Fall in the Sol Coming Sooner than Later

By Nicholas Asheshov —

The pressure on the Sol is building up.   In the first three days of this week, mostly on Monday 26 and Wednesday 28, the Central Reserve Bank sold $665 million from the country’s reserves cache to block a free market fall in price beyond its new S/.3=US$1 level, reached reluctantly last week.

This is a big chunk of change to be extracted from Peru’s foreign exchange reserves. This is especially as it is being used, as everyone understands, to little practical purpose. At this rate it will take less than six months, taking into account weekends and saints’ days, to use up the Central Bank’s own money.

The amount was not quite a record but certainly a sign of trouble.   The way it was done signaled, even more, the delicate outlook for the Sol and for Peru’s stuck economy,  which has ground to a halt after a decade and more of bounce and progress.  Of the $350mn, $150mn was sold on the open market.  The remaining $200mn were not reported but were sold under the table in the form of exchange swaps, for S/.600mn. These swaps only emerge from under their stone down the financial road, say in 90 or 180 days. Monday was not, it seems, a concerted raid by local banks although these are by no means above something of the kind together, perhaps, with a New York vulture fund.  Monday was, instead, just the free market in the form of local and foreign banks and companies running, as they are today everywhere, for safe haven.

At the eye, no longer perhaps so calm, of this gathering storm is Peru’s Central Reserve Bank, whose building on Jiron Miro Quesada in downtown Lima speaks of efficiency and quiet stability.  Above the interior patio rise the colonial cloisters of the Convent of San Pedro.  The bells from a fine old clock tower echo the quarter hour through the carpeted boardroom suites. Built four decades ago by the Velasco Junta, the Bank has tried to provide an island of concrete calm through a succession of turbulent times.

Outside is, disorganized, the traffic.  Inside are economists. Unlike accountants, who understand that they are just counting the dead, economists believe they can use yesterday’s numbers to predict, like coca leaves, the future. They also believe that they can solve economic problems in the same  way as the Andean village women who cure ‘fright’ and other afflictions with chicken egg and guinea pig therapy, pasando el huevo and pasando el cuy.

Economists here also assume that equilibrium, stability, is the norm. Or at least the objective of their labors.

But Maynard Keynes showed, in the very unstable 1930s, just like today in fact, that equilibrium was a fantasy and that the only sure rule was not stability but ‘uncertainty.’

Edmund Leach, another Cambridge thinker, later extended Keynes’ uncertainty into “intrinsic instability:”

The Central Bank thinks, despite these warnings, that its mandate is to promote, to guarantee stability, above all price stability.  This certainly sounds reasonable, especially after the dreadful inflation of the 1970s, 1980s and 1990s, here and everywhere in Latin America.

The problem is that the predictions of the BCR, and the rest of the financial establishment, no longer have a connection with the reality of a bogged-down economy amid financial mayhem abroad. The Bank’s predictions, echoed by the commercial banks and their consultants, are promoting the illusion of stability. They have become, like stability itself, daydreams.  They are saying that the future is going to be not just stable but more rosy than anywhere else on the planet.

So this past week we had Dr Velarde, Executive President of the Central Bank, predicting that this year Peru will grow at 4.8%.

This is in a world where Peru itself today is either side of 0% after a 2014 of 2.5%.   Everywhere else, bar none, is fighting in increasing political desperation to find work for big slabs of their populations.  They are doing this in two ways.  One is to print and give away trillions, not just billions, in free money.  Second, they are devaluing their currencies.

Dr Velarde even gave the IMF, the central bank of central banks, a scolding for predicting that Peru would be ‘only’ 4% this year.

Dr Velarde’s 4.8% prediction for Peru 2015 is, without wishing to be unkind, simply a pipedream.

