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 SIPDIS ENERGY FOR CDAY AND ALOCKWOOD HQ SOUTHCOM ALSO FOR POLAD TREASURY FOR MKACZMAREK NSC FOR DRESTREPO AND LROSSELLO USDOC FOR 4332 MAC/ITA/WH/JLAO 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. -------------- The Legal Mechanics -------------- ¶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. -------------- Financing the GBRV -------------- ¶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.) CARACAS 00001390 002 OF 002 -------------- Financing PDVSA -------------- ¶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. -------------- Transferring Reserves to Fonden Twice a Year -------------- ¶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. -------------- Changing the Nature of International Reserves -------------- ¶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. -------------- Comment -------------- ¶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