Archive for March 28th, 2007

The looming Constitutional battle over Chavez poposal to allow his indefinite reelection

March 28, 2007

I can’t help to show below a video of the autocrat/dictator Hugo Chavez, which I shamelessly stole from Daniel’s blog, to lead this article about the connection between the recent conflict between the National Assembly and the Venezuelan Supreme Court.

As you see, the almighty leader speaks about the way people conspire against the process and himself, curiously referring to himself in the third person, a trait that I will leave to medical doctors to tell us what it implies. But the totalitarian tone is there and very clear, there is no tolerance for dissent and even the Supreme Court is being pressured and manipulated to go against the revolution.

Chavez says:

“And many times they manage to neutralize decisions of the revolution, through a judge, or a court, or even in the very Supreme Court, behind the back of the leader of the revolution, acting from the inside against the revolution. That is, I repeat, treason against the people…”�

What is he referring to in this clear statement of the little regard he has for the separation of powers and the rule of law, given that there has been no recent fight between himself and the Courts?

What most people may not know is the fight that has been brewing between that Court and the Government as discussions in academic and legal circles on all sides of the political fence all point out to the fact that Hugo Chavez’ proposed change in the Constitution to allow him to perpetuate himself in the Presidency can not be done as a simple partial reform of the Constitution, but requires a Constituent Assembly and can not simply be part of a Constitutional reform. Thus, it would not be a matter of a simple reform and then referendum, as the Supreme Court could rule against Chavez’ desire.

You see, Art. 342 to 344 of the 1999 Constitution clearly say that you can modify the Constitution via reform, as long as you don’t “modify the structure and fundamental principles of the Constitutional text“. While Hugo Chavez wants to modify Art. 230 which establishes both the Presidential term and one reelection, which would appear not to be fundamental or part of the structure, in Title I, which contains the fundamental principles of the Bolivarian Constitution, there is an article, Art. 6, which states:

Ari­culo 6. El gobierno de la Republica Bolivariana de Venezuela y de las entidades politicas que la componen es y seran siempre democratico, participativo, electivo, descentralizado, alternativo, responsable, pluralista y de mandatos revocables.

Which translated says:

Article 6. The Government of the Bolivarian Republiuc if Venezuela and its political entities that are part of it, is and will be democratic,..alternative

Now, in Spanish, “alternativo” means “which happens with alternation” and alternation comes from “alternar” which actually has a definition relating to holdng political positions: ” To take turns in holding a position”.

And therein lies the main problem, as the proposal of indefinite reelection is one of the few which has been explicitly proposed by the Government for the upcoming Constitutional reform, and thus has been the subject of much discussion among lawyers and very few of them believe that article 230 can be interpreted in any other possible way: Allowing for Chavez reelection would be a fundamental change as the Constitution clearly says here has to be alternation and a time limit to the President’s reelection was clearly established by the Constituent assembly and only another one can change it. In fact, it has been suggested in the press that Justice Cabrera of the Supreme Court, coincidentally the only one mentioned by name by the National Assembly “mafia” investigation, has told the Government this would not fly by the Constitutional Hall.

So the dots can be easily connected between the autocrat’s favorite proposal for reform, that of his own and everlasting reelection, the interpretation that it can’t be done by a simple reform and the sudden attack on the Court and the threat to remove all members of the Constitutional Hall by the National Assembly. By the way, the last one is moving right along in the committee investigating the Court.

Skeptics and the naive have suggested that what is going on between the
National Assembly and the Supreme Court is simply a normal fight
between two powers. They fail to explain why the Assembly gets so mad
about a simple interpretation by the Court of the word “income” while
delegating on Chavez their Constitutional mandate to legislate for a year and a half.

And the video just proves how all of this is clearly in Hugo Chave’ autocratic and totalitarian mind, blaming it all on his enemies manipulating the Courts and the judicial system to stop “the leader” as he refers to himself, in this apparently out of context and bizarre statement. But the context is quite clear…

The mystery of the tax free status of the PDVSA bonds

March 28, 2007

Sort of in synch with recent posts on tax issues, bonds and the National Assembly, last night I did not mention the mystery that the upcoming PDVSA bonds will be tax free to both Venezuelans and foreigners. Mystery, because while tax legislation gives sovereign bonds their tax free status, no such treatment applies to corporate issues even if they are owned by the Venezuelan Government.

But the mystery was increased when Minister Rafael Ramirez told El Universal that the PDVSA bonds are tax free because the Minister of Finance Rodrigo Cabezas “gave them a dispensation on that issue”.

Well, I really don’t know where to begin. We seem to have a new legal figure in Venezuelan legislation whereby the Minister of Finance has apparently been given some sort of special powers to give “special dispensation” on tax mattes whenever he feels like it. In fact, I talked to a couple of lawyers and neither of them had ever heard of such a legal figure. In fact, one of them told me that it sounded more like an item from the church, than a tax matter.

In any case, as we have learned recently, tax legislation is a matter for the National Assembly and the Supreme Curt can review the Constitutionality of it, but the Minister of Finance certainly has no discretionary power on such matters least of all to decide whether a corporate bond is tax free or not. So, either Minister Ramirez had no idea about what he was talking about or there is something we are missing on this.