Dr Velarde’s previous prediction, a month or so back, was 5.6% growth for 2015, a prediction that needs no further comment.  It is not that the outlook has worsened because it was already awful.  Oil, iron ore, copper, soya, wheat and corn prices had already collapsed as had the Yen and the Euro, the Canadian and Australian dollars and the Real, all of these relevant or vital to Peru’s interests.  Copper, for instance, Peru’s single biggest export, has fallen from already low levels by 25% over the past six months.  Costs here, meanwhile, have risen as the Sol revalues against everything bar the US$ and the Renmimbi. This has caused an artificial squeeze that has helped bring new investment to a full stop.

The answer can be only that since the BCR has to maintain the idea, in its own mind at least, that it is creating stability, that even its most unfortunate predictions must retain an appearance of logic,

In another month or two he will come down to four percent, and so on.

The problem, or at least one of them, for Peru is that Dr Velarde, and his colleagues apparently believe their own story and are using an increasing volume of Peru’s cache of dollars, built up in the good years, to prop up the price of the Sol, selling the dollars cheaply. The best bargain in town.

This attempt to prop up a local currency has been tried so many times in so many places, Peru very much included, you would have thought that the penny would have, as you might say, dropped.  No one else in the world today is trying it.

As the Peruvian Times noted last week, if Peru had just gone along with the neighbors, the dollar in Lima would today be costing S/.3.67 (Chile), S/.3.43 (Colombia) and S/.4.28 (Brazil).    Peru has today suddenly become   expensive for all but US tourists who will, in any case, today find Europe cheaper.  Most of all, the faltering economy, here, buffeted by dangerous international financial strain, needs, quickly, a major financial boost.  This would already have been well on the way if the BCR had allowed the market in dollars to function.  Instead, the BCR, together with one supposes the government itself, has done two unfortunate things.  It is wasting billions of the nations dollar reserves,, which it is going to need and which in any case are not nearly so big or liquid as the gross INR, International Net Reserves, today $62,000mn and falling fast,  might suggest.   At the same time it has unecessarily extended and deepened the slowdown of the economy.

Forget 4.8.  Forget 2.8.

The BCR regularly these days is hiding its use of dollar reserves, as on this past Monday. Without using its reserves, that is, without directly selling dollars, the BCR sells certificates of deposit expressed in soles but indexed to the dollar, which for the person handing over the soles is equivalent to buying dollars.  It is a future sale, when the certificate matures.

So the NIR reserves are already below the published $62bn, who knows by how much.  This is not illegal within Peru itself.  But it does not conform to Peru’s obligations of transparency and clear reporting to the Bank of International Settlements in Basle, nor to the IMF in Washington, to whom Dr. Velarde was so sharpish this past week.

The issue is this.

Peru, like the rest of the world, is not stable.  It has been drawn into a maelstrom of powerful financial and economic cross-currents.  The evidence is that the price of all the main world commodities — starting with money itself and continuing with oil, coal, iron ore, wheat, corn, soya and copper— have plummeted and continue to fall.  There is no bottom in sight although, naturally, everyone is looking.  There was talk that the US Treasury bond 10-year yield could not go below 2% but this week it has been quoted in the 1.70 range.  The European Central Bank has begun a trillion-dollar program to flood the EU with money so cheap that Italian and Spain sovereign debt is, fantastically, lower even than that of the United States.  The Euro itself has collapsed.  At one point last year it was still at $1.4=E1.  Today it has been at $1.11.  Every other currency, including those of Latin neighbors has fallen, too, against the dollar.

All except Peru. The Bank does not say why it is spending this to keep the Sol at a cheap S/.3=$1.  If, for instance, it had let the market devalue our currency alongside the Euro, the exchange rate would be around S/.3.80.

It is not Peru’s fault that Europe, Japan, Canada, China, Brazil —everyone in town, in fact— are in turmoil.  Even the United States recovery seems not to mean that they need a pound more of iron or copper and, for instance, the Camisea jungle gas that Peru exports to California via Mexico.

This is all way over the pay grades of Peru, Chile, Colombia and even of local heavies like Brazil and Mexico, each of which has violence and corruption issues which make Peru look quiet and respectable, almost frumpish.  Venezuela seems about to go under, unsettling at best for Peru.  Closer to home, Ecuador, also a member of OPEC, has had to borrow from China to balance its 2015 budget.

