Latin American Banks Use Reserves to Save Currencies

By Adriana Brasileiro and Andre Soliani

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 sold $2.5 billion in the spot market between yesterday and today, helping their currencies pare losses. Chile may follow suit, 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 after central banks in the U.S., Europe and Canada cut interest rates in a coordinated effort to boost confidence.

``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 gained 7 percent to 2.182 to the dollar at 10:21 a.m. New York time after tumbling yesterday as much as 9 percent. Yesterday's drop was the biggest since the central bank abandoned a currency peg in January 1999 after burning through more than $30 billion of reserves in nine months.

29% Decline

The real is down 29 percent since reaching a high of 1.5545 per dollar Aug. 1. Brazil's central bank didn't say how much it sold in the four dollar auctions it has held since yesterday.

The Mexican peso fell 0.3 percent to 12.3589 to the dollar. Yesterday 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 currency pared losses after the central bank auctioned dollars. The plan includes dollar sales of $400 million starting tomorrow 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 gained 1.4 percent to 606.35 to the dollar after dropping as much as 4 percent yesterday, the most since November 1992, to 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: