Uruguay discourages short-term capital inflow to ensure macroeconomic stability
Uruguay's central bank unveiled measures on Wednesday aimed at cooling the local Peso's appreciation by discouraging foreign investment in the bank's short-term debt. To combat the Peso's rise, officials ordered that 40% of new foreign capital invested in central bank bills be frozen in an account at the central bank.
The decision was supported by exporters that have long been demanding a better priced US dollar for their sales abroad.
The measure, which targets foreign investments in central bank bills with maturities of 30 to 730 days, takes effect on Thursday. It does not affect government debt.
The Uruguayan Peso has been appreciating since late June after losing ground against the dollar earlier in the year. Foreign capital inflows increased after Uruguay earned its second investment-grade debt rating last month.
Since June 28, when it hit bottom, Uruguay's peso has climbed 3.85% against the dollar. This tends to make the country's exports less competitive on the global market.
The central bank also said it was reversing a measure taken last month that forced investors to use Pesos to buy its Peso-denominated bills, which created more demand for the local currency. Investors will once again be able to buy this paper with dollars.
“There is more interest in Uruguay because it's investment-grade now,” central bank chief Mario Bergara said at a news conference. “Demand by non-residents for central bank bills rose significantly, with investment funds and pension funds entering the market”.
Bergara said the new measures would increase the cost of buying central bank bills, thereby discouraging short-term foreign investment.
“The central bank opted for a measure that aims to reduce a little the profitability of short-term capital inflows” Bergara said, estimating the new norm would reduce profits by 2 to 2.5 percentage points.
Squeezed between South American giants Brazil and Argentina, Uruguay for the last eight years has been led by a Broad Front coalition that has kept to the orthodox economic decisions that have been implemented in the country for the last 35 years opening the economy, promoting foreign investment and a floating exchange rate.
Compared to its two neighbours legal security, an independent judiciary branch and respect for contracts are guarantees for foreign investors.
“Even when the demand for Uruguayan debt must be seen as the result of successful policies which make the country more attractive for investors, we must not forget that those capitals, because of their essence and volume are also a challenge for the management of domestic macroeconomic stability”, explained the central bank release.
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Modern open economies like the UK, US and other do need to control short-term capital inflows, which are necessary for all economies, they don´t need to because their current account deficits will act to depreciate any currency bubles.
Excellent post.
But I have a question, what happens when the deficit like in the US economy, is in trillions and grow is not enough to cover that deficit? Also, as US currency is actualy the world currency, what will happen if it depreciates?
It already has because of quantitve easing aka printing money.
28% fall during 2011/12 but it makes little difference to Americans as we, the trading partners, are caught out by it, not them. Their debt just dropped by 28% making repayment that much easier, the value of our store of dollars just fell by 28%.
That is why I think as trading partners of the US, countries should aks themselves this problem and the way it affects our economy so we can deal with the crisis while it last, especially now that it along with Europe´s crisis is beggining to affect even the economy in Asia.
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