Close panel

Close panel

Close panel

Close panel

Economic analysis 08 Jun 2016

Peru: And the exchange rate...?

In Peru, what happens with the exchange rate is news, perhaps more so than in other latitudes.

Ordinary people follow it closely and try to know what is going to happen to this variable in advance. Why? Many of them, households and corporates, save or lend in USD. Anyone with some surplus money is thinking whether to save in PEN or in USD. Anyone saving in USD and thinking about buying something with PEN tries to anticipate the best time to do their currency exchange. It is also not uncommon for someone’s monthly car or home payment to be denominated in USD, or for the rent of an apartment or even the monthly college fees for the children to be linked to this currency. Movements in the exchange rate affect our daily lives and so are important.

So far this year the exchange rate has had fairly volatile behavior, influenced by the external situation and, locally, by the result of the first round of general elections. It has not shown any clear trend in the first months of 2016. What will happen later? What will the exchange rate be in a month? And at the end of the year? These are some of the questions we ask ourselves and that people ask us.

Clearly it is very difficult to know what the exchange rate will be at 2 pm on Friday December 30, 2016, but we can anticipate two things. First, that its underlying trend will be upward from now on. This will be for two reasons. One is that the central banks of the most advanced countries will gradually withdraw – some sooner than others – the huge monetary stimuli of recent years. In this process their currencies will appreciate at the expense of emerging countries. The FED will be first to act and, in our opinion, will adjust monetary conditions faster than most of the market thinks; being taken by surprise, they will shed assets denominated in the currencies of emerging countries, including the PEN, thus pushing up the exchange rate.

The other reason is that the Peruvian economy has a structural requirement for a higher exchange rate. The deficit in the balance of payments current account is still significant and Peru’s foreign debt has been increasing steadily. In the absence of measures to boost productivity and competitiveness significantly, and anticipating that commodity prices – metals in particular – shall not improve much in the future, there will be pressure to devalue the local currency, especially when capital inflows to the Peruvian economy’s tradable sector are weakening (lower mining investment). Devaluation of the PEN will make export activity more attractive and make imports more expensive, thus favoring a reduction in the trade deficit.

The second thing we can anticipate is that this upward trend will surely be accompanied by episodes of high volatility. Every time data is published on the Chinese or US economy that surprises the market, or either of these two countries makes an economic declaration or implements a measure, or whenever indicators are published that, for example, move commodity prices, there will be episodes of exchange rate volatility.

In this context, how fast could the exchange rate rise in the coming months? The pace of increase will probably be lower than seen last year (at times it reached about 15% year-on-year) because additional room to take a position locally in favor of the USD (e.g. deposits in this currency and currency derivatives) has been reduced or has become more expensive. BBVA Research estimates that the remainder of 2016 will see a devaluation of between 3% and 5%, so that the average exchange rate level during December this year will be between 3.45 and 3.50 PEN, and that the upward trend will continue in 2017 with an additional devaluation of between 4% and 6%.

Other interesting stories