Monday, July 16, 2007

The Wrath of a Weakening US Dollar and Impacts on Latin America

For Pablo A. Bread, from Scotiabank, the depreciation of the dollar will likely affect emerging market economies in Latin America. In such an environment, interest rates differentials are one of the most important drivers of capital flows. The global scenario is pointing out for a slowdown in the world economy due to: 1) Increase in interest rates by Bank of England and European Central Bank; 2) Decrease in US retail sales; 3) Unrelenting increase in crude oil since early 2007 and 4) International credit agencies downgraded some US-based sub-prime lending institutions triggering negative expectations in the markets.

Scotiabank, however, believes that the above adverse events have not affected Latin American markets. In Brazil, the negative exogenous effects have not induced a capital outflow because the country has $150 bn in international reserves and is ready to use part of it to decrease FX volatility. In Mexico, these negative external events have not had significant impact in part because of Mexico’s market mood continues to be boosted by rallying crude oil prices and the expected massive flow of foreign direct investment (which some analysts expect to reach as much as US$20 billion this year). In the Andean region, high commodity prices are fostering currencies such as the Chilean peso and the Peruvian sol. Despite a relatively high degree of preparedness to face and adequately manage contagion waves coming from the US, dollar denominated debt securities from Latin America will be adversely affected by an increase in US bond yields or eventually a sudden unwinding of the carry trades positions.

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