Economy

Latin American currencies have gained ground in July. Will they keep doing so?

The dollar has declined against foreign currencies due to persistent infection outbreaks in the U.S.

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  • The Brazilian real has risen 4.75%, but the currency still struggles with high volatility because of the country’s ineffective response to the pandemic;
  • Mexico’s peso is more stable, as its central bank might not cut interest rates by as much as other markets;
  • Colombia and Chile have fiscal room and solid fundamentals to sustain their currencies.

Since the beginning of July, the main currencies in Latin America have gained lost ground against the dollar. The Brazilian real (BRL) and the Chilean peso (CLP) have led the trend, up by 4.75% and 5.51% in the period, respectively. They were followed by the Mexican (MXP) and Colombian peso (COP), with valuations of 3.09% and 1.7%. The only exception among the five biggest economies in the region comes from Argentina, where the currency has slid as the country struggles with its debt crisis.

For importers and administrations across the region, these were good news, as a weaker dollar lowers inflationary pressures internally. Also, when the U.S. currency goes down, cash tends to flow into developing nations, offsetting the problem of less global competitiveness for local exporters, whose goods become pricier under these conditions.

READ ALSO: Almost half of the Brazilian families received government’s aid in June

Despite a few sparks of optimism among investors, after months of a ravaging crisis due to the coronavirus pandemic, the decline in the dollar has more relation to persistent infection outbreaks within the United States. The resurgent number of cases dampen the mood about a recovery for the U.S. economy. Globally, the dollar is down 8% from its highs of the year against a basket of currencies and stands near its lowest level since 2018.

According to Oxford Economics, the Brazilian real could gain further in the short term, to around BRL 5 per dollar – currently, it exchanges for BRL 5.21 – “if political noise recedes”. “We also found that key events involving President Bolsonaro’s erratic response to the pandemic qualitatively explain the rest of the BRL’s decoupling”, says its report. “By the same token, a resurgence in reform talks coincided with gains in recent days.”

READ ALSO: Brazilian tax plan is not bold but is a step toward simplifying the system

However, traders still say they are discouraged from taking a firmer position in the real, given its high level of volatility – in July, the dollar reached BRL 5.47 only to tumble to BRL 5.08 subsequently. “There is no way to be strongly positioned with the dollar fluctuating 2% every single day [against the real],” told Carlos Calabresi, investment director at Garde Asset Management, to Valor Econômico.

Mexico, Colombia and Chile have currencies with stabler prospects

The Mexican peso is holding steadier. Oxford Economics recently predicted that it is stabilizing after suffering intense pressure in recent months. The consultancy says the currency is bound to remain within MXP 22-23 per dollar for the next two years. The main reason for the stabilization, says its report, is that Banxico, Mexico’s central bank, will keep compensating the fiscal and institutional deterioration by not cutting rates as low as other emerging markets.

Both Chilean and Colombian peso have been performing well compared to neighbors’ currencies since reaching lows in mid-March. In the case of Chile, the country has ample fiscal room to provide financial support to the domestic economy, even as the country is severely hit by Covid-19, according to a study published this week by Ebury, a platform specialized in trade and currencies. The Colombian currency leads the gains among Latin American currencies amid higher oil prices, to which the Colombian economy is closely linked.

We remain largely optimistic regarding the Colombian peso. The country’s fairly solid fundamentals, notably high FX reserves equivalent to twelve months of import cover and low external debt (40% of GDP), should continue to support the currency, in our view

Ebury’s Latin America FX Forecast Revision

Dollar dominance in global invoicing leaves less room for exporters

Local currencies variations matter less as they did in the past, as the dollar has become the dominant force in global invoicing and financing, according to a study by the International Monetary Fund (IMF). Because global trade is priced mostly in dollars, demand does not change by much when domestic currencies weaken or strengthen.

READ ALSO: Joe Biden’s economic plan prioritizes U.S. jobs over trade – including with Latin America

Nevertheless, this should be perceived as a macroeconomic point of view, where weakening currencies do not provide relief for local markets anymore, particularly in the form of more competitive exports that could boost struggling economies. But a decline in the dollar still matters a lot to sectors such as tourism and cross-border e-commerce – individuals and small firms do make decisions on the basis of how expensive it is to buy a dollar denominated ticket or product.