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ECONOMY-LATIN AMERICA: The Downside of Strong Currencies

BUENOS AIRES, Feb 10 2011 (IPS) - Latin America returned in 2010 to the strong economic growth it enjoyed over the past decade, after only a minimal slowdown during the global crisis that broke out in 2008. But the weakness of the dollar relative to local currencies is a cause for concern among governments and sectors that produce goods for export.

The Preliminary Overview of the Economies of Latin America and the Caribbean 2010, a report presented in December by the Economic Commission for Latin America and the Caribbean (ECLAC), indicates that GDP grew by 8.4 percent in Argentina in 2010, 7.7 percent in Brazil and 5.3 percent in Mexico, while the estimated average for Latin America as a whole was six percent.

These figures also reflect a steady strengthening of local currencies against the dollar, especially the Brazilian real, which in October appreciated by 26 percent, compared to the average exchange rate for 1990-2009.

At the opposite end of the spectrum is Argentina, where the peso devalued by 36 percent against the dollar compared to the same period.

Argentina is Brazil’s biggest partner in the Southern Common Market (Mercosur), which also includes Paraguay and Uruguay, with Venezuela in the process of becoming the fifth full member.

Brazil is Argentina’s principal export market, while Argentina ranks third among purchasers of Brazilian goods.

The currencies of Colombia, Venezuela, most Central American countries, Uruguay, Ecuador, Chile and Paraguay, in decreasing order, have also appreciated against the dollar. In Peru and Mexico, the nuevo sol and peso respectively have maintained the same exchange values as the average for 1990-2009.

Most economists find the strengthening of local currencies a cause for concern, although not alarm.

Francisco Gismondi, until 2010 the head of economic analysis at Argentina’s Central Bank, said the macroeconomic indicators for Latin America’s economies and the high prices of the commodities they export serve to cushion the threat.

“It is Europe, in fact, that is in danger of behaving like emerging economies did years ago, while in countries like Colombia and Peru, conversely, productivity has improved,” Gismondi told IPS.

Latin American governments have adopted different policies to deal with their currencies, ranging from massive dollar purchases to interest rate hikes and taxes on speculative capital.

Lia Valls Pereira, an economist with the Brazilian Institute of Economics at the Getulio Vargas Foundation (FGV), told IPS that Brazil “has one of the highest interest rates in the world,” in contrast with the low rates in Europe and the United States.

The Central Bank of Brazil raised its benchmark SELIC interest rate 0.5 points to 11.25 percent on Jan. 19, in order to encourage savings and bring down inflation, which reached an unexpectedly high 5.91 percent in 2010.

“At present, manufactured goods make up 40 percent of exports. The growth of Brazilian export earnings last year was due to the high price of commodities, and strong demand from China,” Valls Pereira said.

Brazilian exports of manufactured goods to Argentina have risen, in contrast with sales to other countries.

The trade balance in favour of Brazil could become “a new cause of major tensions,” said Valls Pereira, referring to the way producers in the two countries have taken turns complaining about trading conditions over time. This was virtually the only issue broached by Argentine President Cristina Fernández at her first meeting with Brazil’s new President Dilma Rousseff in Buenos Aires Jan. 31.

In Valls Pereira’s view, the leftwing Brazilian governments of President Roussef and her predecessor Luiz Inácio Lula da Silva (2003-2011) “have so far only taken the most obvious measures, like raising import tariffs and regulating capital inflows.”

In Mexico, the government of conservative President Felipe Calderón has little room for manoeuver in terms of economic strategy. “Interest rates are low on the international markets, and the (Central) Bank of Mexico does not dare lower them because there is an uptick in inflation,” analyst Édgar Amador told IPS. The consumer price index rose by 4.4 percent in 2010.

As in Brazil and Argentina, the strength of Mexico’s Central Bank reserves is a key defence against economic catastrophe. The country has reserves of 118.5 billion dollars, and in January the International Monetary Fund approved a precautionary line of credit for 72 billion dollars.

Mexico was the country in the region that was hardest hit by the global economic and financial crisis, because of its close trading ties with the United States, where the crisis originated in the second half of 2008. Mexican GDP contracted by 6.7 percent in 2009, and 900,000 jobs were lost.

The case of Argentina is different: the economy has grown at an annual rate of between seven and nearly 10 percent since 2003, when it began to emerge from the social and economic meltdown that broke out in late 2001, the worst in its history. The only exception was 2009, when GDP remained static. Its reserves are also at a record level, at nearly 53 billion dollars.

But in recent years, inflation has been the centre-left Fernández administration’s biggest headache. The National Institute of Statistics and Censuses says prices rose by 10.9 percent in 2010, but the opposition, academics, the business community and trade unions question the credibility of this figure, and private estimates for inflation are twice as high.

“Inflation is causing regional currencies to appreciate,” said Gismondi. “When the Brazilian real and the euro stop helping them out, as they have in the past few years, things could get really difficult.”

The former Argentine official predicted that food price inflation, which was double the general inflation figure for 2010, will be lower this year, since many tradable goods and services have reached equilibrium with international prices.

In Gismondi’s view, “what is pushing prices up is the expansion of public spending, and the monetary policy” of printing bank notes.

However, Claudio Katz, an economics professor at the state University of Buenos Aires and a member of the network Economistas de Izquierda (Economists of the Left), told IPS that the exchange rate situation in Argentina does not appear to be “explosive.”

“The government is giving its approval to inflation, or at least allowing it to run its course, and one way or another this policy is affecting the exchange rate of the peso against the dollar,” he said.

Katz pointed out that during the 1990s, when the peso was pegged to the dollar, “the situation was much more complicated: the state budget was not balanced and there was a very large trade deficit.”

The Fernández administration counters criticism by pointing to wage increases, which in many cases are equal to or greater than inflation.

Inflation in Argentina “is not due to public spending, nor to the emission of bank notes, but is determined by the business sector,” Katz said. “After several years of rapid growth, they just adjust prices (upwards) instead of investing.

“When public funds are used to bail out banks, they see it as ‘natural and logical,’ but when subsidies combined with social expenditure are proposed, they are quick to call for cutbacks,” he said.

“There are mechanisms for dealing with oligopolistic groups,” Katz said. “They have made unprecedented profits; it is intolerable that they are raising prices, and the government just lets them,” he complained.

*With additional reporting by Fabiana Frayssinet in Rio de Janeiro and Emilio Godoy in Mexico City.