AN OFFER THEY CAN'T REFUSE? GBRV ASKS LOCAL BANKS

C O N F I D E N T I A L SECTION 01 OF 03 CARACAS 000494

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TREASURY FOR RJARPE
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E.O. 12958: DECL: 04/13/2019
TAGS: ECON EFIN VE
SUBJECT: AN OFFER THEY CAN'T REFUSE? GBRV ASKS LOCAL BANKS
TO FINANCE DEFICIT

REF: A. CARACAS 368

B. 2008 CARACAS 566

C. CARACAS 247 AND PREVIOUS

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


1. (C) Summary: The Government of the Bolivarian Republic
of Venezuela (GBRV) has signaled its plans to ask local banks
to finance a significant part of its anticipated deficit in

2009. The Central Bank (BCV) has taken steps to increase
banks' liquidity and incentives to buy GBRV debt, reducing
the reserve requirement and lowering the interest rate for
its absorption operations. At the same time, banks are
increasingly reluctant to lend to private sector clients and
individuals. For these reasons, most bankers and financial
sector experts post has consulted believe the banks will do
as asked, without having to be forced. While good for the
GBRV in the short term, banks' apparent willingness to buy
GBRV debt is more a symptom of a deteriorating and
increasingly state-oriented economy than a vote of confidence
in the government's economic plans. Banks' relevance to
Venezuela's economy is gradually declining, and they are
increasingly becoming intermediaries between clients'
transactional deposits and the GBRV. End summary.

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Knock and Help Open the Door
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2. (U) The "anticrisis" economic measures announced by
President Chavez March 21 mostly concerned how the GBRV
planned to close a large anticipated budget deficit for 2009
(ref A). Prominent among these measures was the intention to
increase the ceiling for new debt issuance in 2009 from 12 to
34 billion bolivars (Bs),or from USD 5.6 to 15.8 billion at
the official exchange rate. (Note: The National Assembly
subsequently authorized a new ceiling of Bs 37 billion. End
note.) As the yield demanded by international financial
markets would be prohibitively high, the vast majority of
debt issuances this year will be placed in the domestic
market. In particular, they will be aimed at local banks,
who hold more than half of GBRV domestic debt. (Note: As of
December 31, 2008, the GBRV had outstanding internal debt of
Bs 30.5 billion, of which Bs 17 billion was held by banks.
End note.) In his remarks, Chavez claimed the banks had
"plenty of room" to buy GBRV bonds and called on bankers to
work with GBRV officials. On April 4, Minister of Finance
Ali Rodriguez met with representatives of leading banks to
discuss a schedule for placing internal debt "of more than Bs
33 billion" in 2009.


3. (U) As GBRV was developing its financing plans, the
Central Bank (BCV) took several apparently coordinated steps
to free up liquidity. It reduced the marginal reserve
requirement from 30 to 27 percent on January 5 and from 27 to
25 percent on March 9, steps which post calculates will free
up Bs 5.5 billion in reserves. (Note: The marginal reserve
requirement applies to the difference between current
deposits and deposits as of July 2006 in banks with over Bs
90 million in deposits. End note.) The BCV also reduced the
interest rate for absorption operations in three phases by a
total of seven percentage points (e.g., from 14 to seven
percent for a BCV certificate of deposit (CD) maturing in 56
days). This reduction increases the relative attractiveness
of government bonds, as the average yield for new issuances
in 2009 was 16 percent through late March according to one
local bank's calculations. As of February, banks owned about
Bs 26 billion of BCV CDs. In other words, by continuing to
reduce the reserve requirement and lowering its outstanding
stock of CDs, the BCV can free up sufficient liquidity for
banks to finance the deficit anticipated by the GBRV.

