CENTRAL BANK LAW MODIFIED: OPEN THE FLOODGATES?

C O N F I D E N T I A L SECTION 01 OF 02 CARACAS 001390

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E.O. 12958: DECL: 10/30/2019
TAGS: ECON EFIN VE
SUBJECT: CENTRAL BANK LAW MODIFIED: OPEN THE FLOODGATES?

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


1. (C) Summary: The National Assembly has approved
significant modifications to the law governing Venezuela's
Central Bank (BCV). The BCV will have vastly expanded powers
to act as a development bank and finance a wide array of
government projects. It will also be able to buy PDVSA bonds
directly and to count the dollar-denominated bonds of the
Venezuelan government (GBRV),PDVSA, and other GBRV entities
as part of its international reserves. These powers give
President Chavez, who controls the BCV's board, access to an
immediate and unlimited source of financing. The more the
BCV makes use of these new powers, however, the higher
inflation and the parallel foreign exchange rate will climb,
and the more the quality of the BCV's reserves will
deteriorate. End summary.

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The Legal Mechanics
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2. (U) The National Assembly approved a "Draft Law Partially
Reforming the Law of the Central Bank of Venezuela" on
October 29. The draft contemplates modifications to six
articles of the current Central Bank law, which was
previously modified most recently in July 2005. Proponents
in the National Assembly argue the reform is necessary to
give the BCV the tools to support "economic development with
social purpose" in the face of "a process of crisis in the
world capitalist system." The draft modifications will
become law upon President Chavez's signature and publication
in the Official Gazette, steps which most observers expect to
be quickly accomplished. The following paragraphs offer
post's understanding of the most significant changes, based
on our reading of the draft law and on published opinions of
several experts.

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Financing the GBRV
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3. (U) Under the current law, the BCV can provide credit to
a given bank for a period of two years (renewable one
additional two-year period) guaranteed by securities and can
establish "special conditions" (i.e., preferential terms) if
the security is derived from the financing of agricultural
programs determined by the GBRV. It can similarly provide
credit to the "public." The draft modifications
significantly amplify the scope under which the BCV can
provide credit: they eliminate the two-year limit; expand
the types of programs eligible for special conditions to
include construction, export industries, mining, and
"transformation of raw materials"; explicitly allow the BCV
to accept debt from the GBRV and its associated entities as a
guarantee; explicitly give the BCV wide scope in determining
the value of a given security submitted as a guarantee; and
allow the BCV to establish "special conditions" when state
institutions or funds are participating in projects in the
designated economic activities.


4. (C) In our opinion, under a loose interpretation of the
current law the BCV could have found creative ways to finance
the GBRV. For example, a state bank could have bought bonds
issued by the GBRV and then exchanged them for credit from
the BCV, at least for two two-year periods. The new law
gives the BCV and its directors explicit authority to finance
the GBRV in a wide variety of ways, including by offering
preferential interest rates and loan maturities for
designated projects. It also gives the BCV a great deal of
discretion in determining acceptable collateral for any
credit provided; or, as a report from Sintesis Financiera, a
local consultancy headed by a respected former BCV president,
put it, for collateral "anything goes." Economist Orlando
Ochoa (protect throughout) believes the modifications also
will allow the BCV to force private banks to finance GBRV
projects under conditions set by the BCV. (Note: The GBRV
has already used its authority to require banks to direct a
substantial part of their credit portfolio to specific
sectors, sometimes at preferential interest rates. End note.)


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Financing PDVSA
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5. (U) Under the current law, the BCV can buy and sell
securities on the secondary market under market conditions,
but it cannot buy securities directly from the issuer. The
new law will give the BCV the right to buy securities
directly from state oil company PDVSA under "special
conditions" (i.e., preferential terms) as long as the GBRV
approves. In order to issue bonds, however, PDVSA will now
have to seek the opinion of (i.e., basically get the
concurrence of) the Minister of Finance and the BCV.

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Transferring Reserves to Fonden Twice a Year
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6. (SBU) The current law obligated the BCV to present an
estimate to the GBRV on an annual basis of the "adequate
level" of international reserves. The BCV then transferred
any "excess" reserves to Fonden, a state development fund
controlled directly by President Chavez. The new law
obligates the BCV to present this estimate and transfer the
excess reserves on a twice-yearly basis, with the provision
that Fonden must transfer back the hard currency to the BCV
if reserves subsequently drop below the adequate level. As
Sintesis Financiera notes, however, there is no guarantee
Fonden would be able to do so.

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Changing the Nature of International Reserves
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7. (C) Under the current law, the BCV can count bonds issued
by "foreign public entities" as part of its reserves (as long
as they are liquid). The new law will eliminate the word
"foreign." In other words, the BCV could count toward its
reserves dollar-denominated bonds issued by the GBRV, PDVSA,
and other state-owned entities. Ochoa argues the BCV will
also be able to count as reserves dollar-denominated bonds
issued by entities such as Banco del Sur and Banco del Alba,
which are regional development banks the GBRV is in the
process of forming. (Note: These banks could be considered
"international financial institutions." As such, under the
current law the BCV can count their securities as
international reserves. End note.) Sintesis Financiera
argues that a new sentence that discusses in general terms
the BCV's function as administrator of international reserves
was inserted to absolve the BCV directors and staff of
liability in the event of losses.

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Comment
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8. (C) As with many key laws of President Chavez's
Bolivarian revolution, the potential impact of the revised
BCV law is enormous and the actual impact will depend on
implementation. If the BCV makes extensive use of its new
powers, President Chavez will greatly increase his control
over financing in Venezuela, using this control, no doubt, to
boost his candidates' chances in parliamentary elections
slated for 2010. This control would come with a significant
cost, however, in the form of much higher inflation, faster
devaluation of the bolivar in the parallel exchange market,
deterioration of the quality of international reserves, and
increasing loss of confidence in the economy. (Note: It is
unlikely Venezuela will fall into hyperinflation in the near
future, as its large oil revenues help anchor prices and the
currency. End note.) If the BCV makes only limited,
carefully targeted use of these powers, the cost will be far
less. It is hard to tell which way President Chavez will go.
He often makes only symbolic use of new laws (in the
immediate aftermath of their passing) that give him vast new
economic powers, calculating that this symbolic application
accomplishes his political purposes. With the economy
struggling, however, it may prove hard to resist using the
BCV's power to create money. End comment.
DUDDY