Latin America Confronts the Strength of its Currencies

The governments of Latin America’s largest economies study changes in the value of their currencies very carefully. These exchange rates are having a direct influence on economic developments in their country – in most cases, a negative impact. The currency with the best performance in the region this year is the Colombian peso, which has risen by 17% to about 1.925 to the dollar. The Colombian peso has been the best performer among the 71 currencies tracked against the dollar by Bloomberg. Second is the Brazilian real, which has strengthened by 10%, reaching about 1.946 per dollar.

 

All of this is taking place in a global context where the U.S. dollar has generally weakened against other currencies, starting with the euro and the pound sterling. There are only a few countries where the dollar has strengthened and local currencies have weakened. This list includes the Sri Lankan rupee, the Taiwanese dollar, the Nicaraguan cordoba, the Argentine peso, the Mexican peso and the Japanese yen.

“The currencies of Latin America have appreciated a great deal since the beginning of this year because of the strong influx of dollars into the region,” says Rafael Pampillón Olmedo, professor of economics at the Instituto de Empresa business school in Spain. Pampillón points out four reasons for the influx of dollars. The first is the increase of exports [from Latin America]. “Effectively, global demand for the most important Latin American products has peaked, from soy beans to coffee to iron, steel and textiles, and this has propelled Latin American export prices and volumes to record levels,” he notes.

 

The second reason is “the growth of direct investment coming from abroad in an environment where economic growth is relatively stable and sustained.” The third reason: The arrival of speculative capital, which also means a major influx of currencies that propel Latin American currencies higher and the U.S. dollar lower. “The main factors that attract this capital are high interest rates and rising stock markets. The stock markets in Brazil, Chile and Mexico are at historic heights,” says Pampillón. Although the growth in the supply of dollars “reflects confidence in their economies, this growth is unfortunately raising the value of their currencies.”

 

Finally, Pampillón points to the strong influx of remittances of U.S. dollars. “Sending remittances is an economic phenomenon of major significance in Latin America. Over the last 10 years, it has grown at a particularly significant rate,” he says.

This pattern is having an especially negative effect on the economies of countries whose currencies have strengthened the most. In the case of Colombia, “You can say that it has lost competitiveness against some neighboring countries, especially Chile, Peru, Argentina and Ecuador, where local currencies have not gone up as much, or may even have lost value, as in the case of Argentina and Ecuador, which is the most dollarized economy,” says Cesar César Cañola, professor of economics at the University of Medellín in Colombia.

 

A Drop in Competitiveness

 

In Colombia, the decline in competitiveness is measured by the Rate of Increase of Real Change (ITCR in Spanish), which compares the Colombian peso to the currencies of the country’s 20 largest trading partners. When this indicator goes above 100 points, it means that the country enjoys greater competitiveness. However, it is currently at 99.66, which shows that it has lost ground in international markets. At the beginning of 2003, the index was at about 136 points. The dollar was then around 2.960 pesos but today the dollar is around 2.115 pesos.


Generally speaking, Pampillón believes that “a weak dollar slows down exports and makes imports cheaper so it endangers jobs and manufacturing growth in Latin American countries.” Those countries most affected by the appreciation of the dollar, he adds, are those in which the economy is most dependent on exports. “Companies whose businesses have a large proportion of dollars, such as oil companies and exporters of other primary products, will be hurt more than companies that sell in local markets. This appreciation of the currency could undermine
Latin America’s competitiveness, and threaten jobs in sectors such as tourism in Mexico, automobiles in Brazil, assembly plants in the Dominican Republic, fisheries in Peru and coffee in Colombia.”

Experts say that it is not only exporters who are hurt by any currency appreciation. It also hurts local producers who sell at home because their products are cheaper than imports. In addition, those companies that take in remittances from immigrants will suffer damage because they wind up with less of their own currency for each dollar they obtain.

There is a brighter side to currency appreciation. “Revaluation can also be seen as a positive factor because it means that a currency is stronger relative to the U.S. dollar,” says Betancur. “In the case of Colombia, revaluation largely responds to the higher volume of foreign direct investment [in that country]. The decline in the dollar has made imports cheaper, which the manufacturing sector has taken advantage of in order to increase its investment in capital goods.”

