Although one of the biggest changes to Peru Central Bank (BCRP) policy was reported in the English speaking press last week, it has remained almost untouched by commentaries in Peru itself. This is a very strange state of affairs when one considers the importance it will have on the country’s economy in the months to come.
All the things that are normally reported upon were mentioned by the local press. The somewhat surprising rise in the base landing rate from 5.25% to 5.5%, adding to the distance between it and the US Fed, currently at 2.25% (and likely to drop further). Also, locals read about the adjustment in bank required reserve ratios from 8% to 8.5% minimum, marginal from 20% to 25% and foreign currency from 40% to 45%, all this to, ”slow the rhythm in credit growth and thus avoid that price rises from food supply shocks become a permanent part of inflation expectations.” (translated).(1)
But what of the other measure? Perhaps it is because nobody quite understood its gravity. Perhaps they feel that because the measure is aimed at foreigners it will not affect Peru’s internal economy. But for whatever reason, the move to cut off the arrival of foreign speculative capital (aka hot money flow) was almost totally missed by local press and commentators. Hot money, in true “carry trade” style, has been flowing into Peru in large quantities, changing dollars into Nuevos Soles, then after a few days, weeks or months changing back and leaving. The hot money earned its difference thanks to interest accrued and the favorable exchange rate as the Sol strengthened against the dollar. When this capital inflow reached the speed of U$500m per day in the first month of this year, the BCRP applied a reserve requirement on foreign currency deposits of 40%, plus a commission of 0.05% (which is now 0.1%). But it seems this was not enough to stem the flow, because last Thursday the BCRP told the hot money, “You’re not welcome here anymore. We don’t want you hanging around. You’d better leave while the leaving is good.” or words to that effect from the director of the BCRP. (2)
The measure that directly affects the hot money (clause 2c of the BCRP information note) is the key to the issue. It will be applied as from 5th May, the first working day of next month, and says (translated), “Elevation of reserve requirement from 40% to 120%, which will not be remunerated, to the obligations in national currency for non-residential financial entities.”(3)
Finance Minister Luis Carranza must be rather unhappy, if not absolutely furious, about all this. Just a few weeks ago he clearly stated that Peru would under no circumstances place capital controls on short term financial influxes. “We totally reject proposals that put locks on incoming capital.”(4)
Also, the Minister of Foreign Trade must be worried, given that the Free Trade Agreement (FTA) with the USA does not allow discrimination of North American capital, be it hotter than the hottest hot Money. This may well complicate the official 2009 start date of the FTA, taking into account the efforts made to change and adapt to requirements both supposed and imposed from the other party(5). In fact, chapters 10 and 12 of the FTA, or “Promotion of Commerce Agreement Peru/USA”(6), are very clear in this respect, particularly article 12.2 relating to equal trade which must allow transnational capital transactions.
As from May, when the new BCRP measured is applied, somewhere between U$900m and U$1200 would have already left the big Lima casino. There will not be many dollars coming in as replacements, either, because the outward flow of currency has already caused the Sol to devalue somewhat (to the relief of ADEX, the association of exporters). The phenomenon will added to, because the monthly capital flow of currency to pay for imports will be greater than the revenues from exports. As last month when the balance of payments was negative, it is likely to stay that way, although the slow cooling of the economy will lessen this gap as the year goes on. We can assume that the tightening of credit will have a greater effect on imports (lessening them) than the devaluation of the Sol will have on exports (growing them).
(1)Source: Nota Informativa No. 038-2008-BCRP, del 10 de abril 2008(2)Note the well-hidden declarations on page 20 of “Gestion” magazine this week. “Central Bank declares war on infllow of specualtive capital, including the unmistakable declarations of the Director of the BCRP.(3) For more details about this measure and its background see either this note or this one.
(4)Reuters, “Peru says tax on foreign capital is not a control”, Feb 11, 2008.
(6)Complete text can be found here.