Venezuelan Bank Purchases of Government Debt Soar (Update2)

By Daniel Cancel

July 16 (Bloomberg) -- Venezuelan President Hugo Chavez is tapping the country’s banks to finance a third of his budget this year as lenders plow deposits into government debt, a report issued today shows.

Venezuelan banks, hemmed in by foreign exchange controls and shrinking consumer demand, raised government debt holdings by more than half from a year earlier to 88.6 billion bolivars ($41.3 billion) in June, Softline Consultores said. The 2009 deficit may be the biggest since the early 1980s after oil revenue plunged in the first quarter, according to Moody’s Economy.com.

“The banking sector is in trouble and its fate is closely tied to that of Chavez,” said Russell Dallen, head of Caracas Capital Markets, a unit of BBO Financial Services. “The banks are captive clients of the government, and essentially they have to take what’s shoved down their throats.”

Chavez’s ability to tap bank deposits underscores his control of Venezuela’s private industry as he manages the decline in oil revenue with a pegged currency, price controls, and regulated interest rates. He has specifically threatened banks with nationalization in the past unless they cooperate with the government, and earlier this month finished taking over the local unit of Spain’s Banco Santander SA.

Deposit Rates

To help advance Chavez’s socialist plans, banks are required to devote 40 percent of lending to “productive sectors” including micro-credits for agriculture, tourism and manufacturing. Regulators have imposed fines for failure to comply. Only 30 percent of total holdings can be held in foreign currencies, further limiting investment options.

To push bond purchases as the best remaining choice, the central bank this year slashed the rate it pays banks on short- term loans by 5 percentage points to 6 percent. Venezuela’s annual inflation rate was 27.4 percent in June.

Demand for consumer loans, meanwhile, is shrinking. The cars and appliances that Venezuelans financed during a five-year import boom are harder to get and more expensive after a crackdown on foreign currency sales followed the plunge of oil. New car sales, which peaked in 2007, plummeted 50.9 percent in June from a year earlier.

Slowdown in Lending

Total lending in June by the country’s 51 institutions, which had 244 billion bolivars in deposits, rose 17 percent from the year earlier, after expanding 45 percent in June 2008, Softline Consultores said in a monthly report today. Security holdings, 95 percent of which are government debt, rose 54.7 percent.

With high liquidity levels and low demand, most banks are opting to buy government debt, said Oscar Garcia Mendoza, chairman of Caracas-based Banco Venezolana de Credito.

“Banks assume government securities are solid, and the central bank has created conditions to free up liquidity,” Garcia Mendoza said in a phone interview. “We don’t buy them.”

The national assembly tripled the authorized sale of local currency bonds this year to 37 billion bolivars in March and the government has sold 13.3 billion bolivars so far this year, according to the Finance Ministry.

Caracas-based Bancaribe estimates the government will have to borrow the full authorized amount, swelling total internal debt 31 percent to 124.1 billion bolivars, even as oil prices recover from the first quarter, when they were down 56 percent from a year earlier.

Oil Revenue

Crude oil accounted for 93 percent of export sales last year and half of government revenue.

The deficit this year will probably be equivalent to 7 percent of gross domestic product, up from 3 percent in 2008, said Juan Pablo Fuentes, an economist at Moody’s Economy.com.

Morgan Stanley expects the economy to contract 5 percent this year.

Chavez’s debts from the takeover of the cement and steel industries and seizure of as many as 74 oil services companies this year will worsen his cash flow problems, said Efrain Velazquez, a consultant at Azpurua Garcia-Palacios & Velazquez, an economic consulting group in Caracas.

The unpaid bill for nationalized companies such as the local unit of Monterrey, Mexico-based cement company Cemex SAB is estimated at $13 billion by Ecoanalitica, a Caracas-based economic consulting firm.

Boxed In

Politically, Chavez is boxed in by commitments for health care, food subsidies and education that grew with the price of oil over his decade in power. Social spending, which underpins his support by the poor, represents about 40 percent of this year’s $72.8 billion budget.

Chavez already seized $12 billion in central bank reserves, and traveled to China, Japan and Brazil to seek loans. Finance Minister Ali Rodriguez said in January that the government’s National Development Fund, known as Fonden, which doesn’t disclose any data on its operations, had as much as $16 billion available.

“The government doesn’t have enough cash,” said former central bank director Jose Guerra. “The myths of Fonden having $50 billion are over. Who’s in the position to finance the government? The banks.”

To contact the reporter on this story: Daniel Cancel in Caracas at dcancel@bloomberg.net.