Funny that the National Assembly does not find this true invasion of their legislative domain offensive or has said nothing about or initiated an investigation like it did on the Supreme Court’s interpretation of the word “income”.

But I guess, Minister Cabezas must be a friend of the National Assembly of which he was a member until recently, but as we can see only in the revolution can one have such an issue still up on the air and unclear on the eve of the placement of the second largest corporate emerging markets bond issue in the history of those markets.

Taxing Venezuelan bonds

March 28, 2007

A couple of weeks ago, the tx superintendent said that the Government was planning to tax Venezuelan Government bonds because banks were making too much money because of their tax free status. I meant to write about it, but things have been hectic. This is an eminently reasonable proposal in terms of tax fairness and equality. However, nothing is ever simple in economics. As a trained scientist I have learned that the problems in economics is that mankind makes up the rules and once you alter one, it may affect a whole chain of them. In science the rules are there and you study them. Even better, you can rn the experiment again, which in economics its hard to do particularly if you wait too long.

There is an example of a similar tax exemption that would make sense to remove in another country, that of the capital gains tax exemption for foreigners in the US. It would be fair to remove it for US citizens who have to pay taxes, the problem is legislators in the US are afraid that if removed, there might be a mini crash in US stock markets as foreigners decide to take tehir money elsewhere.

The case of Venezuelan bonds is very similar. It may sound fair, but it has too many edges that in the end hurt the Government and its financing needs.

But first, let’s look at the history of this tax free status. Venezuelans, both citizens and corporations have always been weary of Government. This is a Government that decades ago forced banks to give up all their gold, so that in general Government bonds are frowned upon. In fact, this reluctance to invest in Government bonds makes many Venezuelan citizens act irrationally preferring to have their money in banks that in the end depend anyway in Government bonds to pay them interest.

Up to the debt crisis in the early 90’s Venezuela had no dollar denominated bonds, but depended on bank loans, that almost made many foreign banks go belly up. Then came the Brady bonds, which provided a solution to the crisis. But in order to work, Governments had to grant these bonds tax free status to make it attractive for foreigners. Venezuela, for example, taxes foreigners at a rate of 30% if they are not in the country. Thus, when Venezuela’s Brady bonds were created, they were granted tax free status by the Organic Bill that created them. Since then, all new issues have been tax free, because otherwise, the Government would have to pay more interest to make their return comparable to those with tax free status.

The same became true of Bolivar denominated binds, which were not that large, as banks used most of their deposits to grant credits. Then, when Chavez came to power, when the initial stock of Bolivar denominated binds was no more than US$ 1 billion, the Government began issuing more and more local bonds to finance the deficit. To do this, it had to pay high interest to make it interesting, as the stock in these bonds ballooned to some US$ 10 billion by 2002. And they were tax free.

Then came the exchange controls and the Government began forcing interest rates down to the point that today they are extremely negative, with inflation near 20% and Government bonds paying 6%. Banks invest in it, because there is so much liquidity that they have little else to invest in.

Thus, while the proposal is good and seems quote fair, the problem is how to implement it, without creating a crisis. (By the way, interest earned in Venezuela in a savings account or a CD is also tax free).

All bonds, or only those in Bolivars? The first question is whether the exemption would be removed for both local bonds or those denominated in foreign currency. You see, if all of a sudden you removed the tax exemption from all foreign bonds, then foreign investors will ask for a premium to invest in Venezuelan bonds in order to compensate for the new tax. Sfter all, funds that invest in Venezuelan Sovereign bonds look at them in comparison with those of other countries, if all of a sudden you implemented a 30% tax on them, the prevalent 7% yield on Venezuela’s bonds would be cut to 4.9%, making it quite unattractive. Thus, whatever the Government is paying would have to be increased by exactly the tax and nothing would be gained. In fact, its is easy to see this in the new PDVSA bonds. Because they are from a Government owned hydrocarbons company, these bonds are tax exempt. If they weren’t the coupons would have to be much higher tah they were set this week.

Only those in Bolivars? While banks have nowhere to turn because of the exchange control and the legal limitations in foreign currency for local banks, the current yield in local bonds also makes it hard for the Government to remove the tax free status. Since it is the Government that needs the financing, it can not afford to have banks stop buying the bonds. Since yields are near 6%, a 30% tax would drop it to 4%, banks may prefer to lend money cheaper to good risks, at rates near 9%, or more expensive to bad risks, say 20%, rather than get so little from the Government. In the end, it would force the Government to pay a higher interest, because it is the Government that is running a deficit and needs the financing.

All bonds, or only from now on? Finally, the question is whether they say all bonds will have a tax from day one, or they will work them in gradually. Clearly, forcing all of the to have axes from day one creates more of a dislocation, than working them in slowly. This would seem to be the only way for having it work. At the beginning the Government would have to pay more for new bonds to compensate, but as the old ones expire, they could lower yields and there would be a net positive effect for the Government.

In the end, the proposal is good, but the whole thing boils down to the Government needing the bonds more than local banks or investors or foreign investors needing them. It would seem that unless the Government curtails it appetite for spending, removing the tax free status is sort of like running in the same place, the bonds would not be tax free, but the Government would turn around an pay an almost equivalent amount in interest to compensate for the taxes on the bonds.

In the end, it is always excess Government spending which is at the root of all current economic distortions in Venezuela. In the end it is the only problem that is not being attacked.