So the BCR continues to look through the wrong end of the telescope. This also will cause unnecessary damage to the Peruvian economy.

In Europe, Japan and elsewhere, including the United States, it is the central banks that have been pouring zillions into their economies to try to kickstart them, to get prices and employment moving upwards.

In Peru, the Central Bank and the government have done nothing of this kind, apparently, from what they say anyway, because everything is OK.  Even other weak governments, like France and Italy, are pushing. An aggressive devaluation of the Sol down to S/.3.50 and quickly on to S/.4=$1 would certainly kick the economy back into some sort of action, provide the stimulus that other countries, without exception of the biggies —Europe, Japan, China, the United States— are providing this stimulus.

The dollarization Ghost

Peru’s Central Bank has to cope with a special problem, one of its own creation, and it is this that provides, perhaps, the clue to its strange exchange rate behavior.  This is the dollarization of the economy.  Ecuador adopted the US dollar, while Chile never allowed its peso to be replaced by the dollar.  But in Peru people buy cars and apartments in dollars, and go into debt in dollars, on their soles salaries.  Companies have borrowed thousands of millions of dollars from abroad.   As Richard Webb, the great Peruvian economist and twice Executive President of the Central Bank, has observed, having the two currencies is like having two wives, or as it may be, two husbands, under the same roof.

The BCR says it is doing something about this tangle and it will have to get together with the commercial banks —the Credito, the Continental, Interbank and Scotiabank, plus the AFPs—   to solve this bubble.

The fact of the matter seems to be that the authorities and the financial establishment in Lima have placed themselves between an Inca rock and an Andean chasm.  When the Sol zooms to a fair price perhaps — just to put a number on it— 25% above today’s level, Peru’s banks and other financial institutions are going to be left holding a big baby.

This is the Peru version of the same one embarrassing the rest of the world.  The Lima banks and consultants pushed their clients into dollar debt and dollar bonds and reaped hundreds of millions in fees and commissions. They believed their own story and bought into it. The good times were here.

Bubbles, before and since the Amsterdam tulips craze of the 17th century, share the same no-end-in-sight characteristic.

In Lima, stir it together, and Peru’s finances and economy, long regarded here and abroad as armour-plated, has become, as the Chinese are said to say, interesting.

Look out.

Last week’s Peruvian Times included a first warning on the problems facing Peru’s finances (See “Sol Must Be Lower to Face Financial Whirlwind” Jan.22, 2015).  A version of this week’s report, “Tapando el Sol con un Dedo”, appears in Caretas Jan 29. (     (.)

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 has been prominent in the hotel and railway business.



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  1. Joseph Wilkes says:

    I’ve lived in Peru four years as a retired person. My income is in US dollars and every tine I buy something, pay my rent with soles I feel cheated. Why, unless I’m stupid,should I stay in Peru? My apartment lease is up the end of February. If the government doesn’t wake up and smell the coffee very soon goodby Peru.

    • Martin Halpern says:

      If you are living on a dollar retirement [as am I], every time your US dollars provide you with more soles, you should be pleased — assuming the price in soles does not increase more than the percentage drop in the value of the sole. Be pleased. Though the exchange rate being in your favor is not good for Peru.

      A very good article on this subject [in the Peruvian Times] pointed out that the exchange rate should be even more soles to the $US dollar [related to the price of commodities which is still the most important control on the Peruvian economy], but the central bank here is controlling the exchange rate to “help” those who made big time investments in $US dollars that must be repaid in $US.

    • I wouldn’t feel cheated. The dollar will go up to it’s rightful place. The gov. can’t keep it here artificially long term. That’s the point of this article. So actually as long as you earn dollars and pay soles, you’ll be great. Only in the last few years did the sole gain against the dollar, but those days are over according to this article. It’s a ticking time bomb for the peru economy.

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