LatinFinance - March/April 2013 - 21

Currency wars

is going to further inflate the capital flow
pressures into Latin America,” he says.
“The estimates we have for capital flows
into the region are too low.”
The inflow problem has hammered
Brazilian exporters for more than two
years, but it is now spreading. A growing
number of economies – including Peru,
Chile, Colombia and, more recently,
Mexico – are mulling options to protect
themselves against the unwanted pressure.
The currencies of those four alone have
soared by an average of 8% against the US
dollar since the start of last year.
Long-term money in the form of FDI is
also on the rise. And, as the productivity of
capital and labor increases, exchange rates
are likely to increase over time.

Taking action

Countries are resorting to a range
of approaches to tackle currency
appreciation, including exchange market
intervention and macro-prudential
measures, such as raising reserve
requirements on dollar accounts. Most
have so far resisted capital controls, such
as those imposed by Brazil.
Brazil discouraged many speculative
investors with strict controls on inflows
in 2010 and 2011, as a flood of capital
pushed the real up 12% against the dollar.
Ironically, for the country whose finance
minister coined the term currency war
in 2010, Brazil is now likely seeking a
stronger real, rather than a weaker one, to
keep inflation at bay.
But other countries are today
contemplating capital controls, including
Costa Rica.
The government is looking to impose a
number of measures to restrict the inflow
of portfolio capital, which has surged
in recent months. Laura Chinchilla,
its president, told LatinFinance in an
interview in February that she was
mindful of the need to tread carefully.
“We are trying to apply the fewest
possible instruments to discourage this
flow of capital.” But she added: “We will
see if these measures have an impact. If
they don’t, we will have to consider other
measures.”
In Peru, upward pressure on the sol has
intensified, reflecting the country’s strong
investment-driven growth prospects. This

is taking its toll on competitiveness. Net
private capital flows doubled to 11% of
GDP in 2012 from a year earlier – and the
battle against currency appreciation is
unlikely to abate soon.
Policymakers in Lima have so far not
resorted to capital controls. “We don’t see
them as effective – they don’t do much to
change the trend,” Peru’s finance minister
Luis Miguel Castilla tells LatinFinance,
although he says taxes on foreign
portfolios are being considered. “We have
plans for taxes if the situation gets worse.”
Chile’s finance minister has also
spoken out about the pressures facing
Latin America’s currencies, warning in
an interview with LatinFinance that the
risk of tit-for-tat measures is rising at an
alarming clip (see Parting Shot, page 64).

“This is not something that
is going to end rapidly”
Ernesto Talvi, Brookings Institution
Not so worried

Yet investors, so far, are relaxed about the
policy response in most Latin countries. A
record of sound policies in many countries
struggling with appreciating currencies
makes sharp swings unlikely, they say.
More than anything, investors want
clarity on policy. “You’re always worried
about new measures that surprise you,”
says Jim Barrineau, co-head of emerging
market debt at Schroders. “The nice thing
about Latin central banks is they’re fairly
predictable. Colombia has been open and
transparent with the market. The recent
easing was well telegraphed. In Peru, it’s a
similar thing.”
Meanwhile, central banks’ efforts
to keep their exchange rates stable has
reduced volatility for local currency
investors, adds Barrineau. The risk of
many larger Latin American countries
resorting to harsh measures like Brazil’s
IOF tax is minimal, says Edwin Gutierrez,
emerging market debt portfolio manager
at Aberdeen Asset Management in
London.
He expects Colombia, Mexico

and Peru to stick to market-friendly
measures, like tinkering with limits on
reserve requirements and pension funds’
international investments, or cutting rates
further.
“They’re fighting a losing battle. They will
continue seeing inflows,” says Gutierrez.
“But they won’t risk their hard fought
credibility by doing anything Brazil-like.”

Deeper risks remain

Amid the excitement over capital flows
to emerging markets, one downside goes
largely unmentioned: the risk that when
the environment changes, capital could
suddenly flee.
The IIF warns that ultra-easy monetary
policy has increased the risk of a boombust cycle in capital flows – and of
disorderly capital flight when interest rates
change. “The risk of market participants
being unprepared for a reversal of rates is
real and needs to be seriously considered
to avoid disruption,” it said in a January
note.
Agustín Carstens, Mexico’s central
bank governor, alluded to the risk in
February. He stressed that credit booms
may leave emerging markets vulnerable to
a reversal in capital flows once developed
world monetary stimulus is removed.
Suttle says 1994 serves as an important
case study for what could happen when
the US Federal Reserve changes course
on monetary policy. The central bank
had expressed a willingness to keep rates
low for a long time, having cut the funds
rate to 3% in September 1992. By 1994
it decided it was time to hike. The result
was a collapse in capital flows to emerging
markets – and a near default by Mexico.
While Suttle insists he is not predicting
a return of such a boom-bust cycle, he
warns that the risks are vastly greater
today than is being acknowledged. The
volume of capital flows, and the extent to
which the Federal Reserve has loosened
monetary policy, are “orders of magnitude
bigger” compared with 1994, he says.
“Policymakers in the G7 need to
realize that they’re certainly adopting
a more risky strategy than they realize.
They think they’re pushing for safety and
security whereas they’re almost certainly
creating more financial instability rather
than less.” LF

