Uruguay isn’t targeting a specific exchange rate even as it deters capital inflows and overhauls its monetary policy regime to help domestic industry, central bank President Mario Bergara said.
Uruguay last week imposed a 50 percent reserve requirement on foreigners’ purchase of peso bonds and said it was ditching the use of a single policy rate in a bid to curb inflows that have eroded competitiveness. Portfolio investment has been flooding Uruguay over the past 18 months as growth in Brazil has slowed and interest rates there touched a record low, making assets in Uruguay, which has been raising interest rates to fight inflation, more attractive, said Bergara.
“If only a small share of capital that went to Brazil would now come to Uruguay, it would create a massive capital inflow,” Bergara said in an interview at a banking conference in Dubrovnik, Croatia.
Uruguay’s measures, enacted even as Brazil removes barriers to foreign investment amid speculation the Federal Reserve will taper its stimulus efforts, may exacerbate inflation and undermine the bank’s credibility, JPMorgan Chase & Co. said in a June 10 report. Uruguay’s peso has been the world’s worst-performing currency since the measures were unveiled June 6, declining 2.6 percent, while its investment grade-rated bonds are the worst-performing among emerging markets this year, falling 11.9 percent.
On July 1, the central bank will begin managing the money supply instead of using a single policy rate as its main tool to fight inflation, reintroducing a system it used prior to 2007. Bergara said the decision to abandon the five-year-old regime will allow the bank to better fulfill its twin mission of ensuring price stability along with economic growth.
The changes, including a widening of the bank’s inflation target to 3 percent to 7 percent from a current 4 percent to 6 percent range, doesn’t “imply a more expansionary stance for the monetary policy at all,” Bergara said. Inflation in May fell for the third straight month to 8.06 percent.
“We are fundamentalist in our objectives and in our responsibility in keeping the macroeconomic scenario stable,” he said. “But we are more pragmatic in terms of tools.”
Uruguay’s success in stabilizing its economy -- Standard & Poor’s raised the country to investment grade last year -- and a hunt for higher yields in emerging markets have created greater distortions than in bigger economies such as Brazil, whose economy is more than 50 times larger.
In 2011, only 2 percent of Uruguay’s peso-denominated debt was in foreign hands compared with 50 percent currently, Economy Minister Fernando Lorenzo said while announcing the measures last week.
One reason for the strong inflows is an economy that Bergara says will expand at a “reasonable” 3 percent to 4 percent pace this year, faster than the 2.53 percent economists forecast for Brazil. The country’s 9.25 percent benchmark rate also exceeds Brazil’s, though the differential has narrowed since policy makers there began raising the Selic rate in April.
While a weaker exchange rate won’t resolve all of Uruguay’s competitiveness problems, it will help address some of the misalignments without compromising the government’s record of having market-friendly policies, Bergara said.
“We don’t have any specific target, because we think that the exchange rate flexibility is one of the corners of our economy policy strategy,” he said.
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