Hot Money Conundrum

April 4th, 2013
in contributors, syndication

Investing Daily Article of the Week

Investing Daily Article of the Week

by Ben Shepherd, Investing Daily

Conventional wisdom dictates that when someone offers you money, you take it. That is, unless you’re a midsized South American country.

While Argentine politics are still a mess and Venezuela is undergoing what is likely to be a trying leadership transition in the wake of Hugo Chavez’s death, the era of the South American banana republic has long since passed. Most countries south of the US border now have more than a decade of stable, democratic leadership under their belts and have managed their economic affairs surprisingly well.

Peru is an excellent case in point.

Follow up:

Over the past decade, foreign investment has flooded into the country’s mining and energy sectors, spurring heavy infrastructure investment. That has generated a wave of tax revenue for the government, which funded a wide array of social programs and pushed public investment to record levels. Thanks to that virtuous cycle, a budding consumer market is flourishing in Peru and creating wealth across the country, helping its economy grow by an average 7 percent per year.

Because of that attractive growth, low inflation and political stability, foreign money continues to flow into Peru at a rapid clip.

All of that investment and Peru’s own economic strength have proven a double-edged sword for a country dependent upon exports.

A leading exporter of copper, gold and lead as well as agricultural commodities such as vegetables, fish and animal fibers, Peru is feeling the pinch of a rapidly appreciation currency. As shown in the graph below, the Peruvian sol (quoted in the number of Sol to the US dollar) is near its lowest point in more than a decade.

That currency strength has been murder for Peruvian exporters. The country’s sales abroad have been stuck on a plateau for more than two years now, averaging about USD3.2 billion per month, down from nearly $USD4.5 billion.

To help devalue its currency, the Peruvian central bank has boosted its deposit requirements on US dollar accounts eight times in 10 months; a 0.25 percent increase in the nation’s bank require requirement will take effect on April 1. The central bank has also been buying dollars in the spot market hand-over-fist in an attempt to depreciate the currency, on some days purchasing in excess of USD100 million.

The sol has come down by about 1.3 percent so far this year, thanks to the central bank’s aggressive action. While that’s still not much of a dent considering the massive run up over the past several years, it’s encouraging that Peru hasn’t resorted to the sorts of capital controls the Brazilian government has implemented in recent months. However, as volatility remains high, there is always the chance that Peru may take more aggressive action to stem the currency’s rise.

Colombia is in a similar situation, with its peso rapidly appreciating. After nearly five decades of simmering war with the Revolutionary Armed Forces of Colombia (FARC), a negotiated settlement appears to be close at hand. While issues concerning ownership of farmland, landholding limits and mining remain to be resolved, Colombia has had its longest stretch of relative calm in years.

Given Colombia’s vast mineral and agricultural wealth, an end to hostilities would allow the country to become a true economic powerhouse that many believe could rival even Brazil.

Even as talks with the guerrillas have reportedly stalled, the Colombian peso has been rapidly appreciating in anticipation of a deal being reached. To halt that rise, the government has been buying an average of USD5 billion in US currency a year in the spot market and it recently announced that it would double its purchases to USD10 billion.

Like Peru, Colombia is heavily dependent on exports and one of its largest industries is the sale of fresh-cut flowers to the US. As the peso has appreciated, other Latin American countries have snuck into the market, further reducing Colombia’s take on flowers.

All of these machinations continue to add fuel to the fear of a widening Latin American currency war. There’s a danger of a race to the bottom, as countries fight to make their goods and services the most competitive in US dollar terms and enhance their relationships with their largest trading partner.

The competitive devaluation will prove a challenge for American investors in the region who, so far, have seen nearly a third shaved off their performance thanks to the slowing appreciation of local currencies. But in the grand scheme of things that hasn’t, or at least shouldn’t, take the shine off of Latin America.

Asia remains an extremely attractive investment destination, but slowing growth in the region is forcing us to rethink our strategies. A more assertive China is also posing a bit of a problem, as its forays into the South China Sea and other regional waters have sparked a naval arms race in the region. Japan has increased spending on its coast guard to protect its local interests and even Vietnam is working to modernize its navy to check Chinese naval ambitions.

While there’s little risk of open hostilities in Asia over the near term, particularly as the US remains committed to mutual defense treaty obligations in the region, China’s growing influence will increase tensions as the country’s smaller neighbors worry over its growing reach.

Politically speaking, there’s no such risk in South America. While Argentina has been pushing to reopen negotiations with the British over the still disputed Falkland Islands, there’s little in the way of intraregional conflict to potentially impede economic growth there.

Demographically, South America has also become much more attractive than Asia, as Japan continues to struggle with the challenges of its elderly population and China is aging rapidly thanks to its one-child policy. With the median age in South America running in the low-20s, the region can grow for decades thanks to its expanding workforce.

So while we will have to tread more cautiously in South America due to currency challenges, it’s still extremely attractive from a growth perspective.


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