A slowdown in investment flows into Latin America is making it easier for the region's policymakers to raise interest rates, the head of Peru's central bank said in an interview on Friday. "Before one had to mix (rate hikes) with unconventional measures," said Peruvian Central Bank President Julio Velarde, who was in Calgary for the annual meeting of the Inter-American Development Bank. "But now one can go stronger with rates."
Moreover, the prospect that the US Federal Reserve will not expand a $600 billion bond-purchase program, known as "QE2," is taking the edge off the global currency war, he said. "There will be less" complaining, Velarde said of the meetings between government officials from the Americas that are expected in Calgary where talk about currencies is expected to feature prominently.
As the world recovers from recession, nations have clashed over currency policy as countries try to export their way to prosperity. Many countries feel slighted by weakness in the dollar - caused in part by super-low US interest rates - and China's tight controls on the appreciation of the yuan. Brazilian Finance Minister Guido Mantega famously dubbed the situation a "currency war."
Fuelling these tensions, mountains of cash have flowed into Latin American as investors seek higher yields than those offered in the developed world. In Mexico, foreign purchase of debt more than tripled in 2010.
The capital inflows create headaches for policymakers across the region, which bounced back from the global recession in part due to heavy Chinese demand for exports like Peruvian copper and Brazilian soy beans.
Normally, Latin America enjoys and even depends on foreign capital, but the torrent has proven too much of a good thing. Brazil's currency has soared nearly 10 percent in the last year, dealing a blow to the country's export sector. The South American giant's industrial output contracted in two of the three months through January.
EBBING CURRENCY WARS But now, Velarde said a slight regionwide drop in investment flows is easing tensions over currency policy. Foreign purchases of Peruvian government bonds, he said, have fallen "week after week, almost since January."
"Also, the signal that QE2 will probably not extend past June, and perhaps the Fed will start raising rates earlier than the time we were expecting four or five months ago," he said. "Currency wars aren't being talked about as much. A weaker peso in Chile is thought to have given the country room last week to hike rates by more than expected.
More manoeuvring room across the region will help its central bankers tackle accelerating inflation as a soaring commodities market pushes food prices higher. In Peru, commodities prices are a "big worry," Velarde said. Peru's central bank has tightened monetary policy for three straight months to fight inflation, which it sees ending this year around 3 percent, the upper end of its annual target.
Velarde cautioned that he thinks the reversal in capital flows will only be temporary because investor trust in Latin America has increased markedly in recent decades. Indeed, part of the reason Latin America has taken in so much money is because many of its countries manage their checkbooks better than their first-world counterparts.
Brazil's gross debt was equivalent to two-thirds of gross domestic product last year, unchanged from a decade earlier. The US debt load ballooned over the same period to 91 percent of GDP from 55 percent, according to IMF estimates. Mexico owes creditors less than half of annual economic output. Mexico, Peru and Brazil got their acts together in the 1990s after a series of economic crises taught them to reign in deficits and put tough central bankers in charge of the money supply. "I think even if interest rates were the same, (Latin American) assets would be attractive," said Velarde.