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Some Analysts See a Currency Crisis in Chile’s Peso Slump

·3 min read

(Bloomberg) -- A slump in the Chilean peso is reaching crisis proportions, damaging the reputation of a nation once touted as a beacon of light in otherwise murky emerging markets.

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The peso has lost more than a fifth of its value since the start of June, hitting repeated record lows, under the weight of a strong US currency, weakening copper prices and concern over the writing of a new constitution. The currency tumbled 4% on Thursday, the day after the central bank hiked interest rates to the highest since 1998.

“There’s a full-fledged currency crisis going on in Chile,” said Alvaro Vivanco, head of emerging-market strategy at NatWest Markets. “From here, it’s more about the financial plumbing freezing. The central bank was worried about growth, an FX crisis is the worst thing for growth.”

Yet the central bank is keeping to the sidelines, at least for now. Twice this week it has said that the drop in the peso isn’t jolting other markets and that liquidity remains sufficient, indicating it has no plans to intervene. The Finance Ministry by contrast, is selling $5 billion into the market -- with no discernible impact on the exchange rate.

“The central bank is saying that liquidity and market conditions, despite the fast and significant depreciation, have been normal, and doesn’t see evidence that this could be a crisis,” said Bloomberg Economics’ Felipe Hernandez. “Sharp selloff, unprecedented FX meltdown -- but perhaps not a crisis.”

Policy makers started to raise rates earlier than most other nations and have now lifted borrowing costs by 9.25 percentage points in the past year. On Wednesday, they lifted borrowing costs by 75 basis points and warned of further increases to come, ditching comments about slowing the pace of monetary tightening.

“Not only were they unable to reduce the pace of hiking, but they also had to send a signal that they’d hike more,” said Erick Martinez, a strategist at Barclays, which recently published a study noting Chile’s wide current-account deficit leaves it in the worst position among emerging markets to withstand significant portfolio outflows. “At the end, it’s already had an impact on monetary policy.”

As interest rates rise, inflation has continued to accelerate, reaching 12.5% in June, its fastest pace since 1994, and with no signs of slowing to the 3% target any time soon.

Investors are also watching a Sept. 4 referendum closely. Chileans are set to vote on a new constitution that if approved poses “substantial risks for the economy, including investment risks, weaker institutions and a bigger role of the state in the economy, according to Bank of America.

“Part of the pressure on the FX market derives from high levels of political and policy uncertainty, and against that there is not much the central bank can do,” according to Alberto Ramos, chief Latin America economist at Goldman Sachs, who added the peso’s recent slide isn’t a currency crisis.

That is a view repeated by Phillip Torres, an investor at Aegeon Asset Management. In recent episodes in Argentina and Turkey, for example, central banks have run out of money to prop up their currencies, Torres said. Chile’s international reserves have fallen to $45.8 billion from a peak of $55 billion in October, but remain robust.

“The central bank is saying that they shouldn’t be intervening because the peso’s decline is largely due to external factors,” he said. “Their non-action is thought through, as opposed to head in the sand.”

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