market. Contacts at one of
Venezuela's largest brokerages Econoinvest (PROTECT) told
Econoffs September 16 that Lehman Brothers had been a major
purchaser of Venezuelan and other emerging market issues.
They expected the firm's bankruptcy not only to shrink the
market for emerging market debt, but to increase debt spreads
as well when the firm sells off its assets. The BRV could
also see some of its assets erode in value as prices of
emerging market bonds fall. In addition to the notes tied to
Lehman Brothers, the BRV holds as much as USD 700 million in
other notes made up of emerging market debt in FONDEN that
would be vulnerable to such a price decline.


6. (SBU) Comment: BRV and banking sector ties to Lehman
Brothers have generated headlines but do not appear to pose a
major risk to Venezuela. Losses resulting from the latest
round of financial turmoil do not appear to be significantly
larger than those already expected. Nevertheless, the BRV
will feel the effects of the problems in financial markets
through increased borrowing costs should it attempt to issue
new sovereign debt. The most significant risk for the BRV is
that problems at US financial firms could greatly damage its
fiscal position if concerns about the outlook for the world
economy continue to push down oil prices (septel). The BRV
will probably face a much more difficult external environment
going forward, which will limit its margin for error in the
administration of oil revenues, handling of public sector
assets, and management of external debt.
CAULFIELD