VZCZCXYZ0000
RR RUEHWEB

DE RUEHCV #0512/01 0551542
ZNR UUUUU ZZH
R 241542Z FEB 06
FM AMEMBASSY CARACAS
TO RUEHC/SECSTATE WASHDC 3338
INFO RUEHBO/AMEMBASSY BOGOTA 6055
RUEHLP/AMEMBASSY LA PAZ MAR LMA 9907
RUEHQT/AMEMBASSY QUITO 1774
RUEHGL/AMCNSUL GUAYAQUIL 0315
RUCPDOC/DEPT OF COMMERCE
REHC/DEPT OF LABOR
RUEATRS/DEPT OF TREASURY
RUMAAA/HQ USSOUTHCOM MIAMI FL
RHEHNSC/NSC WASHDC

UNCLAS CARACAS 000512 
 
SIPDIS 
 
SENSIIVE 
SIPDIS 
 
HQ SOUTHCOM ALSO FOR POLAD 
TREASRY FOR KLINGENSMITH AND NGRANT 
 
E.O. 12958: N/A 
TAGS: EFIN PGOV PINR VE
SUBJECT: BRV CONTINUS TO FIGHT EXCESS LIQUIDITY 
 
REF: CARACAS 003601 
 
This message is sensitive but unclassified, pleae treat 
accordingly. 
 
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Summary 
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¶1.  (SBU) The BRV continues to struggle with  rapidly 
increasing money supply resulting from xpansionary fiscal 
policy, booming oil revenues, and foreign exchange 
restrictions.  The money suply (M2) increased by 52.7 
percent in 2005 and ha grown approximately 260 percent since 
the BRV iplemented its foreign exchange restrictions in 
Fbruary 2003.  The amount of excess liquidity in the system 
comes to around USD 14.5 billion (roughlyestimated as total 
Central Bank-issued CDs plus he amount of banking system 
reserves held in excss of the legal reserve requirement). 
This exces liquidity is already pushing down interest rates, 
and, if left unchecked, will intensify inflationay pressure 
and threaten the country's over-value fixed exchange rate. 
The BRV has been actively ighting its liquidity problem by 
issuing certifiates of deposit and dollar-denominated bonds, 
purchasing and reselling foreign bonds, authorizing moe 
foreign currency transactions, and increasing bank reserve 
requirements.  While all of these moves help to ease the glut 
of bolivars in circulation, the liquidity problem will not go 
away anytime soon, as oil revenues continue to flood in and 
the BRV continues its profligate spending in the run-up to 
the December presidential elections.  End summary. 
 
¶2.  (U)  While the Venezuelan economy continues to boom on 
the back of high oil prices, the Venezuelan Central Bank 
(BCV) has been dealing with a serious problem of excess 
liquidity.  The combination of continued high oil revenues, 
an extremely loose fiscal policy stance, and foreign exchange 
controls have created distortions in the market and steady 
increases in the money supply.  As measured by the M2 
monetary aggregate, the money supply is currently around USD 
32.6 billion, an increase of 52.7 percentduring 2005 and 
around 260 percent since the BRVimplemented foreign exchange 
restrictions in Febuary 2003.  Of this amount, analysts 
estimate abut USD 14.5 billion to be excess liquidity. 
(Note: Excess liquidity is roughly estimated here as totl 
Central Bank-issued CDs plus the amount of baning system 
reserves held in excess of the legal reserve requirement. 
End Note.) 
 
¶3.  (U)  If left unchecked, this excess liquidity could be a 
real problem for the BRV (and perhaps some banks), causing 
strong inflationary pressures and threatening the integrity 
of the over-valued fixed exchange rate, which is currently 
set at Bs. 2150/USD 1.  The excess liquidity has also put 
downward pressure on interest rates, which has forced the BCV 
to cut rates on its 28-day bill by 150 basis points to 10 
percent. (Note: Currently, real interest rates, or the 
interest rate adjusted for inflation, are negative.  When 
real interest rates are negative, consumers have no incentive 
to save, rather only to spend as evidenced by increasing 
consumer spending, exacerbating the expansion of the money 
supply.  End Note.)  As a result, the BRV, through the 
Central Bank (BCV), the Ministry of Finance (MF) and the 
Foreign Exchange Control Commission (CADIVI), has been 
aggressively combating the problem by implementing several 
types of measures, including the issuance of domestic 
certificates of deposit and dollar-denominated bonds, the 
purchase and resale of foreign bonds, increased foreign 
currency disbursements, and an increase in the bank reserve 
requirements. 
 
