Latin America’s Tug of War: Central Bank determination versus Political Upheaval

Brazil on Map

Latin America’s Central Banks are working feverishly towards stability, but find themselves undermined by a persistent foe: political turmoil. We examine the surprises that financial professionals may find when factoring in the region’s diverse Central Bank activity. 

   Latin America’s Central Banks
   are in a tug of war with
   political instability.

The latest rhetoric from Latin American Central Banks has been one of recovery and perhaps even a return to modest economic growth. However, the success of Central Bank activity remains precarious – and any corporate treasury department looking to sharpen their FX rate forecasting for currencies like the Brazilian Real or Mexican Peso has to consider the external forces that can cause Central Banks to abruptly ditch their plans.

Latin America’s Central Banks are in a tug of war with political instability, both domestic and international. Surprise events have undercut the efficacy of rate changes, dampened growth strategies and sent currencies swinging in directions that belie economic data. In many cases, Central Bankers have been sent back to the drawing board.

Brazil provides the most striking example: The Banco Central do Brazil (BCB) has been fast and furious in slashing its benchmark Selic interest rate over the last year, with eight cuts in 11 months, including four consecutive full-point reductions from June-September 2017.

Few experts anticipated rate cuts at such a frenetic pace. As Brazilian President Michel Temer’s economic reforms were gaining ground, a modest course of rate reductions was expected as a means to propel the recovery. Then, Temer was hit with corruption allegations in June. Facing a fresh wave of economic decline, the BCB was pressed to turn up rate cuts to help stem any backsliding. Though the BCB insists it will slow rate cuts, further economic malaise – and political turmoil – could impact those plans.

Conversely, Mexico’s Central Bank has been operating from a place of relative economic strength. Even so, its efforts to bolster the economy and the health of the Peso have been somewhat hampered by political instability in the US. Since late 2015, Mexico has raised interest rates by 400 basis points to 7% – an effort that involved seven consecutive increases – as a means to temper inflation. Through a disciplined austerity program, Mexico has managed to avoid many of the pains its neighbors felt as oil prices sank.

Yet, the Peso took a pounding when Donald Trump was elected as US President. The currency hit record lows in January 2017 as the newly installed President fired off tweets threatening to pull the US out of NAFTA negotiations. A softened stance has stabilized the Peso in recent months, but the Bank of Mexico has acknowledged that its current rate plan only holds if the currency avoids any more unexpected volatility.

When it comes to Latin America, accountants, corporate treasurers, and financial directors face three distinct challenges.

  1.  There is the discrepancy in Central Bank activity. For example, Mexico and Argentina are both working to stem inflation. But where Mexico’s Central Bank is actively raising rates, the Banco Central de la Republica Argentina has been stifled.

    When discrepancies in Central Bank tactics reign, getting data from a trusted a source with a reputation for accurate exchange rates is key. Even better if the rates come from market makers who are active participants in the foreign exchange market versus rates aggregators whose rate source is often unknown and accuracy can be questionable.
  2.  Some territories require the use of Central Bank exchange rates while other do not. Especially in Latin America, businesses must be aware of regulations demanding the use of local Central Banks as the source of rates, versus the use of market rates. Not all data providers have the level of reach needed to supply Central Bank exchange rates when they’re required.
  3.  Timing is critical. Political developments strike without warning, whether it is a new Trump tweet or a fresh set of Temer allegations. Currencies can whipsaw before accountants have had time to open their spreadsheets. Thus, automated exchange rate feeds become essential for accountants to keep their calculations accurate in real time. Having FX data APIs that plug directly into the appropriate systems can help relieve financial directors of any worry that their forecasting or hedging strategies are suddenly obsolete.

With a frenzy of rate changes, Latin America’s Central Banks are putting up a herculean effort against economic malaise. Yet, political uncertainty is proving to be a stubborn opponent. Corporates operating in the region need more intelligence, faster than ever, to make sense of just who is winning the tug-of-war.