Latin American Banks Dig Into Reserves to Salvage Currencies

By Adriana Brasileiro and Andre Soliani
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Oct. 9 (Bloomberg) -- Latin American central banks are being forced to draw on record foreign reserves built up during the six-year commodities rally to stop their currencies from sinking in the worst financial crisis since the Great Depression.

Brazil sold dollars for the first time in five years and Mexico offered $2.5 billion in the spot market yesterday after their currencies fell the most in at least a decade. Chile may follow suit after its peso fell to the lowest in almost four years, Barclays Capital analyst Rodrigo Valdes said.

The worst currency meltdown in Latin America since the emerging-market economic crises of the 1990s is causing companies' dollar debts to swell as well as sparking derivatives losses, and may stoke inflation. The decision to intervene came hours after central banks in the U.S., Europe and Canada cut interest rates in a joint effort to unfreeze credit markets.

``For a long time, these central banks said their reserve buildup strategy was like an insurance policy,'' said Felipe Pianetti, a strategist at the JPMorgan Emerging Markets team in New York. ``Now is the time to use them.''

Brazilian international reserves increased more than five- fold to a record $208 billion since January 2003, helped by rising revenue from soybeans, iron ore and sugar exports. In Mexico, Latin America's No. 2 oil producer, reserves almost doubled to $83.6 billion in the period. Chilean reserves rose to a record $22.4 billion in August, helped by copper sales.

Brazil's real tumbled as much as 9 percent yesterday to 2.55 per dollar, the biggest drop since the central bank abandoned a currency peg in January 1999 after burning through more than $30 billion of reserves in nine months.

33% Decline

After three central bank dollar sales, the real pared losses to 1 percent to 2.3342 to the dollar. The real is down 33 percent since reaching a high of 1.5545 per dollar Aug. 1.

Brazil's central bank didn't say how much it sold in today's auctions.

In Mexico, the peso at one point fell the most since 1994, when President Ernesto Zedillo was forced to devalue to avoid depleting the country's reserves. The peso sank as much as 13.8 percent to a record low of 14.2927 before paring losses after the central bank announced dollar auctions. The plan includes sales of $1.5 billion today, followed by $400 million in following days if the peso falls more than 2 percent.

``In extraordinary situations, Banco de Mexico has been willing to intervene in the currency market,'' said Gray Newman, chief Latin America economist at Morgan Stanley in New York. ``This constitutes an extraordinary situation.''

The Chilean peso dropped the most since November 1992, plunging as much as 4 percent to 619.40 per dollar, the weakest since October 2004.

Effect on Companies

While governments in Brazil, Mexico and Chile used the commodity boom of the past few years to reduce dollar debt, some companies are suffering as the currencies plunge.

Two of Brazil's biggest exporters, Aracruz Celulose SA and Sadia SA, lost about half of their market value since saying Sept. 26 they made bad currency bets that may cost them a combined $1.2 billion.

Controladora Comercial Mexicana SAB, the owner of supermarkets and Costco stores in Mexico, fell 44 percent yesterday after saying the peso's plunge increased the cost of its foreign debt ``significantly.'' Grupo Industrial Saltillo SAB, the Mexican auto parts and building materials company, asked the local exchange to suspend trading of its shares before announcing it will take a $48.5 million charge related to derivatives.

The currency meltdown may also stoke inflation that has exceeded or is about to top targets set by policy makers in the region.

Interest Rates

``Intervening in the currency when there is an excessive devaluation is the natural thing within an inflation-targeting system,'' Barclays's Valdes said.

Brazil's central bank last month raised the benchmark overnight rate for a fourth time since April to rein in inflation, which quickened to 6.25 percent in September. The target is 4.5 percent plus or minus two percentage points.

Mexico and Chile already busted their targets. Chilean consumer prices rose 9.2 percent last month from a year earlier, more than triple the bank's target of 3 percent. Inflation in Mexico quickened to 5.57 percent in August, above the 4 percent upper end of the target band.

Still, economists expect central bank policy makers will slow the pace of rate increases in response to sluggish global economic expansion and falling commodity prices.

The global credit crunch may put an end to Latin America's fastest economic expansion in 30 years. Morgan Stanley cut on Oct. 6 its 2009 economic growth forecast for the region by more than half to 1.5 percent, down from 3.5 percent.

Intervention

Brazil and Mexico join Argentina and Peru in selling dollars. Central banks in Chile and Colombia have so far used derivatives contracts to arrest the decline of their currencies, without touching reserves.

``There's a very high chance'' that the Chilean central bank will intervene to strengthen the peso, said Gabriel Casillas, an economist with UBS Pactual in Mexico City. The bank ``will be feeling quite uncomfortable with the peso at this level.''

To contact the reporter on this story: Adriana Brasileiro in Rio de Janeiro at abrasileiro@bloomberg.netAndre Soliani in Brasilia at at asoliani@bloomberg.net: