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Lavagna: magnificent performance marred by the fact that what he claimed to have happened in Argentina hadn’t happened |
Latin Americans learned long ago that they should not put too much trust in their currencies. Since the 1970s, hyperinflation, capital flight and economic collapse have been commonplace and many businesses have realized that holding their assets in US dollars was the only sure way to protect them. Currencies have been more stable in recent years, but even so between 2000 and 2003 they lost about half their value against the US dollar and Argentines still hold billions of dollars in savings abroad.
But things might be changing. Since 2004, a weakening US dollar, high domestic interest rates, solid financial accounts and export growth have made free-floating Latin American pesos, reais and soles a smart investment for international investors and ordinary people.
The region’s currencies gained roughly 8% in inflation-adjusted terms last year. Local currencies have benefited from high domestic interest rates and relatively low US rates – investors borrow cheaply in dollars and invest in better-yielding assets. Such assets include Colombian stocks, for instance. Colombia’s stock exchange generated returns of 130% in 2004, making it the world’s top-performing bourse, and its peso appreciated by about 12% last year. In Brazil, the benchmark interest rate is almost 19%, well above US levels.
Record strength
Strong economic growth has also played its part, as the region notched up its best perfomance in a decade last year. Chile’s peso is at its highest level since 2000 as the country reported a budget surplus in 2004; Peru’s sol is at its strongest since 1999, despite almost daily central bank intervention, as commodity prices lift its exports into record territory.
The strength of Latin America’s currencies has also allowed some economies to issue local-currency debt for the first time, providing investors with an alternative to sovereign bonds offered in dollars and euros. Colombia in November issued a six-year, $375 million global bond denominated in pesos but repayable in dollars, a play on the currency’s strength. Banco Votorantim sold Brazil’s first-ever global bond in reais late last year and the government is expected to follow up with a real-denominated bond this year. Mexico is also looking to convert its sovereign debt into pesos.
Pressured by exporters, central banks appear to be the only ones not joining in the fiesta. Across the region, central bankers have stubbornly intervened to prevent further currency appreciation, often under the pretext that they are buying dollars to build up international reserves. “We do not intervene in the currency because it is not our job to do so,” says Peru’s former central bank president, Javier Silva Ruete, despite buying millions of dollars in intervention as bank chief in 2004.
Solid prospects
Some investors believe that if Brazil’s central bank stopped buying dollars, the real could strengthen by up to 15% to R2.40 to the dollar this year. With intervention set to continue, many US investment banks expect the real to finish 2005 at 2.75 to the dollar. Given the presidential elections in Mexico next year, analysts see the Mexican peso staying at about 11 to the dollar for this year, above the psychological barrier of Ps10 to the dollar. “The peso is stable, but that’s a stability you can now depend upon,” says Ignacio Trigueros, an economist at Mexico’s ITAM university.
Many investors believe that the region’s currencies are still undervalued, despite forecasts that Latin American currencies are due to weaken again this year, and that central banks will eventually have to give up buying dollars and accept that they cannot prevent the appreciation. The strength of the currencies could increase people’s purchasing power, lift one of the world’s lowest savings rates, and drive investment, as Latin Americans come to have greater trust in their local currencies. But exporters will need to boost their competitiveness to survive, as their goods become more expensive abroad.
In the short term, traders see the two-year rally for Latin American currencies tailing off by the end of the year, as the US Federal Reserve is expected to raise its rates to near 4% from the current 2.75%, making dollar-denominated assets more attractive. Slower economic growth this year in Latin America and the political instability surrounding elections in Brazil, Mexico, Colombia and Peru in 2006 could also dampen investor confidence, but this setback is likely to be temporary.
