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Wednesday, January 23, 2008

Chile Is Riding The Storm!

Chile's peso gained the most in a week yesterday after the Federal Reserve lowered its benchmark U.S. interest rate. The Fed lowered the overnight rate 0.75 percentage point to 3.5 percent, widening the spread with Chile's 6.25 percent key rate to 2.75 percentage points. This is the biggest difference since 2002.

The rate cut is obviously going to translate itself into increasing appreciative forces in a number of emerging currency markets, among them the Chilean peso one. Indeed, if I had to list half a dozen emerging markets I thought would weather the storm better than others, Chile would definitely be there, as probably would Brzil (in Lat Am), Morocco and Turkey on Europe's southern fringe, and Thailand and India in Asia.

As if to confirm my intuitions Chile's peso advanced the most yesterday since Jan. 11, rising 1.4 percent to 478.64 per dollar at 2:33 p.m. in New York, and extending its advance so far this year to 4.3 percent. The yield on Chile's 8 percent bonds due June 2015 was little changed at 6.64 percent, according to Deutsche Bank Chile.

Concern that a slowdown in the U.S. economy will hurt demand for Latin American exports has put a certain restraint on gains in the region's currencies, and we are now about to see just how much "decoupling" has taken place in this particular corner of the globe.

All of this is reflected in the very upbeat tone adopted by Chile's Finance Minister Andres Velasco, who is quoted by Bloomberg as saying that yesterday's decision by the U.S. Federal Reserve to cut its benchmark interest rate was a "good signal" for markets. Velasco asserted that Chile is well-prepared to deal with the coming international crisis, since the government of the country which is the world's biggest copper exporter has used revenue from record prices for the metal to pay down debt and accumulate a fiscal surplus of $19 billion.

``The other day an investor remarked that when the tide goes out you see who's got their swimming suit on properly,'' Velasco said. ``I have no doubt that in this low tide, Chile will be seen to be very well-prepared and very well-dressed for whatever comes,'' The Fed's cut ``will contribute to the return of calm,'' the finance minister said, ``But there are no magic solutions. The world is living through, and will probably keep living through, a period of international volatility. We have to be very calm and very alert. In previous years we've saved, we've reduced debt, we've had a surplus, we've strengthened public and private finances,'' Velasco said. ``Sometimes people asked why we were doing all this, well now we see the answer and we see it very clearly.''

According to Velasco Chile's government hasn't yet discussed cutting its target for budget surpluses. Senators from the ruling coalition were reported by local newspaper La Tercera to have called yesterday for the government to aim for a balanced budget, instead of an excess of 0.5 percent of gross domestic product. This move seems sensible, given the strong downside risk which exists at this point.

Chile's central bank raised its benchmark lending rate to the highest in six years earlier this month as it seeks to curb the fastest inflation in a decade. Policy makers raised the benchmark rate a quarter point to 6.25 percent.The bank acted in response to inflation that climbed to an annual rate of 7.8 percent in December, driven by higher costs for food and transportation.

In the short term Chile's inflation problem may well get worse before it gets better, but as external conditions steadily change I doubt this will be the main threat to Chile's economic stability, so some counter-cyclical internal demand management in advance of any coming shock would seem to me to be a pretty prudent move.

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