March/April 2013

LatinFinance 21



LatinFinance - March/April 2013

Table of Contents for the Digital Edition of LatinFinance - March/April 2013

Latin Finance - March/April 2013
Contents
A moment in time
Cry of battle
Top of the crop
Comeback club
Dollar pain
Africa: Commodities in common
China: Funding the frenzy
Russia: Beyond energy
Highs and lows
Back-up plans
Infrastructure: Upping the ante
Real estate funds: Reaching overseas
Brazil Stars Index: Managing best
Sub-sovereign debt: Short-term troubles
Banking: Basel high ground
Real estate funds: Fibra advance
Infrastructure: Counting the cost
Casualties of war
LatinFinance - March/April 2013 - Latin Finance - March/April 2013
LatinFinance - March/April 2013 - Cover2
LatinFinance - March/April 2013 - Contents
LatinFinance - March/April 2013 - 2
LatinFinance - March/April 2013 - 3
LatinFinance - March/April 2013 - 4
LatinFinance - March/April 2013 - 5
LatinFinance - March/April 2013 - 6
LatinFinance - March/April 2013 - 7
LatinFinance - March/April 2013 - 8
LatinFinance - March/April 2013 - 9
LatinFinance - March/April 2013 - 10
LatinFinance - March/April 2013 - 11
LatinFinance - March/April 2013 - A moment in time
LatinFinance - March/April 2013 - 13
LatinFinance - March/April 2013 - 14
LatinFinance - March/April 2013 - 15
LatinFinance - March/April 2013 - 16
LatinFinance - March/April 2013 - 17
LatinFinance - March/April 2013 - 18
LatinFinance - March/April 2013 - 19
LatinFinance - March/April 2013 - Cry of battle
LatinFinance - March/April 2013 - 21
LatinFinance - March/April 2013 - Top of the crop
LatinFinance - March/April 2013 - 23
LatinFinance - March/April 2013 - 24
LatinFinance - March/April 2013 - 25
LatinFinance - March/April 2013 - 26
LatinFinance - March/April 2013 - Comeback club
LatinFinance - March/April 2013 - 28
LatinFinance - March/April 2013 - 29
LatinFinance - March/April 2013 - Dollar pain
LatinFinance - March/April 2013 - 31
LatinFinance - March/April 2013 - Africa: Commodities in common
LatinFinance - March/April 2013 - 33
LatinFinance - March/April 2013 - China: Funding the frenzy
LatinFinance - March/April 2013 - 35
LatinFinance - March/April 2013 - Russia: Beyond energy
LatinFinance - March/April 2013 - Highs and lows
LatinFinance - March/April 2013 - 38
LatinFinance - March/April 2013 - 39
LatinFinance - March/April 2013 - Back-up plans
LatinFinance - March/April 2013 - 41
LatinFinance - March/April 2013 - 42
LatinFinance - March/April 2013 - Infrastructure: Upping the ante
LatinFinance - March/April 2013 - 44
LatinFinance - March/April 2013 - 45
LatinFinance - March/April 2013 - Real estate funds: Reaching overseas
LatinFinance - March/April 2013 - 47
LatinFinance - March/April 2013 - 48
LatinFinance - March/April 2013 - 49
LatinFinance - March/April 2013 - Brazil Stars Index: Managing best
LatinFinance - March/April 2013 - Sub-sovereign debt: Short-term troubles
LatinFinance - March/April 2013 - 52
LatinFinance - March/April 2013 - 53
LatinFinance - March/April 2013 - 54
LatinFinance - March/April 2013 - Banking: Basel high ground
LatinFinance - March/April 2013 - 56
LatinFinance - March/April 2013 - Real estate funds: Fibra advance
LatinFinance - March/April 2013 - 58
LatinFinance - March/April 2013 - Infrastructure: Counting the cost
LatinFinance - March/April 2013 - 60
LatinFinance - March/April 2013 - 61
LatinFinance - March/April 2013 - 62
LatinFinance - March/April 2013 - 63
LatinFinance - March/April 2013 - Casualties of war
LatinFinance - March/April 2013 - Cover3
LatinFinance - March/April 2013 - Cover4
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