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Banks Left With Few Options
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4. (SBU) Most of the bankers and financial sector experts
Econoffs have recently consulted believe banks will be
willing to buy GBRV bonds, not because they are attractive
investments but because there are few worthwhile
alternatives. As the economy falters and directed lending
becomes more onerous (ref B),banks have cut back credit to

CARACAS 00000494 002 OF 003


private clients. For the first time since at least 2004, in
2008 banks' total loan portfolio contracted in real terms,
and it declined even in nominal terms in the first two months
of 2009 (partly due to seasonal factors). Thanks to tighter
regulations and rising delinquency, banks' profit margins are
also falling, making the tax-free income from GBRV bonds
increasingly attractive. The GBRV is further sweetening
incentives by developing a "bono agriculo." Banks that buy
this bond can count the purchase (up to a limit) toward the
21 percent of their overall loan portfolio they are required
to direct to the agricultural sector. One downside of
purchasing GBRV debt from banks' perspective is that it is
not particularly liquid: according to one well-respected
local consultant, the only real secondary market is the BCV's
discount window.

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Comment: Whither Venezuela's Financial Sector?
-------------- --


5. (C) Viewed more broadly, Venezuelan banks' likely
willingness to purchase large amounts of GBRV debt is
symptomatic of the financial sector's declining relevance to
a faltering economy. After the GBRV implemented currency
controls in 2003, the sector enjoyed a temporary boom as the
economy recovered from the 2002-2003 recession and massive
government spending drove liquidity up faster than inflation.
As a result, from 2004 through 2007 growth in deposits in
the financial sector far outstripped inflation (360 percent
vs. 95 percent over the four years),and deposits as a
percentage of GDP also grew. These trends were reversed in
2008 as the GBRV economic model ran out of steam, a process
compounded by the steep decline in oil prices in the latter
half of the year. Inflation grew faster than deposits by
almost five percentage points, and deposits as a percent of
GDP fell from 35 percent in 2007 to 32.3 percent by year-end

2008. We expect these new trends to continue in 2009.


6. (C) The declining weight of the financial sector in the
economy does not mean it is on the verge of a crisis. With
the exception of some small and medium-sized banks, the
sector continues to be relatively healthy from a solvency and
liquidity perspective. Instead, the sector is simply
becoming less relevant to the economy, partly because private
enterprise is becoming less relevant. With real interest
rates strongly negative, deposits in the financial system are
largely transactional. Private investment is minimal - one
banker told us many business clients are taking out loans to
buy dollars on the parallel market (i.e., speculating against
the bolivar) rather than invest in expanding local
production. As a result, the public sector will absorb (or
direct) a greater percentage of banks' assets, even as these
assets decline in value in real terms. Banks are gradually
converting into intermediaries between clients' transactional
deposits and the GBRV.


7. (C) Inflation promises to reduce further the real size of
the financial sector. The steps taken to date by the BCV to
free up liquidity are inflationary, and more such steps are
expected. Some local analysts believe that, if oil prices
are stagnant into 2010, the GBRV might resort to having the
BCV essentially finance the GBRV by buying GBRV debt from
banks on the secondary market. The more inflationary the
environment, the more negative real interest rates will
become (unless the BCV raises the ceiling/floor on nominal
interest rates) and the less incentive there will be to
deposit money in the financial sector. Well managed banks
will still be profitable, but their return on equity and
asset level will decline in real terms.


8. (C) Given this economic context, the GBRV's penchant for
nationalizing companies (or announcing their nationalization,
in the case of Banco de Venezuela) without paying, and
President Chavez's overall drive to socialism, bankers will
not invest more discretionary capital in their banks. (Note:
Bankers are obliged to reinvest a percentage of their
profits. Moreover, several wealthy individuals with ties to
the GBRV are seeking a foothold in the banking industry, as
is the case with a supplier to the government food chain
Mercal who is seeking to buy and merge three small banks.
End note.) Local bankers will keep taking out as much as
they can in dividends, understanding they will lose much of
the capital remaining in their banks to inflation and/or

CARACAS 00000494 003 OF 003


potential nationalization. International banks will also see
their capital erode in value, and one of the two Spanish
banks, Grupo Santander, seems to have re-entered negotiations
to sell its Banco de Venezuela to the GBRV (ref C). End
comment.
CAULFIELD