 An employee at a currency exchange in Santiago, Chile, adjusts the sign bearing the exchange rate in this file photo. Chile, which has not bought dollars in the foreign-exchange market since 2008, said on Jan. 3 it would purchase a record $12 billion. Bloomberg photo |
Latin American nations from Brazil to Peru are returning to currency and foreign investment controls that marked the 1980s era of hyperinflation.
Since the start of the year, policy makers across the region have increased dollar purchases to record levels, raised reserve requirements and curbed banks’ ability to bet against the dollar in a bid to stem a 29 percent rally in Latin American currencies since March 2009. Controls may stiffen, and other nations could join the “market-unfriendly” drive, said Alberto Ramos, an economist at Goldman Sachs.
“In all these countries, if it continues, there will be the temptation to escalate the level of restrictions,” said Ramos. “We cannot throw into the dustbin four decades of good economic research. Capital controls have serious economic costs.”
Local-currency bonds in Latin America lost 0.5 percent in dollar terms in the past three months, the first decline for the period since October 2008 in the aftermath of the collapse of Lehman Brothers. Yields on Brazilian government notes due in 2017 jumped 1.11 percentage points since the middle of October to 12.55 percent. The higher rates push up the country’s cost to roll over debt that equals 58 percent of gross domestic product, or GDP, compared with 34 percent in South Korea.
Latin America’s economic turnaround that caused net private inflows to quadruple since 2003 and tamed price increases to record lows comes two decades after defaults spread from Mexico to Venezuela and inflation in Brazil climbed to as high as 6,821 percent in 1990. While governments are taking steps to limit spending, price rises and borrowing costs are picking up and could accelerate should currencies weaken, jeopardizing the nations’ progress, according to Bank of America.
“Central banks view the level of exchange rates as the priority rather than using them to help slow inflation,” said David Beker, chief Latin America strategist at Bank of America. “Once you start targeting multiple objectives, the odds for policy mistakes increase.”
Trying to slow currency appreciation
Developing nations outside of Latin America, from Thailand to Turkey, are also taking steps to slow currency appreciation, as near-zero interest rates in the U.S. and Europe, and the Federal Reserve’s buying of $600 billion in U.S. Treasuries attract inflows to higher-yielding assets.
Action to prevent asset bubbles and protect competitiveness has been concentrated in Latin America, where net private inflows surged to $203.4 billion last year from $57.5 billion in 2003, according to the World Bank. The region’s resilience, reflected in 2010 growth of 5.7 percent that was twice of the U.S., means inflows are likely to keep pressuring its currencies, the Washington-based lender said Jan. 12.
Latin American currencies rose 0.3 percent this year, extending the gain since March 2009 to 29 percent.
Chile, which hadn’t bought dollars in the foreign-exchange market since 2008, announced Jan. 3 it would purchase a record $12 billion, equal to 43 percent of the country’s currency reserves.
In Colombia, where the peso has gained 10 percent against the dollar since the end of 2009, the central bank is buying at least $20 million a day in the spot market. Peru purchased $9 billion last year, the second-biggest amount ever, as the sol rose to a two-year high in October. The government also increased reserve requirements to lift the cost of short-term, overseas borrowing by local banks.
Aggressive policies
In Brazil, where a 38 percent rally in the real since the end of 2008 caused the trade deficit in manufactured goods to double to $71 billion in 2010 from the previous year, the government and central bank have been most aggressive in taking measures to curb the advance.
Finance Minister Guido Mantega tripled to 6 percent in October a tax on foreign inflows. After the real strengthened to a two-year high against the dollar on Jan. 3, the central bank set reserve requirements to curb short selling of the dollar by local banks and sold $1 billion of reverse currency swaps on Jan. 13 in a bid to weaken the real. The government also authorized its sovereign wealth fund to place bets in the currency futures market.
“In these games of cat and mouse, I think policy makers will probably lose,” said Simon Johnson, a professor of finance at Massachusetts Institute of Technology in Cambridge. “There is too much unregulated capital in the world, particularly in developed countries. These guys will find ways around various restrictions.”
