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Venezuelan Central Bank will purchase GDS; what about the CBRT?
Venezuelan National Assembly amended the Central Bank of Venezuela (BCV) Law this week. According to this, BCV can now purchase government debt securities (GDSs). News agencies announced this with "end of Central Bank independence in Venezuela" spots. They said, in Hugo Chavez's country, what is abnormal must be regarded as normal. Reading about this, the statement by CBRY Governor Durmuş Yılmaz as "We will create a GDS portfolio" came to my mind. CBRT would as well purchase GDSs just as Chavez asked from BCV. But what would be the result?
First, let us skim the Venezuela story. Venezuela National Assembly amended the BCV Law. As the amendment made rapidly in the first round stipulates the BCV can transfer funds directly to public expenditure programs in different sectors. To this end, BCV will be able to purchase bonds of publicly owned Venezuelan oil company (PDVSA) and will transfer funds to the Development Fund (FONDEN) semiannually. In effect, the new regulation is not much different than BCV's directly purchasing GDSs. And this is exactly the source of the concerns about central bank independence. This amendment implies that BCV will in fact issue money and finance public expenditures injecting long term liquidity into the market. This is the first point.
In order to evaluate better this new development in Venezuela, we must know about PDSVA and FONDEN. PDSVA is the public company operating Venezuelan oil. The company is managed by Chavez's relatives. If, for instance, the youngsters of the neighborhood need an artificial turf, you convey your demand to the President, he tells this to the PDSVA, and the turf is done. There is not any plan or program; system works just like a municipal administration and just as the President likes. The company has highly non-transparent governance considering the management and expenditures. FONDEN also has the same structure. Through these two tools, public expenditures in Venezuela have a quite soft budget constraint. Soft budget constraint is in fact the polite way of saying "knee deep fiscal indiscipline". So, in a world with soft budget constraint, what happens if you also start to finance budget expenditures through the central bank? The outcome will not be much pleasant even in the unprecedented circumstances of today. Let this be the second point.
And about the third one: As news released on this daily last week suggests, "Central Bank will create a GDS portfolio". When you see this, you ask "So, what is going on? Will the CBRT have the characteristics of BCV?" however, the two situations are not exactly the same. In fact, they are not similar at all: here in Turkey there goes on a poor-fellow situation. To begin with, CBRT already holds a GDS portfolio. So, the Bank will not be purchasing GDS from scratch as BCV. Second, the GDS portfolio already held by the CBRT was created right before the law amendment securing the independence of the Bank. At least it was before the amendment when the portfolio was enlarged. Third, a smaller GDS portfolio was already being used actually for open market operations. Now let us leave behind the legal issues and deal with the economics.
What is the problem? The problem lies here: GDS portfolio of the CBRT represents the residuals of the long term fund transferred to the Bank for the bailout of commercial banks during the chaos of 2000-2001. Thanks to that GDS portfolio, CBRT gained back then the funds to finance the bailout operations. Now, however, the GDSs given to the CBRT in exchange for the fund provided back then mature. At this point the normal procedure would be that the Treasury redeems 8 billion TL of GDSs, i.e. repays the CBRT 8 billion TL in cash withdrawing 8 billion TL from the market. Therefore, the GDSs in the portfolio of the CBRT must be transferred into the portfolio of banks. This is the normal procedure. The normal procedure is making the payment out of the "yesterday's mistakes" account. However, neither Turkey not the world goes through a normal period. The Treasury as well as the Central Bank is in trouble as a result of man-made senseless decisions. Completion of this operation through the normal procedure implies the elevation of interest rates in the short term. CBRT Governor Durmuş Yılmaz pleased commercial banks expressing that GDS portfolio will not be reduced. And this is the third point.
It is not that an additional credit will be provided to the public sector as a result of this operation; however, the maturity of the already given credit will be extended. The Treasury will by the CBRT 8 billion TL, and the CBRT will pay 8 billion TL for new GDSs. There will not be an additional transfer for additional public expenditures. Therefore, what Mr. Yılmaz tries to do is by no means similar to the situation in Venezuela. It is just that Tarzan is in trouble. And this is the fourth point to state.
Nonetheless, with this decision, CBRT starts pursuing Treasury-friendly policies as in the old days. This is the main point to pay attention to. This is the point that makes sense. Just as the path to hell is covered with stones of good will; Treasury-friendly policies of CBRT has pitched the stones of the 2001 hell, and just to sweep under the carpet the mistakes of 1990s politicians. This is what happens today too. And let this be the fifth point.
Various tricks were played tenaciously. Turkey started to accumulate additional risks so as not to sign an agreement with the IMF.
No one will forget the ones responsible.
This commentary was published in Referans daily on 29.10.2009