MercoPress. South Atlantic News Agency

Uruguay tightens terms for the inflow of short-term capital inflows

Minister Lorenzo and banker Bergara (L) making the announcements

Uruguay announced on Thursday new measures to discourage short term speculative capital inflows that have appreciated the Peso, eroded the country’s international competitiveness, made imports cheaper than domestic production and threaten an already stubborn inflation.

Minister of Economy Fernando Lorenzo and Central bank president Mario Bergara announced that the Economy ministry will demand reserve requirements equivalent to 50% of new investments by non residents in local Treasury bills and bonds issued either in Uruguayan Pesos or inflation-indexed units.

At the same time, the central bank raised similar reserve requirements on its paper to 50% from 40%.

Minister Lorenzo said that in August last year, 10% of local debt issued by the Ministry was in hands of non residents, but by last month the percentage soared to 50%.

The higher reserves requirement will force investors to leave a higher percentage of the bonds in the Central bank thus lowering the profitability of speculative funds.

The measure already applies to Central bank paper which demanded 40% in reserves, and now will also increase to 50%, said Bergara.

Another major change in monetary policy announced by Bergara was that the central bank will no longer implement the interest rate to contain inflation, but will start managing monetary aggregates, as of next July first.

This means that instead of managing the price of money (rates) the emphasis will be in the quantity of money circulating in the economy. That was the system Uruguay had applies until 2006.

The reference rate had become less effective for combating price rises and the central bank will focus on other variables, including the amount of money in circulation and bank deposit levels.

“In the current context of volatility, uncertainty and the massive influx of foreign capital, the interest rate has lost much of its signalling capacity and its relevance in domestic financial markets” Bergara underlined.

Therefor the central bank plans to begin tracking money supply variables again as part of its inflation-targeting regime, “setting the interest rate aside.” The bank would then adjust its intervention in money markets to meet the targets.

Bergara also announced the central bank will expand its annual inflation target range to between 3% and 7% starting in July 2014, from 4% to 6% currently.

Uruguay's consumer price inflation reached 8.06% in the 12 months through May.

Uruguay's move to discourage capital inflows comes at a time when most emerging markets are nervous about a potential sharp reversal in flows if the US Federal Reserve starts to taper its super easy monetary policy.

The Central bank quarterly monetary policy meeting is scheduled for June 27 and more details are expected referent the new criteria. The benchmark rate currently stands at 9.25%.-

Uruguay's economy expanded 3.9% in 2012, cooling from 6.5% a year earlier but marking a 10th straight year of GDP.