Peru: curbing the sol

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Like many emerging markets, Peru has been fighting a war – a currency war to be precise.

The country’s currency, the sol, jumped to a 15 year high last week after the US Federal Reserve said it would launch a third round of quantitative easing. And it looks like Lima has decided enough was enough.

The Andean country’s central bank changed its intervention strategy on Friday to increase volatility in the currency.

“We are setting fixed quantities, in order to introduce more volatility,” the bank’s chief, Julio Velarde said in Lima on Monday.

Velarde seems determined to make it hard for traders to forecast currency movements by buying dollars when the sol is weakening as well as when it is strengthening. Peruvian officials are seeking to make the currency movements less predictable after the sol’s 5 per cent appreciation against the dollar in the past year.

Unlike its Andean neighbour, Colombia’s central bank, Peru’s does not follow a pre-announced schedule or amount, buying what it considers necessary on any given day.

Appreciation, alongside low volatility, is boosting demand for credit in dollars. This increases certain risks for the banking system if the local currency plummets. This might seem unlikely to many, especially as bank efficiency in Peru is exceling, according to Fitch Ratings with local banks leading in efficiency due to the sustained economic growth and fierce competition.

True, the Andean country’s economy is stellar, having now expanded for 35 consecutive months, with growth in the first seven months of the year hitting 6.23 per cent, surpassing the six percent target for the year. Gross domestic product expanded in July by 7.2 percent, just a tad above the June number – this is the fastest pace in 11 months, reported the National Statistics and Information Institute this weekend.

But the impressive growth has been boosted, in big part, thanks to consumer spending on the back of consumer credit. And the central bank’s chief, Velarde, is worried about the growth of consumer credit in US dollars for Peruvians who earn in soles.

He has a point, as dollar-denominated mortgages have grown 23 per cent since the beginning of the year while credits for vehicles in the same currency in the same period went up 44 per cent.

On Friday, the sol touched 2.5950, the strongest level since 1997. So the country’s central bank, bought $40m in the spot currency market on Monday, paying an average 2.6023 soles per dollar. That pushed the sol down two basis points to 2.6010 per US dollar on Monday, the steepest decline in two months.

The bank has been buying dollars every day this month, in amounts ranging between $10m and $400m – $674m in the first two weeks of September only. So far this year, the bank has purchased a near record $10.5bn to curb appreciation. International reserves now top $60bn, thanks to those dollars purchased to maintain exchange rate stability.

Related reading:
Chilean peso and QE3: dilemma, dilemma, beyondbrics
EMs and QE3: it’s head-in-hands time, beyondbrics
Peru: LatAm’s latest currency warrior, beyondbrics

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