Chile’s peso tumbled on Wednesday, starting the year in a volatile fashion as many had forecast. The currency dropped 2.1% to 741.66 against the dollar, bringing its decline this year to 4%.
That makes it the worst performing of 24 emerging-market currencies tracked by Bloomberg. The reason is simple. Chile’s central bank announced on Wednesday that it plans to boost its foreign reserves, buying US$ 40 million a day for more than a year until its holdings reach 18% of gross domestic product.
That should ultimately provide some stability in a year that will see two elections and the drafting of a new constitution following the worst social unrest in more than a generation.
In the long term, it could provide a bit of market confidence at a time of macro and fiscal uncertainty,” said Danny Fang, a strategist at BBVA in New York.
In a separate statement on Wednesday, the central bank said that the measures do not equate to currency intervention, and that it will allow exchange rates to fluctuate in line with their fundamentals. The increased reserves will prepare policy makers for potential future shocks, it added.
The increase will bring Chile's reserves closer in line with regional peers. With the current plan, Chile will surpass Mexico -- which has about 15% of GDP in reserves -- but still lag Brazil’s 19%.
The dollar purchases will more than compensate for the US$ 2.55 billion the central bank spent to bolster the peso between December 2019 and January 2020 after a wave of social unrest undermined investor confidence.
The purchases will be completed by the time a Flexible Credit Line with the International Monetary Fund ends in May 2022.
“The measure is necessary to strengthen Chile’s external buffers, particularly in light of the experience following the October 2019 protests,” Goldman Sachs analyst Paulo Mateus wrote in a note.
Chilean markets could be under significant pressure this year as investors await the outcome of an April election that will decide the makeup of a Constituent Assembly in charge of drafting the nation’s new constitution. Many investors credit the current charter for underpinning more than three decades of rapid growth and fiscal discipline.