The Colombian Peso

 

Some of the biggest banks on Wall Street agree that the Colombian peso will collapse this year. Some even say that this decline could erase the 17% rise that the Colombian peso experienced in 2007. Merrill Lynch expects that the Colombian peso will be the worst performer in foreign exchange markets, losing all of its advances against the dollar. Deutsche Bank forecasts a drop of 10.5% by the middle of November, Citigroup anticipates an 8.9% drop by the end of the year, and Goldman Sachs predicts a decline of 6.3%.

 

Despite the fact that the Colombian peso appreciated by 47% over the past four years, other U.S. firms maintain that the peso still has room to gain value. Bear Stearns forecasts that the Colombian peso will rise in coming weeks, ending the year at 1.950 to the dollar. Morgan Stanley predicts that the Colombian peso will not begin to weaken until 2008, and it forecasts a rate of 1.850 by the end of this year.

As for the Brazilian real, economists in that country have raised their forecasts, arguing that primary products are getting more expensive, and attractive interest rates in Brazil help maintain the inflow of dollars into that country. According to a survey by the Brazilian central bank, economists anticipate that the real will trade at 1.93 to the dollar by the end of 2007, compared with earlier forecasts of 1.95 to the dollar. “We see a continuous appreciation in the real,” Pedro Jobim, chief economist for Holland’s ING in Sấo Paulo, told Bloomberg. “Foreign direct investment and the inflow of money into the stock market will continue.”

 

The Peso of Remittances

 

The situation in Mexico is very different. The Mexican peso has strengthened by only 0.2% this year, reaching 10.7847 to the dollar. This makes it the second-worst performer among the major currencies of the region. The only Latin American currency that has performed more poorly this year is the Argentine peso, which has dropped by 0.8% because of the daily purchases of dollars made by that country’s central bank.

 

The remittances that Mexican emigrants send home are the second-greatest source of dollars for Mexico, after exports of petroleum. These payments are being limited by the crisis taking place in the U.S. housing sector. The construction industry is the greatest source of employment for Mexicans in the United States, representing 20% of all jobs, according to Mexico’s central bank.

Indeed, From Los Angeles to New York, the decline of the U.S. housing sector is having an impact on Mexican workers. Permits for the construction of new houses have dropped by 20% this year according to the U.S. Census Bureau. This has had a major impact on remittances, which have grown by only 3.4% during the first quarter of this year — their slowest growth rate in eight years.

Money transfers, which totaled $23 billion last year, have also been affected by President George W. Bush’s efforts to combat illegal immigration. Bush has increased security along the border and intensified oversight of factories that hire undocumented workers. The goal is to help obtain Congressional support for a bill that would give illegal immigrants the opportunity to obtain permanent residency status.


Ana
lysts believe that the drop in money transfers will begin to have an impact on consumer spending in Mexico. Almost 90% of the transfers destined for that country wind up in the consumer sector, according to the country’s central bank.

 

Morgan Stanley predicts that the Mexican peso will fall for the second consecutive year because of declining remittances, lower petroleum production and weakening in demand for the country’s exports. More specifically, it forecasts that the peso will drop 5.4% by the end of the year to reach 11.4 pesos to the dollar. Dresden Kleinwort, the investment banking division of Allianz, the German insurance firm, forecasts that it will drop to 11.19 to the dollar. The value of the peso dropped 1.7% in 2006.

 

Sustained Growth

Despite the currency situation in the region, the International Monetary Fund (IMF) forecasts that Latin Americawill grow by 4.9% this year, which is 0.7% higher than the IMF first predicted. Although this represents an upward revision, the IMF says in its report, “Global Economic Perspectives,” that South Americawill grow more slowly than in 2006, when real Gross Domestic Product grew by 5.5% adjusted for inflation.

The IMF says that the slowdown will affect every country in the region except Braziland Chile, whose economies will perform better this year than in the past. “The economic fundamentals are generally good, since most of the countries have continued to create credible macroeconomic policies, and they have reduced the vulnerabilities in their balance sheets,” wrote Simon Johnson, chief economist of the IMF, in his report.

 

“In an attempt to avoid greater appreciation of their currencies and impede inflows during a cycle when currencies have weakened following a strong upturn, Braziland Colombiahave taken measures aimed at lowering speculation and strengthening their foreign exchange markets,” says Pampillón. “Nevertheless, those currencies have barely reacted to those measures and some currencies — such as the [Brazilian] real and the Colombian and Chilean pesos — continue to appreciate. This is not good news for Latin America.”

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