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Central Bank 
------------ 
¶4.  (U)  The Central Bank (BCV) has used two primary methods 
for fighting liquidity: issuing certificates of deposit to 
absorb excess liquidity and increasing the bank reserve 
requirement to slow bank lending.  The BCV currently issues 
CDs for 14, 21 and 28 days and now has over USD 14 billion 
outstanding.  The negative effect from issuing these CDs is 
that the BCV has to continually recycle this paper in order 
to keep liquidity down.  Also, interest paid domestically on 
these notes (in dollar terms around USD 871 million in 2005) 
has a snowballing effect as it serves to further increase the 
money supply. 
 
¶5.  (U)  Another method used by the BCV to combat the growing 
liquidity is to increase the bank reserve requirements.  The 
BCV recently announced that by March 6, commercial banks will 
be required to reserve 5 percent of their money market 
holdings.  This reserve requirement will then increase by 0.5 
percent every four weeks until it reaches 15 percent, the 
current reserve requirement for demand deposits.  Increasing 
the reserve requirement on money market funds requires the 
banks to hold cash instead of investing it, and effectively 
limits the exponential increase in money supply caused by 
bank lending.  While this increase will help to reduce the 
money supply, it will also have the negative effect of 
reducing bank profits by limiting the amount of capital 
available to invest. 
 
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Ministry of Finance 
------------------- 
¶6.  (U)  While the Ministry of Finance is not responsible for 
monetary policy, their actions have helped to complement the 
policy of the BCV.  The Ministry of Finance has issued 
dollar-denominated domestic bonds as well as purchased 
foreign bonds, both of which have helped to reduce liquidity. 
 In November 2005, the BRV issued USD 3.0 billion in 
dollar-denominated domestic bonds with the intent of soaking 
up some of the excess liquidity in the market (reftel). 
Because the BRV allowed investors to purchase the bonds in 
bolivars, the instrument became an effective mechanism to 
bypass the foreign exchange controls and obtain dollars, 
reducing the glut of bolivars.  While the issue had the 
intended effect (reducing excess liquidity by roughly 21 
percent), it also substantially increased the total debt of 
the BRV. 
 
¶7.  (U)  The Ministry of Finance has also purchased bonds 
from other countries, primarily Argentina, which have helped 
to reduce liquidity.  Over the past year, the BRV has 
purchased approximately USD 2.1 billion in Argentine bonds. 
As with the domestic bonds, the BRV resells these 
dollar-denominated bonds to domestic investors (in some cases 
hand-picked by the BRV) for bolivars.  These investors can 
then resell the bonds for dollars and turn a quick and very 
lucrative profit.  Purchasing the Argentine bonds has the 
benefit of reducing liquidity while not increasing the debt 
burden.  The primary reason for their purchase, however, is 
that they have allowed Chavez to gain political points by 
becoming one of Argentina's major benefactors. 
 
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CADIVI 
------ 
¶8.  (U)  In addition the BCV and the MF, the National 
Exchange Control Administration (CADIVI) has also been 
instrumental in keeping the money supply down.  CADIVI is the 
agency charged with authorizing foreign exchange transactions 
and, in an effort to fight inflation and protect the fixed 
exchange rate it has increased the amount of transactions. 
During 2005, the BCV disbursed (following CADIVI 
authorization) USD 19.43 billion in foreign exchange (an 
increase of 31 percent from 2004) effectively reducing 
liquidity by an equivalent amount. 
 
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Comment 
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¶9.  (SBU)  The methods employed by the BCV have been 
effective in reducing monetary liquidity.  However, this 
problem will not go away anytime soon.  High oil prices are 
still flooding the market with cash and the BRV is continuing 
its profligate spending on social programs (and can be 
expected to do so at least until the December presidential 
elections).  The high oil revenues and increased government 
spending are driving the extraordinary real GDP growth we 
currently see (9.4 percent in 2005, and an expected 6-7 
percent in 2006), and, for the short-term, there is no threat 
of hyperinflation.  However, these pro-cyclical policies are 
unsustainable in the medium-term and will undoubtedly 
exacerbate the eventual downturn that occurs when oil prices 
ease. 
WHITAKER