Archive for October 25th, 2009

PDVSA bonds and Central Bank Law changes: Printing money to address the political problem

October 25, 2009


While all of the attention was on Chavez’ press conferences on water and electricity, the Government was toying with the economy, setting us up for a crash like never before as the country’s debt goes up and the mishandling of the economy reaches new levels of irresponsibility as the Chavez administration continues to look for stop gap measures that will one day come to haunt it.

Recall PDVSA was issuing a trio of bonds that were not very attractive if your goal was to acquire foreign currency. With this issue, PDVSA would have outstanding bonds in the amount of US$ 13 billion, up from barely US$ 4 billion when Chavez took over. Those bonds were retired by the Government because they were issued under US regulations which requires filings by PDVSA for which the Board was responsible. They have now been replaced by US$ 7 billion in bonds issued under US law, but not registered in the US and the Petrobonos which are issued under Venezuelan laws. That means that investors would have to go to Venezuelan Courts in any dispute, which makes these bonds less attractive to foreigners (i.e. they yield more than the others)

While people were expecting the Government to change the terms to make the bonds more attractive, the Government took a different route. First of all, it made the interest payments tax exempt, which they were not when the bonds were first announced. The Government was going to withhold 4.95% of all interest payments, which implied that the coupons (The amount paid by the bonds every six months on their face value) would actually be lower. This was solved by given the interest payment (not capital gains) tax exempt.

But more importantly, the Government also announced that the bonds would not count as part of the foreign currency position of banks. Let me explain this for the uninitiated: In Venezuela, banks can only have a certain percentage of their equity in US$, that amount is set at 15%. Therefore, banks can not cover (hedge) themselves against the devaluation of the swap market except for a fraction of their equity. They can protect themselves form a devaluation of the official rate of exchange by buying bonds called TICC’s which are denominated in US$ but only trade in Bolivars and their face value will chnage only if there is a devaluation of the official rate of exchange.

So, what the Government did was to make the new Petrobonos exempt from this limit. What this means is that these are extremely attractive for local banks, not as a away of buying dollars and making a profit, but as a way of protecting themselves against future devaluations of the parallel swap rate. This means that banks will buy these bonds in US$ instead of buying Bolivar denominated bonds, which yield the same or less than the Petrobonos. But on top of that the Petrobonoz give the banks devaluation protection.

What is so laughable about this is that ten days earlier when Giordani, Merentes and Rodriguez held their Ferrari press conference, they said exactly the opposite. At the time they talked about limiting how much banks had in Government paper, so that they would lend more. That is long term policy under Chavez: Less than two weeks.

As if this were not enough, the illustrious Deputies of the National Assembly rushed a bunch of changes to the Central Bank’s Law. The first one, surprise, surprise, was to allow the Central Bank to buy PDVSA’s debt, something that was expressly forbidden before. This alone guaranteed that the placement would be successful, even if it has yer to become law. Additionally, the Central Bank will now be able to accept Venezuela’s bonds as guarantees for loans from the Central Bank. (The Central Bank is expressly barred from financing the Government). Finally, the changes force the Central Bank to establish what is an “adequate level” of foreign reserves every six months and transfer the excess to the development fund Fonden. But then, in the most creative change to the Law, it allows for Fonden to sell dollars to the Central Bank for Bolivars. Thus, the Law will allow each dollar to be converted into Bolivars many times, which guarantees that some time in the future there will be an explosive devaluation of the currency.

Why? Because every time the Central Bank gets foreign currency, it creates Bolivars for the Government. Thus, suppose PDVSA gives the Government US$ 1 billion, immediately, the Central Bank creates Bs. 2.15 billion in local currency. This has gotten so bad, that the IMF gave Venezuela US$ 3.5 billion in drawing rights, which increased the countries reserves by 11% and the last week in September monetary liquidity went up 10%, i.e. the Bolivars were created and these are not even dollars the Central Bank has, these are special drawing rights that Venezuela can use when it wants.

The problem is, that then the Central Bank gives Fonden dollars from the reserves, so that the Bolivars that were created have not backing. There are currently Bs. 7.4 for each dollar in the Central Bank. This is in part what has created what the Government calls “structural” inflation, these huge number of Bolivars is not backed by dollars or the result of higher production, thus there are too many Bolivars chasing few goods, which results in more inflation. This is simply printing money to survive a few more months. At that time a new “solution” will be found or tried.

Except now the Government will even have more freedom to create Bolivars as the Fonden will be able to convert the same Dollars back into new Bolivars: A recipe for disaster! When? That is the tough question. There is no experience in doing that, but clearly the official rate of exchange can not stay at Bs. 2.15 per dollar with so many Bs. around looking for dollars. The more Bs. they create holding the reserves constant, the bigger the adjustement will one day be.

And on top of that, allowing the Central Bank to buy PDVSA bonds simply becomes a way to circumvent the fact that the Central Bank (which is broke by the way) can not finance the Government. It will now do it indirectly via PDVSA. Of course, the President of the Central Bank Nelson Merentes, a Mathematician, sees no inflationary effects from all this, because he has no clue. Somehow they blame the “structural” inflation as the source of the problem, without realizing that they created the “structure” that makes Venezuela the country with the highest inflation in the Americas at close to 30%, when everyone’s has fallen into single digits. This is simply the result of printing money and now they set up the tools to print even more.

So, tomorrow they will gloat at having placed all of the bond (they did today already), as the new bonds yield in the gray market close to 17% in a world of dropping yields. But even to sell it all, they had to all these shenanigans that we will all have to pay for one day.

Of course, the day it all explodes, the Government will blame the US or some external power for it. The newly appointed Minister of Electric Energy sent his first public interview talking about the foreign campaign against PDVSA, rather than addressing the huge problem created by the inaction of the Chavez administration in the last eleven years. This is no surprise, his only qualification for the new position is his political loyalty to Hugo Chavez. He is a former oil industry worker, with no qualification for the position other than being in charge of the Energy Sub Committee of the National Assembly.

And therein lies the problem: For Chavez, it is all a political problem, but the problem is really technical and managerial and a Mathematician in the Central Bank and an oil worker in the Ministry of Electrical Energy will not solve the problems we face any more than they have in the past eleven years.

Both areas wlll simply implode or explode in their faces and Venezuelans, particularly the poor, will pay the full price. And Chavismo will pay the “political” one.