Why, or Rather How, Peru Threw $25 Billion Down the Drain

By Nicholas Asheshov

The Central Bank (BCRP) has stepped up slightly the rate of devaluation of the Sol though it continues to burn, every week,  hundreds of millions of the country’s diminishing foreign reserves.

Towards the end of last week the dollar was costing close to an official S/.3.40, a 14% devaluation since the S/.2.98 of the beginning of the year.
Long gone are trade, budget and capital surpluses although the government, as represented by the Central Bank and the ministry of Finance, continues  to predict impressive growth figures for the coming year.

A year ago they talked of 2015 as a 5.6% year even as 2014 was coming in at 2.4% which looks like being the figure, too, for this year.  For 2016 they are talking of between four and five percent.  It could be so but, according to a new view of the Central Bank’s management of the exchange rate, it is unlikely.

For a start, this is in a world where Japan and EUrope are just this side of recession and where the U.S. and China will be lucky to get to 3%.  For Peru the story is easy to see.  Copper is at $2/lb compared with $4.80 four years ago.  Gold seems to be lowering towards $1,000/oz. (in 2011, $1,900) and silver, heading for $13/oz. compared to over $40 four years ago.

Minerals and metals bring in over half of Peru’s foreign exchange.  To hammer in the nail, iron ore, of which Peru is a marginal producer, used to be at $150 and could not go below $120, according to Rio Tinto, Vale do Rio Doce and BHP, who were spending tens of billions on opening vast new mines with cheap credit.  Today iron ore is at $45.  It was $25 a dozen years ago.

Oil, the other barometer, will be spending 2016 nearer $30 than $40, good news for Peru and Chile, net importers, like Japan, China and Europe.

It is not unusual for central banks and finance ministries to be behind the curve.    But the disconnect with reality at the Central Bank in Lima has produced a disaster.  Two, in fact.

One is the  loss of $25 billion, a staggering sum, in foreign reserves, spent over the past 30 months —$1,000, give or take, for every man, woman and child in Peru— on propping up the price of the Sol instead of allowing it to fall into a free market, as has happened everywhere from Uzhbekistan to Uruguay.

The second calamity has been an unnecessary, certainly unjustified stagnation of Peru’s economy.  Hundreds, perhaps thousands of export businesses have gone broke or soon will and thousands more have failed to get going because of the mismanagement of the exchange rate by the BCRP’s board, led by Julio Velarde, an old-school economist who has been in the job since 2003.  The Congress, fractured and factious, was unable to agree on replacing him and other directors as of 2011.

Velarde says he is combating “speculators,” the old cry of dictators and socialists alike, who try to boost the price of their local currency.   Two famous ones were Pinochet in 1982, whose insistence on maintaining the peso at 39 bankrupted three-quarters of the country, including the banks; and the Bank of England in 1992, where the Oxbridge mandarins at the Treasury spent billions of GBPs in a mano a mano with a youthful George Soros who forced them to devalue, making him, and deservedly, a zillionaire.

But this week saw a powerful new voice demanding an immediate change in policy, starting with taking foreign exchange out of the hands, the sooner the better, of the Central Bank.

The attack came from Richard Webb,  Peru’s most respected economist and himself twice executive president of the Central Bank (1980-86, 2001-2003), both times of political and financial stress.

In an Op-Ed column in El Comercio on Sunday Webb said, speaking in carefully couched diplomatic terms, that the BCRP has failed to understand that it must provide a stable and adaptable exchange rate system for the future.  Instead, today’s skewed exchange rate merely reflects the “metals boom” of the past,  not a future where “competitiveness” is  the essential feature, a difficult future that will be very different from the past decade. A new system for managing foreign reserves should begin, presumably urgently.

Webb said the problem is that BCRPs calculation consists in looking back. “The appropriate level of an exchange rate is not a question of the past but of the future.”

Webb’s definition of the correct Sol/Dollar rate is straightforward, like any decent revolution. “It would be a dollar that ensures a high growth rate in exports,” especially non-traditional ones, which depend largely on their costs to be competitive.

“It is true,” Webb says, “that statistics are limited to the past… but when the future brings substantial changes, what you win in statistical precision is lost in the relevance.”

Everything points to the world being very different in the next 10 years and the future will be substantially more competitive than in the recent past.

Webb says that our neighbours, presumably referring to Chile, Colombia, Brazil and Mexico, understand that “The stability of the past will not be necessarily that of the future (a reality that has been recognized by a large number of countries that our competitors and who have been preparing to devalue their currencies in recent months).”

Peru should by law, in any case, have a free market in foreign exchange, not the controlled rate of the BCR.

Webb says that the BCRP “is not technically prepared” to control the exchange rate.  Its focus on price stability means that it will always hold back a devaluation instead of preparing for future economic growth and the creation of jobs.

The exchange rate is especially a delicate matter in Peru where the Dollar is, under the Constitution, as legal as the Sol itself, a relic of the inflation catastrophes of the 1970s and 1980s.  In theory the Sol/dollar rate is free.  But the Central Bank has assumed, with no special legal backing, the right to push and pull the market through its control, a legal one, of the country’s official foreign reserves.  The Bank’s only other official mission is to preserve price stability.  This, as Webb says, means that it will always hold back on devaluations, even though this is patently bad, especially for an export-oriented country like Peru.

The economic teams of the two leading candidates, PPK and Keiko Fujimori, for the presidency this coming year understand the Sol/Dollar issue.

It is, after all, not that difficult.

Nick Asheshov was editor of the Andean Air Mail & Peruvian Times during the 1970s and 1980s, and of The South Pacific Mail, Santiago during the 1990s.  He was Latin America Editor of Institutional Investor, New York over the same period.  He lives in Urubamba, where he writes a blog and where he has been prominent in the hotel and railway business.

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