Economist Nouriel Roubini said “intelligent intervention” is preferable to letting currencies gain. “If you don’t do anything, your currency can appreciate more than is justified by the economic fundamentals,” he said. “Excessive appreciation is a danger that can lead to loss of competitiveness.”
Since the start of the year, policy makers across the region have increased dollar purchases to record levels, raised reserve requirements and curbed banks’ ability to bet against the dollar in a bid to stem a 29 percent rally in Latin American currencies since March 2009. Controls may stiffen, and other nations could join the “market-unfriendly” drive, said Alberto Ramos, an economist at Goldman Sachs.
“In all these countries, if it continues, there will be the temptation to escalate the level of restrictions,” said Ramos. “We cannot throw into the dustbin four decades of good economic research. Capital controls have serious economic costs.”
Local-currency bonds in Latin America lost 0.5 percent in dollar terms in the past three months, the first decline for the period since October 2008 in the aftermath of the collapse of Lehman Brothers. Yields on Brazilian government notes due in 2017 jumped 1.11 percentage points since the middle of October to 12.55 percent. The higher rates push up the country’s cost to roll over debt that equals 58 percent of gross domestic product, or GDP, compared with 34 percent in South Korea.
Latin America’s economic turnaround that caused net private inflows to quadruple since 2003 and tamed price increases to record lows comes two decades after defaults spread from Mexico to Venezuela and inflation in Brazil climbed to as high as 6,821 percent in 1990. While governments are taking steps to limit spending, price rises and borrowing costs are picking up and could accelerate should currencies weaken, jeopardizing the nations’ progress, according to Bank of America.
“Central banks view the level of exchange rates as the priority rather than using them to help slow inflation,” said David Beker, chief Latin America strategist at Bank of America. “Once you start targeting multiple objectives, the odds for policy mistakes increase.”
Trying to slow currency appreciation
Developing nations outside of Latin America, from Thailand to Turkey, are also taking steps to slow currency appreciation, as near-zero interest rates in the U.S. and Europe, and the Federal Reserve’s buying of $600 billion in U.S. Treasuries attract inflows to higher-yielding assets.
Action to prevent asset bubbles and protect competitiveness has been concentrated in Latin America, where net private inflows surged to $203.4 billion last year from $57.5 billion in 2003, according to the World Bank. The region’s resilience, reflected in 2010 growth of 5.7 percent that was twice of the U.S., means inflows are likely to keep pressuring its currencies, the Washington-based lender said Jan. 12.
Latin American currencies rose 0.3 percent this year, extending the gain since March 2009 to 29 percent.
Chile, which hadn’t bought dollars in the foreign-exchange market since 2008, announced Jan. 3 it would purchase a record $12 billion, equal to 43 percent of the country’s currency reserves.
In Colombia, where the peso has gained 10 percent against the dollar since the end of 2009, the central bank is buying at least $20 million a day in the spot market. Peru purchased $9 billion last year, the second-biggest amount ever, as the sol rose to a two-year high in October. The government also increased reserve requirements to lift the cost of short-term, overseas borrowing by local banks.
Aggressive policies
In Brazil, where a 38 percent rally in the real since the end of 2008 caused the trade deficit in manufactured goods to double to $71 billion in 2010 from the previous year, the government and central bank have been most aggressive in taking measures to curb the advance.
Finance Minister Guido Mantega tripled to 6 percent in October a tax on foreign inflows. After the real strengthened to a two-year high against the dollar on Jan. 3, the central bank set reserve requirements to curb short selling of the dollar by local banks and sold $1 billion of reverse currency swaps on Jan. 13 in a bid to weaken the real. The government also authorized its sovereign wealth fund to place bets in the currency futures market.
“In these games of cat and mouse, I think policy makers will probably lose,” said Simon Johnson, a professor of finance at Massachusetts Institute of Technology in Cambridge. “There is too much unregulated capital in the world, particularly in developed countries. These guys will find ways around various restrictions.”
Economist Nouriel Roubini said “intelligent intervention” is preferable to letting currencies gain. “If you don’t do anything, your currency can appreciate more than is justified by the economic fundamentals,” he said. “Excessive appreciation is a danger that can lead to loss of competitiveness.”
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