South America sees new currency wars

MEXICO CITY – Currency market intervention has cost South America’s central banks more than US$13 billion in the last two-and-a-half years but they are likely to maintain their defenses against hot money inflows if a fresh rush of cheap money sparks another round of currency wars.

Latin American finance ministers meeting in Chile last week said monetary easing in developed countries could hurt their export competitiveness by pushing up currencies in the region – a problem they have been wrestling with since the global financial crisis. Bank of England Governor Mervyn King warned last week that a 2013 might see a growing number of countries deliberately weakening their currencies to offset the impact of a slow global economy. Central bank data shows Brazil, Chile, Colombia and Peru have bought US$135 billion in dollars to help keep a lid on their currencies since mid-2010, just before the US Federal Reserve announced its last round of monetary easing, dubbed QE2. The Fed is now well into QE3, and Chilean Finance Minister Felipe Larrain has said the decision to further bolster US asset purchases was a ‘source of worry’ for all emerging markets with healthy growth and floating exchange rates. Low interest rates in advanced economies encourage investors to seek higher returns in faster-growing emerging markets such as Latin America, but accelerating capital inflows put unwelcome upward pressure on currencies, making exports more expensive.’This is the third round of QE and we are starting at a level where the FX [foreign exchange] rates are a lot stronger,’ said Jefferies Latin America strategist Siobhan Morden, who sees central bank intervention as the biggest concern for investors in local debt.’It clearly places more stress on policymakers in how to manage this liquidity.’Low inflation in Peru, Chile and Colombia and healthy budget balances give central banks plenty of leeway to keep buying dollars, adding to already-swollen reserves, analysts said – a contrast to the last round of QE, when many countries were struggling with inflation fanned by a V-shaped recovery. Most dollar purchases so far have been offset by market operations, such as issuing bonds, to mop up or sterilize excess liquidity – but these operations have a high cost due to the gap between very low US yields and higher local interest rates.Calculations by Thomson Reuters put the accumulated opportunity cost of currency purchases from mid-2010 to November 2012 at about US$13,9 billion, more than US$11 billion in Brazil alone, without taking currency fluctuations into account.Brazil’s cost reflects benchmark interest rates which were as high as 12,5% in mid-2011, before an aggressive easing cycle which slashed them to a record low 7,25%, while US official rates were – and are – close to zero.Intervention has cost Chile, Peru and Colombia between US$500 million and US$1 billion each, according to estimates based on central bank data on reserve asset returns, or local and US market interest rates where not.DIFFERENT STROKESOfficials attending the Community of Latin American and Caribbean States (CELAC) meeting in Chile did not come up with a joint solution on how best to handle hot money flows, but agreed they were a major challenge to the region. Brazil has slapped strict controls on foreign investment and intervened heavily in markets, while the Andean nations have largely eschewed capital controls and analysts expect they will continue to rely on market intervention in the future.While Brazil and Chile have scaled back or paused their interventions this year, Peru and Colombia remain very active in the market – despite having an even higher interest rate gap with the United States than they did in mid-2010. – Nampa-Reuters

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